cia annual meeting assemblée annuelle de l’ica
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CIA Annual Meeting Assemblée annuelle de l’ICA. June 29 & 30, 2006 Ÿ Les 29 et 30 juin 2006 Ottawa, Ontario. SERP Commuted Values Other SERP Actuarial Issues Doug Chandler. Typical Situation – Commuted Value only monthly income is specified scanty documentation - PowerPoint PPT PresentationTRANSCRIPT
PEN-22 SERP Pension Session
CIA Annual MeetingAssemblée annuelle de l’ICA
June 29 & 30, 2006 Ÿ Les 29 et 30 juin 2006Ottawa, Ontario
• SERP Commuted Values• Other SERP Actuarial Issues
Doug Chandler
PEN-22 SERP Pension Session
CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA
Typical Situation – Commuted Value
• only monthly income is specified• scanty documentation• both parties want a lump sum settlement• sponsor and member trust actuary
PEN-22 SERP Pension Session
CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA
Standards of Practice• Commuted Value standard does not apply
(3810.03)• don’t say it does (3850.06)• CSOP does apply:
– unbiased calculations (1740)– assume a tax rate (1710.06)– disclose stipulated assumptions (1720.03)– disclose alternative to extreme assumption (1720.06)
PEN-22 SERP Pension Session
CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA
All the Usual CV Issues…• mortality• discount rate • future retirement age• marital status at future retirement
And a Couple of Others…• tax adjustment• integration with Registered Pension Plan
PEN-22 SERP Pension Session
CIA Annual Meeting Ÿ Assemblée annuelle de l’ICAAdjusting for tax can be a big deal!
Example:• $100,000 per year annual pension• payable immediately at age 60• Joint and 50% Survivor, UP94@2015• $1.4 million without tax adjustment (5% discount rate)• $1.8 million with 40% tax adjustment (3% discount rate)• Even bigger difference for indexed or deferred pensions
$-
$500,000
$1,000,000
$1,500,000
$2,000,000
No Tax Adjustment With Tax Adjustment
PEN-22 SERP Pension Session
CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA
Employer Perspective• corporate tax deduction for lump sum• cost is after-tax cost of capital (or debt)
Employee Perspective• tax on lump sum• tax on interest, dividends and capital gains • no tax on withdrawals from after-tax funds• broader range of tax strategies
PEN-22 SERP Pension Session
CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA
Non-Registered Funds First
$0
$50,000
$100,000
$150,000
60 63 66 69 72 75 78 81 84
RPP net of tax Tax on RPP
SERP net of tax Tax on SERP
$0
$50,000
$100,000
$150,000
60 63 66 69 72 75 78 81
RRIF net of tax Cash net of tax
Tax on RRIF Tax on Cash
PEN-22 SERP Pension Session
CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA
Effective Tax Rate on aNon-Registered Investment Fund
EarningsMost Efficient
Investment Strategy
Least Efficient Investment
StrategyLess than $35,000 7% 22%$35,000 to $70,000 13% 31%$70,000 to $120,000 17%* 39%*Over $120,000 20% 46%
* plus OAS clawback after 65
Be sure to validate your assumption with current tax rules and province of employment, e.g. www.kpmg.ca/en/services/tax/taxratesPersonal.html
PEN-22 SERP Pension Session
CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA
Commuted Values and Tax AdjustmentAvoiding the Issue
• Specify commuted value basis in plan document• Take direction from client (stipulated
assumption)• Explain the effect of taxes and report a range
PEN-22 SERP Pension Session
CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA
Commuted Values and Tax AdjustmentExamples of Specified Basis
• same basis as RPP (no tax adjustment)• purchase price of prescribed annuity• discount rate reduced by a tax rate of x%• commuted values at y% fixed
PEN-22 SERP Pension Session
CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA
Commuted Value Assumptions Required for Explicit Tax Adjustment
• Asset mix• Equity turnover rate• Tax rates (for lump sum, monthly pension, and
income on various asset classes)
PEN-22 SERP Pension Session
CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA
• Annual normal retirement benefit is $5,000 per year of service
• Plan reduction is 5%/yr from 65
• Plan indexing is ad hoc
• RPP pays ITA maximum
• Retirement at 60 in 2009
Example – Integration with RPP
$0
$500
$1,000
$1,500
$2,000
$2,500
$3,000
$3,500
$4,000
60 62 64 66 68 70 72 74
Age
Ann
ual P
ensi
on p
er Y
ear o
f Ser
vice
SERPRPP
PEN-22 SERP Pension Session
CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA
Other Types of SERP “work”
• funding valuations – Retirement Compensation Arrangement
• determining the face amount of a Letter Of Credit
• plan design cost studies
• corporate accounting – CICA3461, FAS87, IAS19
PEN-22 SERP Pension Session
CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA
50% RCA Tax Rate intended to prevent tax advantage (at 1986 rates) does not reflect recent changes in corporate and personal tax rates, capital gains tax inclusion rate, dividend tax credits a neutral rate today would be about 30% many more employers would fund RCA’s if the tax rate were lowered
http://www.watsonwyatt.com//canada-english/news/pdf/WW_Submission_2005_Federal_Pre-Budget.pdf
PEN-22 SERP Pension Session
CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA
Retirement Compensation Arrangements
Reason for Funding Valuation Basis
Eliminate Balance Sheet Liability Accounting Basis
Stable Contribution Rate Going Concern
SERP is part of a registered plan Going Concern and Solvency
Tax Deduction for Employee Contributions Matching
Benefit Security Settlement Cost
PEN-22 SERP Pension Session
CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA
Letters of Credit can be a tax-effective alternative to RCA funding
require actuarial report to determine face amount same problems as commuted values:
- no specified basis for settlement
- optimal tax adjustment depends on plan member
PEN-22 SERP Pension Session
CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA
Letter of Credit Valuation be aware of annual cycle deadlines and roles:
- sponsor- trustee- bank- Administrator
you’re telling them how much insurance to buy face amount must cover triggering event any time in the year
- fluctuations in interest rates
- mid-year cliff vesting
- new members
- bonuses that boost final average pay
PEN-22 SERP Pension Session
CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA
Letters of CreditDon’t forget about the Refundable Tax Account
$0
$500,000
$1,000,000
$1,500,000
$2,000,000
$2,500,000
40
45
50
55
60
65
70
75
80
85
90
95 10
0 10
5
Age
Amount required to Settle
Face amount of LC
PEN-22 SERP Pension Session
CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA
Letter of Credit Valuations:Integration with RPP
typical SERP combines with RPP to pay “whatever the RPP would pay without tax limits” hypothetical wind-up scenario – both plans
- does legislated grow-in increase or decrease SERP obligation?
- if surplus in the RPP is distributed through indexing or other improvements, do those improvements increase or decrease the SERP obligation?
PEN-22 SERP Pension Session
CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA
Approach to security Additional cost
RCA for actives 80%
LOC for actives 40%
RCA for retirees 33%
LOC for retirees 15%
Lump Sum Settlement with 50% marginal tax 33%
Lump Sum Settlement with 20% marginal tax 15%Prescribed Annuity 33%
Cost Comparisons
Figures are for illustration only – do your own calculations and sensitivity testing
PEN-22 SERP Pension Session
CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA
Questions about Cost Comparisons1. Should the LOC fee be expensed on a cash basis or an accrual
basis?
2. What about trustee and administration fees?
3. What is the going concern value of an RTA balance that will never be recovered?
4. How do you factor in corporate tax costs?
5. What about life insurance products?
6. What is the actuary’s role in conflicts between the interests of executives and the interests of the company?
PEN-22 SERP Pension Session
CIA Annual Meeting Ÿ Assemblée annuelle de l’ICA
Questions about Corporate Accounting1. What retirement age should you use?
• most likely (earliest unreduced)• most expensive (could be 65)•scale from 55 to 65
2. Should you discount for forfeiture on early termination?
3. How do you account for an increase in the tax limits?
5. Should SERP and RPP assumptions be the same?
6. Should you disclose the sensitivity to salary and bonus changes?
7. Do you need to measure the extra SERP liability arising from individual salary variations?