Module 4 Pension Plans Questions + Solutions PDF

Module 4 Pension Plans Questions + Solutions Problems 1. Indicate if each of the following independent statements is true or false 1. Contributions and investment income can accumulate within a registered plan such as a RRSP or RPP without an immediate tax consequence since income tax...

Module 4 Pension Plans Questions + Solutions Problems 1. Indicate if each of the following independent statements is true or false 1. Contributions and investment income can accumulate within a registered plan such as a RRSP or RPP without an immediate tax consequence since income tax is deferred until an amount is withdrawn from the plan. 2. The accumulation of funds and the distribution of income from a registered pension plan are subject to rules under the Income Tax Act that are consistent across Canada. 3. The Income Tax Act governs the operation and administration of provincial pension plans. 4. The Canadian Association of Pension Supervisory Authorities (CAPSA) has legislative authority to change pension laws. 5. The majority of people who have registered retirement plans are members of a defined contribution plan in Canada. 6. Where an employee is required to contribute to a defined benefits pension plan, at least 50% of the benefit payable each year must be attributable to employer contributions. 7. Generally, the higher the survivor benefit, the lower the pension income and the longer the guarantee period, the lower the pension income. 8. If a spouse is entitled to benefits under the provision of a pension plan upon the death of her spouse, her benefits will be affected if she remarries. 9. Payments from a registered pension plan must begin by the end of the year in which the member reaches age 69. 10. Under an Individual Pension Plan (IPP), the unused value or assets upon the death of the plan member remain in the company’s pension plan. Solution 1. True 2. True 3. False, provincial laws regulates the operation of these plans. 4. False, CAPSA is a collaborative group intended to promote and facilitate an efficient and effective pension regularity system in Canada, but it has no legislative authority. 5. False, 85% of individuals who participate in registered pension plans are covered by a defined benefit plan, 13% by defined contribution plan (money purchase) and 2% by a combination of both plans. 6. False, at least 50% of the benefit payable when a member retires, dies or terminates must be attributable to employer contributions. 7. True 8. False, entitlement to benefits as the spouse of a decreased plan member will not be affected if the spouse remarries. 9. True  10. False, under an IPP, the assets in the plan belong to the plan member and upon his death the assets are paid to the estate or his spouse/partner. 2. Explain the purpose of each of the three pillars of the retirement income system in Canada. Solution The first pillar refers to a minimum level of income that is provided through social security benefits of Old Age Security (OAS) Guaranteed Income Supplement (GIS) and other supplements provided at the provincial level. The second pillar is the public pension schemes of the Canada and Quebec Pension Plans, which provide retirement benefits to replace a portion of the an individual’s working income. The first and second pillars are intended to provide a minimum level of income. The third pillar includes tax assisted-savings plans such as Registered Retirement Savings Plans (RRSPs), employer-sponsored programs (RPPs) and personal non-registered savings are intended to supplement retirement income to a level of comfort important to each individual. 3. What is the role and goals of the Canadian Association of Pension Supervisory Authority (CAPSA)? Solution CAPSA is a national interjurisdictional association of pension supervisory authorities. Its mission is to facilitate an efficient and effective pension regulatory system in Canada by promoting the simplification and harmonization of regulatory requirements and enhanced security through a common set of investment rules. CAPSA does not have any regulatory authority. 4. Match the following terms with the definition a. Pensionable service b. Vesting c. Locked-in provision d. Portability e. Contributory plan f. Non-contributory plan 1) An employee’s irrevocable entitlement to benefits from the pension plan. 2) A plan member’s ability to transfer credits or benefits accrued under the registered pension plan to another registered plan. 3) The plan member’s employment period used in determining the amount of pension retirement benefits that accrues under a defined benefit type of plan. 4) A pension plan that does not require a plan member to make contributions. 5) Pension contributions cannot be withdrawn or forfeited in specific circumstances, and the pension funds may only be used to provide retirement income. 6) The employee shares in the cost of providing the benefits that result from participation in the pension plan. Solutions 1) b 2) d 3) a 4) f 5) c 6) e 5. Xia, Lyn, Hannah and Mary, all 60 years of age, met for lunch last week. They all expect to retire next year and started comparing the defined benefit pension plans they had at their different jobs to determine who would have the highest annual pension. Surprisingly, all four individuals had the same income for the last five years (2006 to 2001), $51,000, $65,000, $60,000, $54,000 and $52,000 and they all have participated in their employers’ pension plans for 25 years. g. Xia has participated in AverageEarning Inc.’s pension plan, which provides benefits of 2% for each year of services based on the member’s average earnings in the final four years of service. h. Lyn has participated in BestEarnings Inc.’s pension plan. The pension plan provides a benefit based on 2% of her best earnings over four consecutive years. i. Hannah’s defined pension plan was based 2% of the plan member’s career average earnings. Hannah has been a member of the pension for 25 years. Assume Hannah’s average earnings was $58,000. j. Mary belongs to a pension plan which accrues a $1,100 flat benefit for each year of service. Calculate the value of each individual’s pension benefit to determine who will have the highest annual pension. Solution Since Xia’s average final earnings are $57,500 (51,000 + 65,000 + 60,000 + 54,000) ÷ 4), her pension will be $28,750 (2% X $57,500 X 25) Since Lyn’s best earnings are $57,750 ($65,000 + $60,000 + $54,000 + (52,000) ÷ 4, her pension will be $ 28,875 (2.0% X $57,750 X 25) Hannah’s pension will be $29,000 (2% X $58,000 X 25) Mary’s pension will be $27,500 ($1,100X 25 years) Thus, Hannah will have the highest pension per year. 6. Explain the differences between a defined benefit plan and defined contribution benefit plan in regards to the amount of employer contributions required, maximum benefits at retirement, and who assumes responsibility for investment risk between the employer and plan member. Solution  Defined Benefit Plan Defined Contribution Plan Employer Contributions Amount is determined Fixed, known amount based on actuarial valuation of the plan Maximum benefits $2,111 per year of service There is no maximum (as of 2006) benefit. Amount is based on funds available at retirement Investment Risk Assumed by the employer. Assumed by the employee. Employee retirement Reduced or increased income is not affected by investment performance investment performance directly affects the employee’s pension income. 7. Since payments from a registered pension plan must begin by the end of the year in which the member reaches age 69, many members purchase a retirement annuity. Describe the differences between a life income annuity, a life annuity with a guaranteed period, a joint and survivor annuity and joint and survivor option with a guaranteed period. Solution A Life income annuity provides a retirement income to the retiree for his lifetime, ceasing upon death. A Life annuity with a guaranteed period pays a pension for the later of the life of the retiree or the guaranteed period. The Joint and Survivor annuity means that the retirement income must be calculated based on the combined life expectancies of the member and his spouse and in the event that the member spouse predeceases his spouse, a minimum percentage of the income must continue for the surviving spouse’s lifetime. With a Joint and Survivor option with a guaranteed period, if a minimum guarantee period is selected and both spouses die prior to the end of the guaranteed period, the remaining pension payments are commuted and paid to the beneficiary. 8. What are the income tax implications of registered defined benefit or defined contribution pension plans for employee & employer contributions and benefit payouts? Solution An employer’s contributions to a registered pension plan (defined benefit or defined contribution) are treated as a tax deductible business expense for the employer and not considered a taxable benefit for the employee and thus are not included in an employee’s taxable income. An employee’s contributions are tax deductible by the employee in respect of the year the funds were contributed. Since amounts paid into a registered pension plan as contributions nor the investment earnings on contributions have not yet been taxed, amounts paid out to employees on a periodic basis are generally fully taxable to the recipient. Certain circumstances exist where the transfer of funds from one registered plan to another plan is allowed on a tax-free rollover basis. 9. Identify the criteria that should be used to determine if a company should set up an individual pension plan (IPP) for its executives. Solution An individual pension plan (IPP) is an employer-sponsored, defined benefit registered pension plan created for the benefit of qualifying individuals. To qualify for an IPP the plan member must be an employee of an incorporated company, which is taxable under the Act and have T4 income. Generally, an IPP is most suited to executives or owner-managers of incorporated companies, who are forty or older, with regular annual earnings of at least $100,000. 10. What is the rule for the division of pension assets upon a marriage breakdown? What are the criteria for a tax-free rollover of pension assets from a plan member to his spouse or former spouse? Solution All provinces, except Prince Edward Island, require that pensions be included as part of the divisible property upon marriage breakdown. Money from a registered pension plan may be transferred to a spouse or former spouse on a tax-deferred rollover basis, provided that the transfer meets the following specific criteria: the transfer must be for a single sum, made as the settlement of property rights based on a court order or written agreement due to a relationship breakdown and transferred directly to an RPP, RRSP or RRIF.  Module 04 Registered Retirement Savings Plans Questions + Solutions Exercises 1. Identify each of the following statements as True or False 1. All withdrawals from registered savings plans all taxed as regular income. 2. Investments held within a registered plan that produce capital gains or dividend income are treated as regular income, for tax purposes, when withdrawn from a registered plan. 3. An RRSP must mature no later than the end of the calendar year in which the annuitant reaches age 69. 4. RRSPs were developed to address the payout or income phase of retirement. 5. An unmatured RRSP is a plan that is paying retirement income to the annuitant (plan owner). 6. There is no minimum age at which an RRSP may be established. 7. There is limit to the number of RRSPs an individual may hold. 8. One of the benefits of a self-directed RRSP is that the administration and sales commission fees are tax-deductible. 9. A single contribution limit employer sponsored registered pension plan (RPP), Deferred Profit Sharing Plan (DPSP) and a Registered Retirement Savings Plan (RRSP) 10. The maximum RRSP contribution limit an individual can make is 18% of earned income from the prior year. 11. Employer contributions to an individual’s RRSP generates a pension adjustment. 12. A pension adjustment reversal (PAR) will decrease an individual’s RRSP contribution limit in the year it is credited to the individual. 13. A taxpayer may carry-forward unused RRSP contribution for a maximum of 10 years. 14. The interest on RRSP loans is tax deductible. 15. In all years except the year that an RRSP matures, a taxpayer may select to deduct contributions made within the first 60 days of the subsequent year, in either the taxation year during which the contributions were made of the previous taxation year. 16. The CRA allows a $3,000 lifetime RRSP over-contribution limit for taxpayers. 17. A one percent monthly tax is imposed on contributions that exceed the over- contribution limit.  18. When an annuitant withdrawals funds from an RRSP, the withholding tax is a fixed percentage of the amount withdrawn. 19. Contributions to a spousal RRSP affect the RRSP contribution room of the contributing spouse. 20. RRSP contributions can be made by the estate’s trustee to the decreased taxpayer’s RRSP after her death. Solution 1. False, in specific circumstances a tax-deferred rollover of assets between registered plans may be possible. 2. True 3. True 4. False, RRSPs were designed to address the savings or wealth accumulation phase of retirement planes not the payout or income phase. 5. False, a matured RRSP is a plan that is paying the annuitant. 6. True 7. False, there is no limit to the number of RRSP a person can hold. 8. False, Administration and sales commission fees for a self-directed RRSP are NOT tax deductible. 9. True 10. False, the maximum contribution is 18% of earned income to a maximum dollar limit ($18,000 for 2006), less any pension adjustment, plus any carry forward of unused contributions. 11. False, Employer contributions are considered employment income and do not generate a pension adjustment. 12. False, a pension adjustment reversal (PAR) will increase (not decrease) an individual’s RRSP contribution limit in the year it is credited to the individual. 13. False, a taxpayer may carry-forward unused RRSP contribution indefinitely. 14. False, RRSP loan interest is not tax deductible. 15. True 16. False, the over-contribution limit is $2,000 17. True 18. False, the withholding tax percentage ranges from 10% to 30% based on the amount withdrawn. Amounts withdrawn and repaid under the Home Buyer’s Plan and Lifelong Learning Plan are not subject to the withholding tax. 19. True 20. False, RRSP contributions after death are not allowed. Question 1. “A RRSP provides a tax-assisted savings vehicle that is important in the achievement of a financially secure retirement.” Do you agree or disagree? Solution Student responses will vary for this question. The key points are that RRSP’s were established to assist individuals who were not covered by an employer’s pension plan to save for retirement. In the past, individuals relied upon company and government- sponsored pension programs to provide income for retirement. Today, career changes, early retirement, longer life expectancy, and more active lifestyles create a need for individuals to save in order to fully enjoy their retirements. 2. List the tax advantages of RRSPs. Solution RRSP allow for the deferral of income tax which helps accelerate the accumulation of savings. Contributions, up to a yearly maximum, may be deducted from income which reduces the amount of income tax payable. Savings grow tax-sheltered until withdrawn. 3. Why is it significance in regards to RRSPs of filing an income tax return? Solution The RRSP contribution room in the current year is based on the individual’s earned income from the immediately prior year’s income tax return. 4. Is there a minimum or maximum age that an individual can contribute to an RRSP? Solution There is no minimum age that an individual can establish an RRSP. For each year that an individual is younger than the maximum contribution age of 69 and has earned income last year, they can contribute to an RRSP. If a person has earned income in any year, the filing of an income tax return establishes the RRSP contribution limit for the next calendar year. A person must collapse a RRSP or the RRSP matures at the end of the calendar year in which the annuitant reaches the age of 69. 5. Explain the choices available for an RRSP annuitant when they decide to retire. Solution The individual can i) convert the RRSP to an RRIF, ii) purchase a registered annuity or iii) cash out the RRSP. All RRSPs mature or need to be closed at the end of the calendar year in which the annuitant reaches age 69. 6. Explain the differences between Individual RRSPs, Self-Directed RRSPs and Group RRSPs in regards to investments, Solution Individual RRSP – An individual RRSP established between the annuitant and the financial institution. Generally, investments are based on a single or group of investment products. Self-directed RRSP a. An individual RRSP that allows an individual to hold multiple types of investments all a single RRSP. It offers a wider choice of investment options compared to an individual RRSP. b. It is important to assess whether the benefits of a self-directed RRSP outweigh the financial costs of account set-up, on-going administrative fees and investment sales commissions. c. These plans are designed for people who wish to actively manage the assets held with the plan by buying and selling a wide variety of different types of investments. Group RRSP a. A series of individual RRSP accounts where contributions are made through payroll deductions. Contributions may be made by both the employee and matched by the employer. b. Where RRSP contributions are made by payroll deduction, the CRA allows the amount of income tax withheld from the employee’s pay to the reduced in recognition of the RRSP contribution. c. Contributions made by the employer are treated as additional income for the employee and are subject to government deductions for the employer and employee (CPP, EI, worker’s compensation). d. Group RRSPs are more flexible and less onerous than registered pension plans for companies. 7. Discuss the possible tax implications that an individual should consider when transferring property in-kind to a self-directed RRSP. Solution  The annuitant must report any capital gain arising out of such a disposition as a contribution of securities or other property into an RRSP constitutes a disposition for capital gains purposes.  Non-arm’s length rules within the Act do not permit the deduction of any capital loss incurred on such a transfer.  The RRSP administrator is required to indication contributions in-kind when preparing the annual RRSP receipts.   If a self-directed RRSP purchases property from the annuitant and pays more than the fair market value for the property, the excess amount of the payment above the fair market value is taxable as income of the RRSP annuitant. 8. Which of the following types of income are not included within the definition of ‘earned income” for RRSP contribution purposes? a. Net rental income b. Taxable capital gains c. Old Age security benefits d. Income from office or employment e. Business income earned as a limited partner f. CPP/QPP disability pensions received g. Dividend income h. Interest income i. Royalties from an invention j. Employment insurance benefits k. Retiring allowances Solution b. Taxable capital gains c. Old Age security benefits e. Business income earned as a limited partner g. Dividend income h. Interest income j. Employment insurance benefits k. Retiring allowances 9. Describe the term “Pension Adjustment” and discuss how pension adjustments are calculated for Deferred Profit Sharing Plans (DPSP), and Defined Contribution and Defined Benefit Registered Pension Plans (RPP). Solution A taxpayer’s pension adjustment (PA) is the value of the benefits earned or accrued to a taxpayer because of her participation in a registered pension plan or Deferred Profit Sharing Plan. A pension adjustment ensures that all individuals with comparable income will have access to comparable tax assistance, regardless of the type of plan to which they belong. DPSP – PA is equal to the amount of the employer’s contributions into the DPSP RPP (Defined Contribution / Money Purchase Plan) – PA equal to total employee and employer contributions to the plan for a given year. RPP (Defined Benefit) – prescribed formula: (9 X benefit entitlement) - $600 Note: benefit entitlement = (year’s pensionable earnings X unit percentage earned) 10. What factors are used to determine the current year’s RRSP contribution room?  Solution The formula for calculating the current year RRSP contribution room is:  18% of the taxpayer’s earned income for the immediately preceding year, to a maximum of the RRSP dollar limit for that current year; Minus  The taxpayer’s pension adjustment (PA) in respect of the preceding taxation year Plus  The taxpayer’s pension adjustment reversal (PAR) in respect to the current taxation year; Minus  Any past service pension adjustment (PSPS) in respect of the current year. 11. Which of the following investments are qualified investments for RRSP purposes? a. Shares or debt of a Canadian public f. Limited partnership units listed on a corporation the TSE b. Commercial Real estate g. Canada Savings Bonds c. Investment grade gold and silver h. Antiques d. Precious stones and gems i. Public company shares listed in the TSE e. Mutual fund trusts j. Works of art Solution The following are qualified RRSP investments: a, c, e, f, g, i 12. What is the formula to calculate the maximum amount of retiring allowance money that can be rolled over to an RRSP or RPP? Solution The formula to calculate the maximum amount of retiring allowance money that can be rolled over to an RRSP or RPP is: - $2,00 times the number of years that the employee was employed with the employer or related employer, prior to 1996; and - $1,500 times the number of years of employment, prior to 1989, during which the employee was not a vested member of a pension plan or DPSP.  Case Jinder and Carl Sing Jinder and Carl Sing, a married couple aged 30 and 35, have set up a meeting with you, a CFP, on January 9th, 2007 to discuss the Home Buyer’s Plan. They have been renting an apartment in Kitchener since they were married seven years ago and are now interested in purchasing a new home in November of 2008. Jinder has never owned a house before and Carl owned a house prior to them being married. Jinder’s spousal RRSP is worth $20,000 and Carl’s RRSP is worth $125,000. They plan to withdrawal the maximum amounts allowed on April 2, 2007. Carl plans to make his usual spousal contribution of $5,000 on February 20, 2007 in time for the 2006 taxation year. They plan to ask you the following HBP questions during the meeting: a. What are the conditions of participation in the Home Buyer’s program? b. What amount of money can each of them withdrawal from their RRSPs to participate in the Home Buyer’s Plan? c. When and over what length of time do they have to repay the HBP? What is the amount they will be required to repay each year? d. What happens if they can not repay an annual repayment amount? Prepare a written response to the Sing’s questions. Solution a) Some of the conditions must be met prior to an eligible RRSP withdrawal, whereas others apply to the period when or after the HBP funds have been received. - The RRSP annuitant and her current spouse or common-law partner must not have owned or occupied as a principle residence a home in the period that begins January 1 of the fourth calendar year prior to the year of withdrawal and ending 31 days before the withdrawal. The Sings satisfy this requirement since they have been renting for the last seven years. - The HBP applicant must be a resident in Canada at the time that she receives the funds and must remain resident in Canada until he/she acquires the qualifying home. The Sings satisfy this requirement. - All HBP withdrawals must be received within the same calendar year, with one exception – any amount received in January of the year following the first withdrawal is considered to have been received in the same year as the first withdrawal. The year of withdrawal is dictated by the date of the first withdrawal. No issues to address in regards to the Sings. - A taxpayer must buy or build a qualifying home prior to October 1 of the year following the year of withdrawal. If the Sings withdrawal RRSP funds on April 2, 2007 they need to buy the qualifying house by October 1, 2008 not November, 2008. They should delay their HBP withdrawals until 2008 if they plan to purchase a home in November 2008.  - A taxpayer’ RRSP deduction limit will not be affected by participation in the HBP provided they do not contribute to their RRSP within 90 days prior to the HBP withdrawal (or contribute to a spousal RRSP within 90 days prior to the spouse’s HBP withdrawal). It is advisable that Carl not contribute the 5,000 spousal RRSP contribution in 2007 because will not deductible since the planned HBP withdrawal of $20,000 equal to the fair market value of the RRSP 90 days prior to the withdrawal. b) The maximum amount of all withdrawals from a RRSP is $20,000 per taxpayer. Any amount above $20,000 is considered to be excess and treated as taxable income to the taxpayer in the year of receipt. In total, the Sings can withdrawal $40,000 or $20,000 each. c) A taxpayer who participates in the HBP has 15 years to repay the RRSP amount that has been withdrawn under the HBP. Repayment begins the second calendar year following the year in which the taxpayer made the withdrawals. The taxpayer must make a contribution to her RRSP in the year the repayment is due or within 60 days of the following year. In total the Sings will have to repay $2,667 each year ($40,000 ÷15 years) starting in 2009. d) Any portion of the required repayment that is not made within the required timeframe must be included in the taxpayer’s income for the year the payment was due. Module 4 Retirement Income Questions + Solutions Exercises 1. Indicate if each of the following independent statements is true or false. If the statement is false, explain why. 1. Assets from a registered pension plan may be transferred to a locked-in plan (LRIF) to generate retirement income while maintaining the status of the pension benefits? 2. Can a RRIF be established at anytime? 3. Capital gains and dividend income producing assets receive special tax treatment when held within a registered retirement income fund (RRIF). 4. The assets used to establish a RRIF can be contributed by an individual directly similar to an RRSP. 5. One benefit of a RRIF compared to an annuity is that at the death of the annuitant, the remaining capital is available to the annuitant’s estate. 6. A RRIF can be owned by an individual, corporation or an employer. 7. Minimum RRIF withdrawals start the year that the RRIF is established.  8. A qualified beneficiary must transfer the funds directly to a RRIF to maintain the tax-deferral status of the assets. 9. As tax planning technique, the election to utilize a spouse’s or common-law partner’s age in the minimum withdrawal calculation can be made each year. 10. There is a maximum amount that can be withdrawn from a RRIF each year. 11. While all RRIF withdrawals are taxable, a withdrawal based on the minimum amount is not subject to withholding tax. 12. LIFs and LRIFs have a minimum that must be withdrawn and maximum amounts that may be withdrawn each year. Solutions 1. True 2. True 3. False, they do not receive any special tax treatment. 4. False, the assets must come from another registered plan. 5. True 6. False, a RRIF can only be owned by an individual. 7. False, the minimum withdrawals begin the year after it is initially established. 8. False, the assets should be transferred directly to a RRIF but if the beneficiary receives the funds personally, they have until 60 days after the end of the year when the assets were received to contribute the assets to a RRIF to maintain the tax-deferred feature. 9. False, the election to use a spouse or common-law partner’s age in the minimum calculation must be made when a new RRIF is established and continues as long as the RRIF exists. 10. False, there is a minimum amount that must be withdrawn, but no maximum amount. 11. True 12. True 2. What are the four criteria that you should consider when choosing retirement income products from a financial institution? Solution Flexibility of product – How flexible is the product to the needs of the client and is it possible to change the type of investments held within the product or the income schedule Choice of investment options – What investment options are available? Protection for guaranteed investments – Are the investments covered by CDIC, Assuris, CIPF or a credit union? Strength of financial institution – The strength of the institution is important to long-term decisions. If it fails will assets be frozen and thus inaccessible? 3. What are the three choices available to an individual who moves assets out of an RRSP? Solution The three options are: convert the RRSP to a RRIF, purchase a registered annuity or cash in the RRSP. 4. Describe the main characteristics of a registered retirement income fund (RRIF) Solution RRIF were created in 1978 to increase the retirement options of RRSP owners. Assets within a RRIF are used during the payout or income phase of retirement to provide an income to the annuitant. The assets used to establish a RRIF can only come from another registered plan, as no funds can be contributed directly by an individual into a RRIF. All income withdrawn from a RRIF is taxable, except in the case of tax- deferred rollovers, and prescribed rules dictate a minimum percentage of the plan assets that must be withdrawn as income beginning in the year following the year in which the RRIF is established. Assets that remain within the RRIF may continue to grow tax sheltered. 5. How can an individual establish a RRIF? Solution An individual can establish a RRIF with property transferred from a matured or unmatured RRSP, another RRIF or a registered pension plan. 6. Explain the difference between a refund of premiums and a designated benefit. Solution A refund of premiums is a term used to describe assets from an unmatured RRSP resulting from the death of the RRSP annuitant and which are paid to a qualified beneficiary under specific conditions. A designated benefit is used to define assets from a RRIF resulting from the death of the RRIF annuitant that are paid to a qualified beneficiary. In both situations, generally, qualified beneficiaries include the RRSP annuitant’s spouse or common-law partner and the RRSP annuitant’s financially dependent child or grandchild who was dependent because of mental or physical infirmity. 7. What is the difference between a qualified and non-qualified RRIF? Why is the classification important? Solution A qualified RRIF is one that was purchased before January 1, 1993 to which no property has been transferred after 1992 or to which property has been transferred after 1992 but the transferred property was from another qualifying RRIF. A non- qualifying RRIF is one that does not meet the criteria for a qualified RRIF. The classification is important because qualified RRIF have lower minimum withdrawal requirements than a non-qualified RRIF for an annuitant between the ages of 71 and 77. Both types of RRIFs have the same calculation of minimum annual income up to and including age 70 and after age 77. 8. What information is used to calculate the RRIF minimum withdrawal for a specific year? Solution The calculation of the minimum withdrawal for a specific year utilizes two key pieces of information: the market value of the assets in the plan as of January 1 of that year and the age of the annuitant as of January 1 of that year (or the age of the annuitant’s spouse or common-law partner if this election was made). 9. What are some of the more common choices for designing an income flow from a RRIF? Solution Common choices for designing an income flow from an RRIF include: receiving the minimum amount income only, interest only; and a level income per period. 10. Explain the significance of the “current plus two year” attribution rule for spousal RRIFs. Solution Income may be attributed back to the contributing spouse for withdrawals from a spousal RRIF, if the contributing spouse has made a deposit to a spousal RRSP in the current year or in the previous two years. Attribution rules apply to the excess amount (amount above the required minimum) withdrawn by the RRIF owner. The amount that is attributed to the contributing spouse is the lesser of: the excess RRIF withdrawn and contributions made to the spousal RRSP in the current and previous two taxation years that have not already been attributed. 11. Under what situations does attribution on a spousal RRIF not apply? Solution The situations under which attribution does not apply are: - the minimum amount is withdrawn - the payment is received after the death of the contributing spouse - the contributing spouse or annuitant is non-resident at the time of the withdrawal - the spouses are living separate and apart from each other due to a reason of the breakdown of the marriage (if spouses reunite, attribution rules will again become applicable) - the annuitant collapses the RRIF to purchase a qualifying annuity. 12. What are the tax consequences of a RRIF acquiring a non-qualified investment? Solution When a RRIF acquires a non-qualified investment, - the fair market value of the investment is included in the annuitant’s income. Later, when the investment is disposed of, the lesser of the  proceeds of disposition and the amount previously included in income may be deducted by the annuitant. - The RRIF trust is subject to a one percent penalty on the fair value of the non-qualified investment for each month the non-qualified investment remains in the RRIF. The penalty is calculated on a month-end basis and payable annually. - The RRIF trust is subject to income tax on the investment income earned on the non-qualifying investment while it remains in the RRIF plan. 13. Why is it important for financial planners to ensure that their clients understand how RRIF withdrawals are taxed for income tax purposes? Solution Minimum RRIF payments do not attract withholding tax; however, the payments are fully taxable in the year received and must be included in the recipient’s income. The annuitant needs to understand that the RRIF income will contribute to his total income and that his tax liability will be based on his total income. 14. What are the transfer options available for qualified beneficiaries, such as the surviving spouse, financial dependent and dependents due to physical or mental infirmity, in order to defer immediate tax consequences when designated funds are received from a decreased RRIF annuitant’s plan? Solution See Table Three in the textbook. The designated benefit may be transferred by: The surviving spouse to a RRSP, RRIF or annuity, A financial dependent (but not due to mental or physical infirmity) to an annuity, A financial dependent due to mental or physical infirmity to a RRSP, RRIF, or annuity. 15. What are the conditions under which transfers to or from an RRIF are eligible for a tax-deferred rollover of assets as a result of a relationship breakdown? What type of registered plans are transfers from a RRIF and transfers to a RRIF allowed as a result of a relationship breakdown? Solution To be eligible for a rollover of assets upon a relationship breakdown, the recipient spouse or common-law partner must be entitled to the assets under a decree order or judgement of a court or written separation agreement relating to the division of property as the result of a relationship breakdown. Transfers from a RRIF can go to an RRSP or another RRIF. Transfers to a RRIF can come from a RRSP, another RRIF, or RPP. 16. Zack is a member of a defined benefit pension plan. He was wondering what options he had to transfer his pension plan funds when he leaves his current company. Solution Locked-in pension funds may generally be transferred from a registered pension plan to one or more of the following: another RPP, a locked-in RRSP or locked-in Retirement Account (LIRA), a locked-in RRIF (LRIF), a life income fund (LIF), a prescribed RRIF (PRRIF) (Saskatchewan only) or for the purchase of a qualified life annuity. 17. List the conditions under which an annuitant can “unlock” retirement funds. Solution - Access to a cash payment or series of payments may be possible where the annuitant is certified to have a significant shortened life expectancy because of a medical disability. - Access to lump-sum cash payment may be possible where the total value of the plan assets is quite low, based on specific criteria in the jurisdiction. - Access to a lump-sum cash payment for the entire LIRA/ locked-in RRSP account balance where the annuitant is no longer a resident of Canada under the Act. 18. Compare and contrast the characteristics of a Life Income Fund (LIF) and a Locked-in Retirement Income Fund (LRIF). Solution Similarities between a Life Income Fund (LIF) and a Locked-in Retirement Income Fund (LRIF). Both plans: - are a restricted form of a RRIF designed to hold and distribute locked-in funds. - are subject to all the rules of the Act that apply to RRIFs. - pension benefits regulations restrict withdrawals and provide spousal protection - follow the same general investment rules as a RRIF, and the same minimum annual withdrawal limit - are subject to maximum withdrawal limits, but the calculation is different between a LIF and LRIF - can only be established with funds transferred from specific registered plans Differences Similarities between a Life Income Fund (LIF) and a Locked-in Retirement Income Fund (LRIF): - calculation of the maximum withdrawal limit differs between the two plans. - A LRIF never requires the purchase of a life annuity with the balance of the plan’s assets by a prescribed point in time, whereas this is a requirement for some LIF depending upon the pension jurisdiction. - There are qualifying and non-qualifying LIFs. - LRIF available in Alberta, Manitoba, Newfoundland, and Ontario 19. How is the maximum withdrawal limit calculated for a LIF? Solution Maximum Payment = V ÷ P, where V = the value of the LIF on January 1 and P = the value of the projected annual pension of $1 beginning on January 1 of the year and continuing for the period ending December 31 of the year in which the annuitant turns age 90. The interest rate used to calculate the annual payments is usually less than 6 percent or the rate of interest on long-term Canada bonds for the first 15 years and a maximum of 6 percent thereafter. 20. How is the maximum withdrawal limit calculated for a LRIF? Solution The maximum payment for each year is equal to the greater of: - the LRIF minimum prescribed payment - net investment income, which equals total income earned less withdrawals. - The investment income earned during the immediately preceding fiscal year; and - For the first two years, 6 percent of the market value of the fund at the beginning of each year. Note: the formula can differ by pension jurisdiction. 21. What are the factors that determine the amount of income provided through an annuity? Solution The amount of income provided through an annuity is based on the amount of money deposited, interest rate assumptions, annuitant’s age, annuitant’s sex, the number of years that the financial institution promises to make payments and whether the payment amount increases over time. 22. What are the income tax implications of registered versus non-registered annuities? Solution Payments from registered annuities are fully taxable to the recipient in the year that the payment is received. With non-registered annuities, only the interest portion of the payment is taxable. The interest income can be reported based on the prescribed tax treatment or non-prescribed tax treatment. 23. Describe the prescribed taxation treatment. Solution The prescribed tax treatment assumes that the interest component of the annuity payment is spread out over the life of the annuity contract, and as such, the taxable income from interest remains level throughout the duration of the annuity. 24. Do temporary annuities and impaired annuities serve the same purpose? Solution No, temporary annuities provide payments for a specific period, such as, the period between an annuitant’s early retirement date and his regular retirement date. An impaired annuity is designed to pay a higher amount than a regular annuity to an annuitant who has been diagnosed with an illness or disability that may reduce his life expectancy. 25. Why would an individual purchase a reverse mortgage? Solution Since many people who their own homes free and clear of a traditional mortgage, they may wish to use some of the home equity to purchase a reverse mortgage as a way to augment their retirement income. Generally, Canadians who are at least age 62 can access the equity in their home and can defer repayment of the resulting debt, interest and principal associated with the mortgage, until the debt obligation becomes due at a point in the future such as at death or when the home is sold. 26. What is a Retirement Compensation Arrangement (RCA)? Solution A retirement compensation arrangement (RCA) is a plan or arrangement under which an employer, former employer or a non-arm’s length person makes contributions to a custodian, who holds the funds in trust for the purpose of distributing a benefit to the employee, on or after retirement, loss of an office or employment or any substantial change in services the employee provides. A RCA is used to provide a supplemental pension, above the limits imposed on registered savings for highly paid executives. Case Catherine Catherine, age 69, has been working for the last 35 years. She has approached you to provide advice on what she can do or has to do with her various retirement plans. She heard on the radio that she needs to convert her RRSPs by the end of the year in which she turns 69, which would be this year. Her assets are: RRSP, $250,000 A defined benefit registered pension plan, worth $310,000 from her old employer. Personal residence, $400,000 with no mortgage. A locked-in RRSP from a company she left 20 years ago, worth $50,000. Catherine has sent you the following questions: 1) Which assets does she have to convert by the end of this year? 2) What factors should she consider when selecting a retirement income product? 3) Assuming she converts the RRSP, the defined benefit pension plan and locked-in RRSP to one or all of the three plans, a RRIF, a LIF or an annuity: a. Are there any retirement assets that she is not allowed to transfer into any of the three plans? b. Assume that Harriet transfers her RRSP funds into a RRIF and her locked- in RRSP into a LIF and her pension plan funds into a qualified life annuity. i. Briefly explain the main characteristics of each type of plan. ii. Explain or calculate (if applicable) any minimum or maximum amounts that she needs to withdrawal under each plan one year after she establishes each plan. Assume she lives until 90 years, the interest rate is 6% and she receives one payment at the beginning of each year. iii. Explain the tax implications of receiving payments. 4) Catherine was watching TV last week and she saw an advertisement for “reverse mortgages”. She would like you to discuss the benefits and disadvantages of reverse mortgages. Solution – Catherine 1) Catherine is required to convert her existing RRSP, locked-in RRSP and the defined contribution pension plan into an income producing retirement product. 2) There are generally four factors to consider when choosing retirement income products from a financial institution. Flexibility of product – How flexible is the product to the needs of the client and is it possible to change the type of investments held within the product or the income schedule? Choice of investment options – What investment options are available