Get involved in client’s pension planning

In the Canadian psyche, the RRSP has become synonymous with retirement. So much so, that most folks forget to factor in other sources of pension, which make up a significant part of their retirement incomes — in many cases more than their personal savings.

Alternative pension plans have become an even more important component of the income support system for retirees, given volatile markets, the challenges of an aging population, and the changing nature of pension plans.

Kirk Polson, an investment advisor for the Polson Bourbonniere Financial Planning Group at Dundee Wealth, agrees defined contribution plans are too often neglected by employees. “To me it’s a no-brainer. You want to make sure you take advantage of all the employer contributions,” he says.

He adds advisors have a huge role to play in making sure clients make the right investment choices within pension planning, and that their defined contributions are coordinated with their overall retirement strategies. “And coordinated not only for investment, but also for when the clients want to retire and how much income they wish to draw at retirement.

“If a client has 10 to 20 investment choices in the defined contribution plan, the tendency is to look at those choices and chase the returns, without considering the investment time horizon,” Polson adds.

Advisors, he says, can determine what investments make the most sense by looking at a client’s pension plan to see how much he or she might need to contribute; determining whether, and how much, company money is actually going into the pension plan; weighing investment options; measuring risk tolerance; and ascertaining retirement objectives.

When it comes to balancing a defined contribution plan with an RRSP, Polson suggests advisors make sure not to duplicate the investment options the employer already has in the pension plan, but rather look at a different management approach. “If they have all active managers in the pension plan, we’d look toward having more passive managers outside it.”

Defined benefits vs. defined contributions

In these volatile times, many employers have switched from defined benefit plans to defined contribution plans in an effort to cut costs and remain profitable. Benefit plans establish payouts for employees once they retire. Thus, in times of economic distress, companies are forced to make up shortfalls resulting from lower investment returns in their pension funds. By contrast, defined-contribution plans set out how much cash workers and companies put into the retirement pot, not how much gets paid out. The employees are responsible for selecting the investments they hold, and therefore responsible for the returns they earn.

Polson says a lot of employees are pleased with the switch because suddenly they have access to a pool of capital. “But they need to take stock of how the new defined contribution plan measures with the old defined benefit plan. They also have to keep in mind how much risk they are prepared to take, because now the employer contributions will fluctuate with the markets.”

In such an environment, he stresses advisors must religiously review their clients’ investments in a defined contribution plan, and have a carefully designed plan for a long-term strategy. “Especially, given the current markets, advisors must reconfirm if their clients’ financial goals have changed, or if they need to reassess their risk tolerance.”

Polson adds employees quite often miss the boat in understanding the role asset mix plays. “They have to understand asset mix drives the returns. Sometimes being conservative is a risk too.”

Retiring as non-residents

Investment considerations and tax implications can drastically change if your clients plan to move south of the border after retirement.

“If they are former Canadian residents, where a majority of their wealth is back in Canada, yet their long-term retirement lifestyle is going to be in the U.S. dollars, it can create issues from a long-term planning perspective,” says Terry Ritchie, a Calgary-based cross-border financial planner with expertise in both American and Canadian tax regimes.

For such clients, Ritchie tries to hedge the dollar.

“We do look at allocating and developing portfolios relative to risk tolerance, and what stage in life our client is in. But we have to go a step further, and make sure investments are more U.S. dollar-based over time, so that when we do have a requirement for income in the U.S., they’ve already got assets in the U.S. dollar.”

In most cases, profit-sharing plans can be rolled into self-directed RRSPs. And if the client severs Canadian tax ties, assets in those plans can grow on a tax-deferred basis within Canada.

And then there’s the pension factor. “When the dollar touched par in November of 2007, we encouraged clients in the U.S., who hadn’t collapsed their RRSPs, to do so,” says Ritchie. “If the dollar were to go down to 70 cents it would create some long-term impact.”

Clients locked into defined contribution plans may not always have the ability to collapse these plans. In those cases, under the Canada-U.S. tax treaty, the payor is obligated to hold back 15% of non-resident withholding tax for Canadian non-residents receiving a corporate pension in the U.S.

The pension is also fully taxable in the U.S., so make sure your client recovers some of that tax in lieu of the 15% withholding tax already paid in Canada.

“The two biggest determinants of good performance are tax and cost,” says Ritchie. “If portfolios are tax efficient and use cheap products such as ETFs, we can minimize risk and enhance returns.”