Module 1: Designing Registered Pension Plans

Question 1

Describe in general terms how the Income Tax Act (ITA) applies to the operation of registered pension plans (RPPs).

Answer 1

Subject to certain conditions and limits, registration of a pension plan under the ITA allows plan members and plan sponsors to deduct their pension contributions from their respective incomes for tax purposes. Registration also exempts the pension fund’s investment income from taxation. All benefits (except for certain transfers) paid out of the pension plan are taxable to the recipient.

Question 2

Explain how pension standards legislation impacts RPPs.

Answer 2

Pension standards legislation governs the terms and conditions of the RPP, minimum funding requirements and investments of plan assets. The intent is to protect the interests of plan members. The pension commitments must be funded by advance payments under an accepted method. Pay-as-you-go and terminal funding are not allowed under the legislation.

All Canadian provinces have enacted pension standards legislation except Prince Edward Island, which has prepared legislation but not proclaimed it in force. A pension plan must be registered in the province where the majority of plan members are located and must also comply with the pension legislation of any other province where plan members report for work. The federal government has enacted pension standards legislation that governs pension plans for businesses operating under federal jurisdiction (e.g., transportation, communication and banking) and for employees in the Yukon, Northwest Territories and Nunavut.

Question 3

Describe the pros and cons that an employer might perceive when considering whether to implement a registered pension plan (RPP). Pros:

Answer 3

Some reasons to implement an RPP include:

(a) Improves the employer’s competitive position in bidding for labour, particularly labour with specialized skills

(b) Allows for accumulation of contributions of pretax dollars in a fund, with the earnings not subject to income tax until a benefit is paid to the plan member

(c) Allows an employer to expense its pension costs in the years in which the pensions are earned by and credited to their employees (a sound business practice)

(d) Establishes a framework for orderly retirement of employees as they reach retirement age or as part of business restructuring

(e) Can improve plan members’ interest in the employer’s profit objectives
(e.g., employer contributions can be tied to the level of employer profit in a deferred profit-sharing plan (DPSP) or a group Registered Retirement Savings Plan (RRSP)).

Question 4

Describe the pros and cons that an employer might perceive when considering whether to implement a registered pension plan (RPP). CONS

Answer 4

Some reasons not to implement an RPP include:

(a) A preference to use the plan funds for investment within the enterprise itself

(b) Rising administration costs

(c) Time and effort required to comply with the requirements of the regulatory regimes compared to those requirements for nonpension registered plans

(d) An attitude that retirement savings is the employee’s responsibility.

Question 5

Explain the reasons why an employee might see advantages of participating in an RPP as compared to a nonregistered arrangement.

Answer 5

Pension standards legislation is intended to protect the interest of RPP members. This includes minimum funding requirements for RPPs. Funding of the plan gives employees confidence that the promised pension will be paid because the pension assets are in the hands of a third party.

RPPs are also registered with CRA and must comply with ITA legislation. This registration allows for favorable tax treatment of member and employer contributions as well as investment earnings. Under a registered plan, employees are not taxed on employer contributions made on their behalf, and investment earnings on plan funds accrue tax-free.

In contrast, in a nonregistered arrangement, employees are taxed on employer contributions made on their behalf, and investment earnings on plan funds are generally taxed. The protections offered by pension standards legislation are not available under nonregistered arrangements.

Question 6

List the three main categories of registered pension plans.

Answer 6

(a) Defined benefit (DB) pension plan

(b) Defined contribution (DC) pension plan

(c) Combination or hybrid pension plan

Question 7

Summarize the characteristics of the four main types of defined benefit (DB) pension plans: Flat Benefit

Answer 7

The annual pension is a specified number of dollars for each year of service. This approach ignores differences in earnings. The flat amount of pension is established in terms of wage levels and dollar values at the time the benefit level is set, even though most of the pensions will not be paid until a future date when wage levels and dollar values are likely to have increased. For this reason, most flat benefit plans are subject to periodic upgrades in their benefit formula to reflect increases in inflation and wage levels.

Question 8

Summarize the characteristics of the four main types of defined benefit (DB) pension plans: Career average

Answer 8

The pension is calculated as a certain percentage of earnings in each year of plan membership. It gives equal weight to employment earnings in each year of the member’s working lifetime and, therefore, may provide a low pension relative to employment earnings just prior to retirement.

Question 9

Summarize the characteristics of the four main types of defined benefit (DB) pension plans: Final average earnings

Answer 9

The pension is based upon the length of service and average earnings for a stated period before retirement. To protect members whose earnings decline as they approach retirement, some plans may use a best average earnings base in the benefit calculation.

Question 10

Summarize the characteristics of the four main types of defined benefit (DB) pension plans: Flexible

Answer 10

The plan sponsor provides a basic level of defined benefit pension, and plan members’ contributions are used to purchase additional ancillary plan benefits. There are two ways that a flexible pension plan can work—In one, the member chooses the ancillary benefits in advance (front end); in the other, the ancillary benefits are chosen when the member terminates or retires (back end). Examples of ancillary benefits include postretirement spousal benefits, an enhanced definition of final average earnings, enhanced early retirement benefits and indexing.

Question 11

Identify the characteristics of defined contribution pension plans and describe two approaches to setting employer contribution levels.

Answer 11

A defined contribution pension plan specifies the level of contributions to be made to the plan by both the employer and the employee. Contributions accumulate with investment earnings until retirement. The amount of retirement income that may be purchased with the account balance is thus unknown until the actual retirement date. The projected retirement income can only be estimated based on certain assumptions such as the level of contributions, expected investment return and market conditions.

The method used to determine the employer contributions can vary. Employer contributions may be a fixed percentage of earnings, dollar amount, or specified amount per year or service or hours worked. Another approach, called a “profit-sharing pension plan,” links employer contributions to the profitability of the company. The Canada Revenue Agency (CRA) requires that employer contributions be at least 1% of employees’ earnings even in years of little or no profit. Allocation of profits among plan members may be based on a points system under which points are assigned based on service, earnings or both.

Question 12

Describe the types of RPPs that have both DB and DC characteristics: List

Answer 12

Hybrid pension plan
Combination pension plan
Multi-employer pension plan (MEPP)
Target benefit pension plan

Question 13

Describe the types of RPPs that have both DB and DC characteristics: Hybrid pension plan

Answer 13

Pension of one type (e.g., DC) is subject to a minimum equal to the pension of the other type (e.g., DB). The most common type of hybrid plan provides the greater of a DB pension and the pension that may be purchased with the member’s defined contribution account balance. For example, the defined benefit may be calculated as 1.5% of final average earnings for each year of service. The employee may be required to contribute 5% of earnings to a defined contribution account in the plan, and these contributions may be matched by the plan sponsor. At retirement, the member’s account balance is converted to a pension. If the DC pension amount is less than the DB pension amount, then the DB pension amount is paid. If the DC pension amount is greater than the DB pension amount, then the DC pension amount is paid. This type of plan alleviates some employee uncertainty associated with a DC plan because it guarantees a minimum level of retirement income. However, like a DB plan, an actuarial valuation is required to determine the adequacy of the fund to support the defined benefit guarantee.

Question 14

Describe the types of RPPs that have both DB and DC characteristics: Combination pension plan

Answer 14

Total pension is the sum of pension determined by a defined benefit provision and the pension provided through the defined contribution provision. Typically, the plan sponsor will provide a defined benefit of, for example, 1% of final average earnings. An employee contributes to the plan, and their contributions are deposited in a defined contribution account that will accumulate until retirement. There may also be some plan sponsor matching of the employee’s contribution. At retirement, the plan member receives the DB pension in addition to the pension that can be purchased with their defined contribution account balance.

Combination plans are sometimes created when an employer wishes to cease operating a defined benefit pension plan and instead sponsor a defined contribution plan for future years. DB benefits are “frozen” (i.e., members stop earning defined benefits) and no new members may join that section. Existing and new plan members participate in the defined contribution section effective from the date of the change. Membership in the defined benefit section of the plan is then limited and will reduce over time.

Question 15

Describe the types of RPPs that have both DB and DC characteristics: MEPP

Answer 15

Usually established through collective bargaining and covers employees of many employers within a single industry or trade. Plan specifies both the level of contribution and the level of benefits. Generally, if contributions do not support the benefits, benefits may be decreased. A legislative modification following a recent legal case confirms Quebec as an exception to this rule.

Question 16

Describe the types of RPPs that have both DB and DC characteristics: Target benefit pension

Answer 16

Similar to a MEPP in terms of plan specifics but sponsored by a single employer. Both the contribution level and the level of benefits are specified, and the benefits may be reduced if they cannot be supported by the current level of contributions. Target benefit plans are designed to deliver a targeted benefit while giving administrators the flexibility to adjust benefits in response to the plan’s funded position.

Question 17

Explain the concept of retirement income adequacy and describe how adequacy is measured.

Answer 17

A major goal of retirement income arrangements is to ensure that employees will have an adequate level of retirement income. Adequacy is a relative rather than an absolute concept. Many employers measure the adequacy of their retirement income plan by comparing it to an industry standard or to plans offered by their major competitors rather than measuring it against some accepted norm.

Adequacy is often measured as the ratio of an employee’s income from all sources to the level of earnings just prior to retirement. The retirement replacement ratio of after-tax pension to the after-tax rate of pay just before retirement is seldom 100%. Income needs in retirement are usually less than in working years. As a rough guide, considering standard expenses and income tax deductions, most individuals believe they need approximately 60-70% of preretirement income to enjoy the same standard of living as they enjoyed prior to retirement. A middle-income individual could receive approximately 30-35% replacement from the Canada Pension Plan/Quebec Pension Plan (CPP/QPP) benefits (based on the expansion of CPP/QPP between 2019 and 2025 intended to increase the replacement rate on pensionable income for service accrued after January 1, 2019) and Old Age Security (OAS) as they currently exist. Therefore, an employer plan that delivers 30-40% of preretirement earnings could be considered adequate for a middle-income employee.

Question 18

Provide an overview of pension plan equity and explain how equity is viewed differently for DB pension plans and DC pension plans.

Answer 18

A pension plan should be equitable among members with different employment histories. The plan should also be seen as equitable to employees in varying circumstances.

Several different concepts of equity exist, sometimes in conflict. It is useful to look first at the amount of “pension”—the monthly dollar amount due to be paid to the retiree. For example, should pensions be equal in value or equal in amount? In a DB plan, pension standards legislation requires that the amount of pension for males and females with the same employment history be the same, although this treatment provides greater relative value to females who, on average, live longer than males.

In a DC pension plan, the employer does not guarantee a stream of income. The amount of the employer’s contribution in respect of employees must not vary by gender of the employee. So two employees, one male and one female, with equal earnings through identical periods of plan membership, will receive exactly the same contribution from their employer. This can be seen as a form of equity. On the other hand, in a DC pension plan, the pensions of two individuals of different ages who are retiring now with identical work histories will not be of the same amount (i.e., the same account balance at retirement will provide a male employee a higher monthly pension amount from a decumulation option than a female employee because females, on average, live longer). These pensions, however, will have the same value.

While DC plans provide equal value to all members regardless of age, DB plans may provide equal pensions to two individuals of different ages, but the values at any point in time before the employees’ retirement ages will not be equal. This means that at a particular date before retirement, the value of the pension for a young employee with the same years of service and earnings history as an older employee will be lower than the value of the older employee’s pension. Many pension plans provide valuable ancillary benefits to employees who meet certain criteria. Plans may also impose constraints on service or earnings when calculating benefits. When these complications are introduced, equity may be more difficult to achieve.

Question 19

Explain the purpose of a pension plan text/document.

Answer 19

A pension plan text (also often referred to as pension plan document) quantifies the promises in a pension plan, when they will be paid, who will pay for them and other obligations of the plan sponsor and plan members. A pension plan document informs plan members and their representatives, the government authorities that register the pension plan, and the plan sponsor and its representatives what those promises are.

A pension plan document is a written, signed legal document that describes terms and conditions that apply to the pension plan—a detailed description of all relevant rules and regulations that relate to rights and obligations of both plan members and the plan sponsor under the plan.

Question 20

List the principal provisions included in an RPP

Answer 20

Eligibility requirements.

Pension formula.

Pensionable service.

Plan member contributions (for contributory plans).

Retirement age.

Normal and optional forms of pension.

Death benefits before retirement.

Termination benefits.

Disability benefits.

Inflation protection.

Question 21

Identify the most common requirement for eligibility in a pension plan.

Answer 21

Most pension standards legislation requires that employees be eligible for membership on the completion of two years of employment, regardless of their age, if they belong to the class of employees for whom the plan was established.

Also, in most jurisdictions, part-time employees who are in the same class as eligible full-time employees and who have earned at least 35% of the year’s maximum pensionable earnings (YMPE), as defined under the Canada Pension Plan (CPP), for two consecutive years must be allowed to join the pension plan. Alternatively, an employer may set up a separate plan for part-time employees if it provides reasonably equivalent benefits.

Question 22

Identify a typical pension formula for each of a final average earnings DB pension plan and a career average earnings DB pension plan and provide a sample calculation of each.

Answer 22

In a final average earnings pension plan, a typical pension formula is 1.5% of average earnings for the last five years prior to retirement, multiplied by years of membership.

For example, Katrina retired after being a member of Gatetown Insurance’s DB pension plan for 30 years. The pension plan formula is 1.5% of her average earnings for her last five years prior to retirement (in this case, $70,000). Katrina’s annual pension would be $31,500 (1.5% X $70,000 X 30).

In a career average earnings pension plan, a typical formula is a pension equal to 1.5% of the employee’s earnings in each year. This approach is equivalent to averaging the employee’s earnings over their career and multiplying this average by the employee’s years of service and the formula rate.

For example, Malik retired after being a member of Inglis Insurance’s DB pension plan for 25 years. His average earnings over that period are $50,000. Malik’s annual pension would be $18,750 (1.5% X $50,000 X 25).

Question 23

Explain the purpose of a bridge benefit sometimes included in a DB pension plan and how it is typically determined.

Answer 23

The purpose of a bridge benefit in a DB pension plan is to provide a retirement income to a retiring member that is approximately level before and after commencement of government retirement benefits (i.e., there is no sudden increase in pension income when CPP/QPP starts). This is done by including a supplemental pension that “bridges” the period between retirement and the age at which government pensions are paid. The bridge benefit can be a dollar amount per year of service, or it can be determined by reference to CPP/QPP and/or OAS benefits.

Question 24

Describe how pension benefits at retirement are determined in a DC pension plan.

Answer 24

Recall that for the purposes of this module, “CAP” should be read as “defined contribution pension plan.” There is no pension formula that defines the pension benefit provided by a DC pension plan at retirement. Instead, a formula defines the level of contributions to be made by the plan sponsor and the plan member. Contributions are allocated to a member’s individual account and are invested, and the accumulated value at retirement is used to provide retirement income. Various decumulation options are allowed under pension standards and income tax regulations. The plan member does not know the exact pension amount that will be received until retirement.

Question 25

Explain how a pension plan sponsor can offer different pension or contribution formulas within their plan.

Answer 25

Legislation does permit different benefit levels, contributions or qualifying conditions that depend on an employee’s position in the company or salary level.
An employer may cover one or all classes of employees in a pension plan and have different pension plan provisions for different classes of employees. However, there must be no discrimination by age, sex or marital status, and all employees in the same class must receive the same benefit.

Question 26

Describe pensionable service as it applies to pension plans.

Answer 26

A pension plan must define the period of service for which the plan member will earn pension benefits (whether DB or DC), typically called “pensionable” or sometimes called “credited” service or “membership.” Certain periods of absence are required by law to be included as pensionable service (for example, maternity or parental leave). ITA regulations limit the periods of service that can be recognized for pension service under a DB pension plan.

Question 27

Contrast the advantages to an employer of a contributory DB pension plan vs. a noncontributory DB pension plan.

Answer 27

In a contributory defined benefit plan, the employees are required to contribute and the employer pays the balance of the cost. This means that the employer cost associated with a contributory DB pension plan for a given level of benefit is lower, or the employer may be able to provide a higher level of benefits. Further, employees tend to be more interested in the plan because they share in its cost.

In a noncontributory DB pension plan, the employer pays the full cost of the plan and may have more autonomy in investment and benefit provision decision making (since there are no employee assets). A noncontributory plan is usually simpler and less expensive to administer than a contributory plan. In a noncontributory plan, all eligible employees are covered under the plan.

Question 28

Identify factors that affect the level of plan member contributions to a DB pension plan.

Answer 28

The level of plan member contributions to a DB pension plan is governed by such factors as the level of benefits provided and the plan sponsor’s willingness and/or ability to pay. Plan member contributions in DB pension plans tend to fall in the range of 5-8% of earnings and are higher for large public sector plans. The large public-sector plans, including those for federal and provincial public servants and teachers, mostly require a basic employee contribution in the range of 7-9% of earnings.

Question 29

Explain the 50% rule as it applies to DB pension plans.

Answer 29

Pension standards legislation requires that a plan sponsor fund at least 50% of the value of the benefits that are paid to each individual plan member with respect to their membership after the date the legislation came into effect. This is commonly known as the 50% rule.

The plan member’s contributions with interest are compared to the value of the pension benefits being provided, and the excess, if any, above 50% of the value of the pension benefits is either refunded to the plan member or used to provide additional benefits.

Question 30

Explain normal retirement age (NRA) as it applies to pension plans.

Answer 30

NRA is the age specified in the pension plan text/document at which a plan member has the right to retire and start receiving a pension.

For DB pension plans, it is the age at which the plan member qualifies for a full, unreduced pension. NRA is usually age 65, which is the commencement age for unreduced benefits from CPP/ QPP. Pension standards legislation in several jurisdictions prohibits a pension plan from having an NRA later than age 65 or 66.

In a DC pension plan, the concept of a “full” or “unreduced” pension does not apply as the retirement pension is based on the value of the member’s account balance at time of retirement rather than by a pension formula.`

Question 31

Identify the age at which ITA permits pensions to be paid from a DB pension plan on an unreduced basis.

Answer 31

ITA permits pensions to be paid on an unreduced basis from a DB pension plan
as early as the age of 60, when the plan member’s number of years of age plus pensionable service total 80 “points” or after 30 years of pensionable service, regardless of age (i.e., 30 and out).

If an individual is employed in a public safety occupation (i.e., paramedic, commercial airline pilot, air traffic controller, corrections officer, police officer or firefighter), the age-of-60 requirement is reduced to age 55, the 80-point requirement is reduced to 75 points and the 30-year requirement is reduced to 25 years. Note that plans are not required to allow these early retirement provisions for these categories of employment; ITA is only permissive, not prescriptive.

Question 32

Describe the features of a phased retirement plan and the ITA rules surrounding periods of phased retirement from a DB pension plan.

Answer 32

A phased retirement program includes any program that provides employees with assistance or incentive in the transition from employment to retirement. It almost always involves a gradual reduction of work time during a specified period immediately prior to some formal retirement date. ITA permits the accrual of DB pension credits while receiving benefits from the same plan or another plan of the same or related employer, under certain conditions during a period of phased retirement. Monthly payments in the amount of up to 60% of the accrued pension may be made to eligible members.

The tax rules do not impose any requirements that a member reduce work hours to receive a pension payment, and the amount of the pension need not be linked to any work reduction.

Bridging benefits are also permitted to be paid, either on a standalone basis or in conjunction with phased retirement benefits, during the phased period.

During phased retirement, a member will generally be considered an active member, and the payment of phased retirement benefits will not be treated as a commencement of pension in pay. Phased retirement benefits are treated as temporary, payable over the phased retirement period only. The phased retirement period ends when the member terminates employment or the plan terminates. On full retirement, the member makes any elections as to the form of the lifetime pension.

Question 33

Describe alternatives available to employers who are considering how their pension plan should treat members who continue employment past NRA.

Answer 33

Employers have several options when establishing their pension plan rules relating to employees who continue employment past their NRA.

(a) Some RPPs (whether DB or DC) allow the pension to start at NRA, even though the plan member continues in paid employment. Support for this approach comes from those who believe that pensions are deferred wages that should not be suspended because retirement is postponed.

(b) Other plans allow pension credits and contributions to continue to accumulate after NRA (with the plan member continuing to pay required contributions, if there are any), so that when postponed retirement occurs, a larger pension may be paid.

(c) Alternatively, for a DB plan, the pension on postponed retirement may be the actuarial equivalent to the pension that would have been paid at NRA. This does not apply for a DC plan, where the pension amount is always determined by the value of the member’s account in the plan at the point in time when it starts being paid.

(d) In Quebec, DB plans must actuarially adjust benefits to reflect the postponement period. Members are allowed to receive payment of all or part of their normal pension during the postponement period but unless an agreement has been made with their employer, and the plan document allows it, the amount cannot exceed the amount of any permanent reduction in remuneration during the postponement period.

Regardless of plan type, the ITA requires that the pension start no later than the end of the year the member attains the age of 71.

Question 34

Describe why a DB pension plan member needs to know the normal form of pension provided from their pension plan and provide some examples of forms of pension.

Answer 34

The normal form of pension provided from a DB pension plan determines what benefits, if any, are payable to a retired plan member’s beneficiary or estate after that member’s death. Every pension plan must define the normal form of pension that is payable.

Pensions are always payable for the lifetime of the retired plan member. It is possible that the normal form of pension payable from the plan will provide some type of survivor benefit as well. Examples of acceptable normal forms of pension include:

A life-only annuity: This pension is payable only for the lifetime of the retired member; it stops after that person’s death.

A pension with a guarantee period: Again, the pension is paid for the lifetime of the retired plan member. There is also a minimum guaranteed payment period, which applies if the pensioner dies between the retirement date and the end of the guarantee period. Common guarantee periods are five, ten, or 15 years. If the guarantee period applies, the pensioner’s payment will be paid to the named beneficiary until the guarantee period has been completed.

A pension with a joint and survivor option: This pension is paid for the retiree’s lifetime and a percentage of that pension is paid after that person’s death to the “joint annuitant,” usually the member’s spouse. The percentage paid to the joint annuitant may be 50%, 60%, 66 2/3%, 75% or 100%, as determined by the pensioner at the time of their retirement.

In some plans, the normal form of pension will be different for members who do not have a spouse and those who do. Pension standards legislation in all jurisdictions requires that the pension elected by a retiring member must be a joint and survivor annuity continuing to a spouse unless a waiver is signed by the spouse. Further, the pension payable to the spouse must not be less than 60% of the pension payable before the member’s death. Because of this legislation, some plans call for the normal form of pension for members with a spouse to be a joint and survivor pension.

DB plan members are customarily allowed, before their pension payments commence, to elect a form of pension different from the normal form. The plan will typically include a list of available choices, called optional forms of pension. This allows the plan member to choose the form that best suits their needs at retirement. The amount of pension paid under the optional form is usually the actuarial equivalent of the normal pension so that the election does not result in either a gain or loss for the pension fund.

Question 35

Describe the cash payments available to a DB pension plan member at termination of employment or at retirement.

Answer 35

Each jurisdiction has a provision that allows the value of a small pension to be paid in cash. Generally, a “small” pension is one in which the annual pension due is less than 4-10% of the YMPE or, depending on the jurisdiction, if the commuted value is less than 10-40% of YMPE.

In some jurisdictions, 25% of the value of benefits, earned before the legislation was revised, may be taken in cash if employment terminates before retirement, even if the termination occurs shortly before NRA.

Question 36

Describe the death benefit provided should a DB pension plan member die before retirement.

Answer 36

Pension standards legislation in all jurisdictions requires all pension plans to provide preretirement death benefits, and those benefits must be defined in the pension plan text/document. The definition of spouse, the rules on pension credit splitting upon a marriage breakdown and the treatment upon remarriage vary considerably by jurisdiction. Pension plans should include a definition of spouse, and that definition is subject to minimum provincial standards.

Prior to legislated minimum standards in this area, death benefits provided were minimal. For periods of membership after those reforms, minimum death benefits are now payable to the surviving spouse or beneficiary of a plan member, with the specific minimums dependent upon the jurisdiction. In some jurisdictions, the spouse has the right to waive entitlement to the death benefit; allowing it to be paid to another beneficiary.

In a DB pension plan, the death benefit for postreform membership may be the commuted value of the benefit that would have been payable to the member had they terminated service on the date of death.

Question 37

Explain how benefits are determined and paid to a DB pension plan member who terminates employment.

Answer 37

Every pension plan must define the benefits and rights of a member who terminates employment other than by retirement or death. A member is always entitled to their own contributions; the amount and method of payment of the actual benefit will depend upon how the plan’s vesting, locking-in and portability provisions apply to the employee. Pension standards legislation has established minimum standards of vesting, locking-in and portability:

(a) “Vesting” is the right of a plan member who terminates employment to the portion of the pension benefit provided by plan sponsor contributions. Vesting normally depends upon the member’s age at termination and/or length of service or plan membership. While this legislation varies by jurisdiction, most now require immediate vesting of benefits.

(b) Locking-in normally occurs at the same time as vesting. “Locked-in” means the terminating plan member cannot receive any contributions or portion of the benefit in cash. The benefit can only be received in the form of retirement income.

(c) “Portability” means that the member’s locked-in termination benefit may be transferred to another RPP or to a prescribed retirement arrangement, to be administered on a locked-in basis.

A DB pension plan member who terminates and who is vested will typically be entitled to the pension amount earned up to the date of termination.

Question 38

Describe the death and termination benefits provided should a DC pension plan member die or terminate before retirement.

Answer 38

Since most jurisdictions require immediate vesting, death and termination benefits payable from a DC pension plan typically are equal to the value of the member’s account in the plan, comprising employee and employer contributions up to the date of death or termination and accumulated investment growth. In jurisdictions that do not require immediate vesting, death and termination benefits may be equal to the vested portion of the member’s DC account.

Question 39

Describe the death and termination benefits provided should a DC pension plan member die or terminate before retirement.

Answer 39

Since most jurisdictions require immediate vesting, death and termination benefits payable from a DC pension plan typically are equal to the value of the member’s account in the plan, comprising employee and employer contributions up to the date of death or termination and accumulated investment growth. In jurisdictions that do not require immediate vesting, death and termination benefits may be equal to the vested portion of the member’s DC account.

Question 40

Describe how a DB pension plan can deal with a period of disability experienced by a plan member during their period of employment.

Answer 40

A majority of employees are covered by their employers under some form of short- or long-term disability plan that provides for regular payments to the employee to replace a portion of salary or wages while the employee remains disabled. If such a plan is in place and delivers adequate benefits, there is no need for a pension plan to provide disability pensions. Canadian ITA regulations allow periods of disability that meet a prescribed definition to be recognized as being eligible for the accrual of benefits under a DB pension plan. As a result, a DB pension plan member who receives disability benefits usually receives a pension at the age of 65 that is based on their period of service as an active employee plus a deemed period of service while disabled. In contributory plans, it is usual to waive any required employee contributions during the period of disability.

If employees are not covered for or not eligible for long-term disability benefits, the DB plan can be designed to provide immediate unreduced pension. The pension is usually equal to the full pension accrued to the disability date with no adjustment for early commencement.

Question 41

Contrast the effectiveness of different types of pension plans in providing inflation protection before retirement.

Answer 41

Final average earnings DB plans generally provide inflation protection up to the point of retirement, although there may be some shortfall since the last five-year-average salary can fall well below the salary at retirement date in periods of high inflation.

Career average earnings and flat benefit DB pension plans do not compensate for inflation that occurs prior to the plan member’s retirement age unless they are updated from time to time.

Defined contribution plans will automatically provide some inflation protection as long as the investment return of the member’s account rises in step with inflation rates.

Question 42

Describe the most common method used by large employers in the private sector to provide postretirement inflation protection for retirees from their DB pension plan.

Answer 42

Large employers in the private sector usually make ad hoc pension adjustments to compensate for postretirement cost of living increases. This method is common because the related costs are completely under the employer’s control, and there is no commitment to make such increases on a regular basis. It may be a percentage increase in all pensions that have been paid for a number of years or a percentage increase for each year since the last adjustment, a flat addition (e.g., $50 per month), the introduction of a minimum pension or a combination of these approaches. Further, unlike automatic indexing, many factors can be considered: inflation, the employer’s financial position and changes in government-sponsored benefits.

Question 43

Describe how DC plan members can obtain inflation protection after retirement.

Answer 43

Members of a DC plan choose the form of pension to receive at the time of retirement and can elect to purchase an annuity that contains a provision for automatic indexing. Plan sponsors do not provide any type of automatic or ad hoc adjustments to pensions after retirement.

Question 44

Describe the retirement income alternatives available to retiring DC plan members.

Answer 44

When a DC plan member retires, the member’s retirement income will depend upon the accumulated retirement savings in that member’s account. The member may choose to purchase an annuity with their account to obtain a monthly income, or to establish a Life Income Fund (LIF) (or other similar vehicle, depending on the jurisdiction) and withdraw their income from that plan. These vehicles have legislated minimum and maximum withdrawal amounts.

Most jurisdictions also allow the retiring member to receive income amounts based on LIF rules, directly from the pension plan itself, if the plan’s provisions permit payment of variable benefits. This approach may have the benefit of providing the member with lower plan investment and administrative costs negotiated by the employer.

Income tax regulations now also allow the use of a new type of annuity called an Advanced Life Deferred Annuity (ALDA), which allows a member to defer the start of a portion of their retirement income until as late as age 85. Pension standards legislation amendments will be required before these annuities can be used by DC members.