Planit:Case Study on Calculating and Entering Defined Benefit Pension Plans

From Planipedia

This case study is specific to financial planning in Canada, so has fixed values rather than indices by country. For a similar case study applicable to other countries, please see Planit:UK Defined Benefit Pension Plans Case Study, Planit:Malaysian Civil Servant Pension Case Study or Planit:Entering Other Revenues Case Study.

The Pension Plan is one of the most critical numbers that you input into your calculations and projections for your clients. With many variations and factors going into their calculations, it is important to be able to quickly calculate the pension plan amount without hassle. With benefit pensions there is a Defined Benefit Pension Calculator for an accurate estimate of the annual benefit and possible lump sum amount your client can receive.

Example Problem One: Defined Benefit Pension Plan:

Julie Evans is currently age 49, and hopes to retire in 6 years. She has given you a booklet from her work – where she has been working 20 years – that identifies some of the key properties of her defined benefit pension plan. They are listed below:

• Final Average Earnings are calculated over the period of the last 5 years. The Benefit Rate is 2%
• The Early Retirement Reduction Factor is 5%.
• The Normal Retirement Age is based on the age plus service factor, which is 85. The pension is integrated with CPP.
• Julie has also indicated that she would like Survivor Benefit Upgrades to assume a 60% survivor option.

Julie wants to know the amount that she will receive from this pension plan upon retirement.

She has also told you her current salary is $60,000 and her inflation assumption is 4%.

Solution Using the Pension Calculator:

Use the Defined Pension Plan Calculator, a calculator spreadsheet tool. The yellow boxes show where data entry is necessary.

1. In the Client’s Age Today field, enter Julie’s age 49.

2. Set the Current Years of Service field to 20 as Julie identified.

3. Set the Target Retirement Age to 55.

5. Set the Inflation Assumption to 4.0%.

6. The Final Average Earnings Period can be set to 5, since this is what Julie’s pension booklet identified.

7. The YMPE can be left at the default since it is set by the government every year and is set as a default in the spreadsheet.

8. The Pension Formula to YMPE is the same as the Benefit Rate, which in this case is 2.0%

9. The Pension Formula on Excess is a field for when the pension is two- tiered and has a different rate for the amount exceeding the YMPE. Julie’s pension is not two tiered, so this field should be set to the same rate as the Pension Formula to YMPE field.

10. The Reduction Factor per Year can be set to 5.0%

11. The Normal Retirement Age or Age Plus Service Factor can be set to 85.

Note: you do not need to identify which type of pension plans your number is reflecting: Normal Retirement Age or Age Plus Service. Based on the number entered, the spreadsheet will automatically deduce how to treat the pension.

12. The Maximum Reduction field can be left at the default of 100%.

13. Since Julie indicated she wanted a 60% survivor options, according to the paragraph at the bottom of the spreadsheet, this would require a 10% reduction in the overall benefit. So in the Further Reduction for Survivor Benefit Upgrades field, a value of 10% should be input.

14. Beside Is the Pension Integrated with CPP, type “Yes” in full.

15. Record the value of the Lifetime Pension and Pension Bridge for later entry into the Pensions and Other Revenues screen.

After calculating the amounts of Julie’s Lifetime Pension and her Pension Bridge, we can exit the Pension Calculator Spreadsheet tool, and return Home using the link on the top menu bar.

From here, click on the link Pensions and Other Revenues.

1. Click Add above the existing revenue streams

2. Enter an appropriate Description such as Julie’s Lifetime Pension

3. The Owner drop-down list can stay at its default.

4. In the Amount Per Year field, enter the amount you recorded from the Pension Calculator Spreadsheet for Julie’s Lifetime Pension.

5. Set the From Year to start at her retirement at her age 55, 6 years from now.

6. Set the To Year to Julie’s assumed mortality at age 90, 41 years from now.

7. The Index Rate can be left at the default, since it will be the same as the inflation assumption in the Personal Information screen, and the index rate you used when calculating the pension amount.

8. Since the pension is fully taxable on receipt, the Percent Taxable can remain at 100%

9. The Amount on Death and Amount on Disability should both be set to 20%.

Note: because Julie has not actually retired yet, she is not receiving the pension or survivor benefit upgrades. When this does happen, the Amount on Death and Amount on Disability can be set to 60% as allowed by the reduction for the survivor pension benefit. The 20% value was displayed in the Pension Calculator Spreadsheet.

10. The Model As option should be set to Start During Retirement since only the start year will be pushed back in the event that retirement is delayed.

11. The Additional Increase field allows you to identify by how much the value of the pension will increase annually as retirement is delayed. The value input should be the same as the Pension Formula or Benefit Rate: in this case 2.0%.

12. Click Save to return to the summary Pensions and Other Revenues

To complete Julie’s Defined Benefit Pension Plan, you must also add her Pension Bridge.

1. Click Add above the existing revenue streams

2. Enter an appropriate Description such as Julie’s Pension Bridge

3. Leave the Owner at Client in the drop-down list

4. In the Amount Per Year field, enter the amount you recorded from the Pension Spreadsheet Calculator for Julie’s Pension Bridge.

5. Set the From Year to start at her retirement at her age 55, 6 years from now.

6. Set the To Year to Julie’s age 64, 15 years from now.

7. The Index Rate can be left at the default, since it will be the same as the inflation assumption in the Personal Information screen, and the index rate you used when calculating the pension amount.

8. Since the pension is fully taxable on receipt, the Percent Taxable can remain at the default of 100%

9. The Amount on Death and Amount on Disability should both be set to 0% as was displayed in the Pension Calculator Spreadsheet.

10. The Model As option should be set to Start During Retirement since only the start year will be pushed back in the event that retirement is delayed.

11. The Additional Increase field allows does not apply for Pension Bridges, so this field can be set to 0%.

12. Click Save to return to the summary Pensions and Other Revenues

Go to the exercise to test your knowledge on Calculating and Entering Defined Benefit Pension Plans