Copycat Annuity

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longinvest
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Copycat Annuity

Post by longinvest »

I'm opening a topic about copycat annuities. It's the first time I'm hearing about such a thing:

Worried about your pension? Why a ‘copycat’ annuity might be right for you
by Alexandra Macqueen, The Globe and Mail, January 11, 2018
Alexandra Macqueen wrote:In a recent case Ms. Koiv reviewed, a pension that paid $4,600 a month to start, rising with inflation over time, had a commuted value of $1.6-million, but the amount that could be transferred to a tax-sheltered account was approximately $600,000. This meant that if the employee commuted her pension as a lump sum, she'd get a tax bill of approximately $500,000 on the remaining $1-million.

However, if she chose to buy a copycat annuity to mirror the pension benefit, she could avoid the tax bill and retain an income for life that isn't subject to market fluctuations. If the commuted value is not enough to let the plan member buy an annuity that fully mimics what the plan would have provided, the Canada Revenue Agency will still allow it provided the annuity is not "materially different" from what the plan would have provided.
I used to think that only three option existed when one leaves a job with a pension plan:
  1. leave the money in the plan,
  2. transfer the money into a LIRA and pay tax on any money exceeding the maximum transferable amount unless it's transferred into an RRSP, or
  3. transfer the money into another employer pension plan.
Apparently, there's a fourth option.

Feel free to share any additional knowledge you have about copycat annuities.
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Re: Copycat Annuity

Post by brucecohen »

A friend sent me that article a few days ago and it was new to me too. I wish Alexandra (an FWF member) had included numbers from a real case so we could see how much of a haircut the plan member took. In addition to covering the market and longevity risk it assumes, the insurer has to cover the cost of providing a custom quote and, of course, the cost of a sales commission. ISTM because the pool is much smaller than that of the DB membership, the insurer's market and longevity risk will be much greater.

Notwithstanding space limitations, I wish Alexandra had pointed out that it's important to check the health of the DB plan, not just the health of the employer. Because DB assets are held in trust separate from the sponsor's assets, it is possible for an ailing company to have a plan that's reasonably well funded. The friend who sent me the article works for a company in a struggling industry, but it's DB plan is more than 90% funded. Would you accept, say, a 50% haircut from the insurer when sitting tight might get you 80-90% once the company completes bankruptcy?

One sentence in the article confused me and I've been too lazy to ask Alexandra directly. My reading is that this is generally available only to those more than 10 years from pensionable age. Since plans typically set their early retirement age 10 years below the normal retirement age, I think she meant this is available only to those who have not yet reached the early retirement age. That's when the commutation window closes.
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Re: Copycat Annuity

Post by cnicole »

I thought i'd post here in case someone is searching for copycat annuity and finds this thread. The sunlife post i found states there can't be a material difference between the pension and annuity according to revenue canada. However they say revenue canada hasn't issued any guidelines about this so you wouldn't know until tax time when if revenue canada didn't think they were similar enough they'd tax the full amount of the annuity. I can't find the document now of course.

I found it its called Transfers from a registered pension plan to a sunlife payout annuity advisor guide
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Re: Copycat Annuity

Post by ghariton »

Section 147.4 (1) of the Income Tax Act:
RPP annuity contract
147.4 (1) Where
(a) at any time an individual acquires, in full or partial satisfaction of the individual’s entitlement to benefits under a registered pension plan, an interest in an annuity contract purchased from a licensed annuities provider,
(b) the rights provided for under the contract are not materially different from those provided for under the plan as registered,
(c) the contract does not permit premiums to be paid at or after that time, other than a premium paid at that time out of or under the plan to purchase the contract,
(d) either the plan is not a plan in respect of which the Minister may, under subsection 147.1(11), give a notice of intent to revoke the registration of the plan or the Minister waives the application of this paragraph with respect to the contract and so notifies the administrator of the plan in writing, and
(e) the individual does not acquire the interest as a consequence of a transfer of property from the plan to a registered retirement savings plan or a registered retirement income fund,
the following rules apply for the purposes of this Act:
(f) the individual is deemed not to have received an amount out of or under the registered pension plan as a consequence of acquiring the interest, and
(g) other than for the purposes of sections 147.1 and 147.3, any amount received at or after that time by any individual under the contract is deemed to have been received under the registered pension plan.
From CRA's technical notes:
Subsection 147.4(1) of the Act is intended to protect annuity acquisitions only where the rights provided for under the annuity contract are not materially different from those provided for under the RPP. The ultimate determination of what exact rights are provided for under the RPP has been tied to the concept of plan as registered as defined in subsection 147.1(15).

It is not intended to allow a plan member to reconfigure the amount or modify the form of the benefits provided under the RPP. Plan members who want such flexibility can achieve this by transferring the value of their pension entitlements to an RRSP or RRIF (within the constraints of section 147.3 of the Act).
Section 147.1(15) of the ITA:
Plan as registered
(15) Any reference in this Act and the regulations to a pension plan as registered means the terms of the plan on the basis of which the Minister has registered the plan for the purposes of this Act and as amended by
(a) each amendment that has been accepted by the Minister, and
(b) each amendment that has been submitted to the Minister for acceptance and that the Minister has neither accepted nor refused to accept, if it is reasonable to expect the Minister to accept the amendment,
and includes all terms that are not contained in the documents constituting the plan but that are terms of the plan by reason of the Pension Benefits Standards Act, 1985 or a similar law of a province.
So you have to look to the details of the commuted pension as set out in its registration documents, to see if there is a material similarity. I suspect that this will be a matter of judgment by CRA and, if appealed, by the courts.

I'm not aware of any case law interpreting s. 145.4(1), but then I don't have access to the specialized databases that a tax lawyer would have.

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Re: Copycat Annuity

Post by longinvest »

Given the significant amount of money involved, can't a tax payer ask the CRA for some kind of advance ruling? If yes, are there costs involved in that?
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Re: Copycat Annuity

Post by cnicole »

It sounds like from the sunlife guide that you can't get an advance ruling but the person would have to talk to their annuity provider or revenue canada to be sure.
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Re: Copycat Annuity

Post by brucecohen »

longinvest wrote: 18 Feb 2018 08:29 Given the significant amount of money involved, can't a tax payer ask the CRA for some kind of advance ruling? If yes, are there costs involved in that?
Yes, you can seek an advanced tax ruling but there are criteria and it would cost at least several hundred dollars as CRA charges for the time involved. See here and here.
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Re: Copycat Annuity

Post by Shakespeare »

You can also transfer the commuted value to an LRSP/LRIF, which is what I did.
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Re: Copycat Annuity

Post by Lea Koiv »

With respect to copycats, I am quoted by Alexander Macqueen extensively in the article in The Globe. I have considerable experience here, and am on some bodies seeking greater clarity from CRA. I was also involved in having CRA change its policy some years ago with respect to these annuities. With a lot of copycats, there is no issue in replicating what the plan would provide. The situations which are more interesting are those in which the commuted value is not sufficient to provide the same rights as the pension plan would. The rights under the annuity that is issued cannot be considered by CRA to be "materially different" from the rights under the pension plan. I am dealing with a number of clients who are in poorly funded plans sponsored by companies who are not in good shape. Who wouldn't want to bail in a situation such as this? The "Factor of 9", which underpins the tax assistance to retirement savings, is sadly out of date. Interest rates were very different in 1991 than they are today. Thus, the maximum transfer rule, when put in place in 1991 was meant to catch (i.e., limit) transfers from Cadillac DB pension plans to money purchase plans (RRSPs, DC RPPs, etc.). But even Plain Jane plans (no indexing, etc.) are being caught. A copycat lets the plan member remain in a defined benefit environment. Thus, assuming no investment, market or longevity risk. Sadly, a copycat is only available if the provisions of the pension plan allow for this. Anyone contemplating commuting their pension needs to seek an experienced advisor. I see a lot of bad advice here, especially in situations that I am the "expert witness" for litigation in this area.
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Re: Copycat Annuity

Post by longinvest »

Lea, could you clarify two points for me? Did you mean that if I decided to leave my employer before age 55, I won't be able to buy a copycat annuity unless my employer's pension plan has specific provisions for it? Also, did you mean that if the commuted value is not sufficient to provide similar payments, the lower-payment copycat annuity will be considered "materially different" by the CRA?
Last edited by longinvest on 20 Feb 2018 22:19, edited 2 times in total.
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Re: Copycat Annuity

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Lea Koiv wrote: 19 Feb 2018 16:46 I am dealing with a number of clients who are in poorly funded plans sponsored by companies who are not in good shape. Who wouldn't want to bail in a situation such as this? The "Factor of 9", which underpins the tax assistance to retirement savings, is sadly out of date. Interest rates were very different in 1991 than they are today.
Lea, thanks for joining the conversation. Without naming any names could you describe a real case. As I mentioned above, I don't understand how with added costs and the bespoke nature of the arrangement an insurer can deliver the same benefit as a pension plan at the same cost. That is, unless the client is male since the pension has to reflect unisex mortality while the copycat, I assume, could use a male longevity table.

I've long thought the Factor of 9 is out of date and have wondered why there hasn't been an adjustment.

Also, could you please clear up a point in Alexandra's article that I found confusing. Is a copycat available once a person has reached the plan's early retirement age?

And, if the pension due is more than $2,000/month can the copycat be divided between two insurers for full Assuris coverage?
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Re: Copycat Annuity

Post by Lea Koiv »

With respect to the question of what happens if there isn't enough money, CRA has published commentary on still being able to proceed and not automatically being offside. This has been their position since 2012. (Up until they changed their position - and I had a hand in this - one could not have proceeded.)
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Re: Copycat Annuity

Post by Lea Koiv »

With respect to Bruce Cohen's question, one has to change one's thinking about annuities bought with funds from commuted values. The actuary, in calculating the commuted value, has to use certain interest rates. For example, the January 2018 rates for the first 10 years for a non-indexed plan were 1.8% and 3.3% thereafter. For a fully indexed plan, 1.3% for the first 10 years, and 1.5% thereafter. Commuted values are sky high because the CIA interest factors are so low. Because of these low interest rates, I am seeing commuted values in the $2M range, especially for indexed plans. If you look at these rates, they are not unlike the rates that an insurer would be earning on the investments backing the annuity. Also, remember that there is the mortality credit that comes into play with annuities. This is why they work. We have to stop thinking about the fact that "this is a poor time to purchase an annuity". This mindset isn't appropriate when one is thinking about a copycat.

As to whether someone can have a copycat, let's look at Ontario's pension legislation. The legislation governs when someone can actually commute their pension. The legislation further provides that if a plan does allow someone to commute, the annuity option is only available if a plan allows for it. Thus, theoretically in Ontario a person may be able to commute their pension but not necessarily acquire a copycat with their commuted value. Whacky, but this is how the legislation reads.

To me, the copycat lets someone stay in a defined benefit environment.

Hope that this helps.
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Re: Copycat Annuity

Post by Lea Koiv »

One more response to Bruce. Remember that with a copycat the annuity has to have the same rights as the pension paid by the plan would have had. Thus, if someone is entitled to a pension (discounted or not) upon an early retirement, the copycat could start to pay at this same date. You would want to know what the amount would be at that date and try to match it (and the other rights).
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Re: Copycat Annuity

Post by ghariton »

From CRA's technical manual (which I linked to above):
There may be circumstances where the commuted value is not sufficient to purchase an annuity with the same payout. The fact that the annuity payments are less than the benefits provided under the RPP will not in and of itself cause the annuity acquisition to lose the protection afforded by subsection 147.4(1) of the Act.
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Re: Copycat Annuity

Post by Flights of Fancy »

Notwithstanding space limitations, I wish Alexandra had pointed out that it's important to check the health of the DB plan, not just the health of the employer. Because DB assets are held in trust separate from the sponsor's assets, it is possible for an ailing company to have a plan that's reasonably well funded. The friend who sent me the article works for a company in a struggling industry, but it's DB plan is more than 90% funded. Would you accept, say, a 50% haircut from the insurer when sitting tight might get you 80-90% once the company completes bankruptcy?
This is a great point, which I wish had been included. Getting this piece through the editorial process was exceptionally tough. If I had had free rein, the piece would have looked substantially different than it does, although I am ultimately satisfied with what was published.

Lea is the expert here and is much more qualified to answer your questions than I. There is *almost nothing* published on copycat annuities so it is difficult to validate or verify information. The numbers given in the piece are an accurate reflection of an existing, real-life case.
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Re: Copycat Annuity

Post by Flights of Fancy »

And, if the pension due is more than $2,000/month can the copycat be divided between two insurers for full Assuris coverage?
Yes.
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Re: Copycat Annuity

Post by longinvest »

Lea Koiv wrote: 21 Feb 2018 00:16 As to whether someone can have a copycat, let's look at Ontario's pension legislation. The legislation governs when someone can actually commute their pension. The legislation further provides that if a plan does allow someone to commute, the annuity option is only available if a plan allows for it. Thus, theoretically in Ontario a person may be able to commute their pension but not necessarily acquire a copycat with their commuted value. Whacky, but this is how the legislation reads.
Lea Koiv wrote: 21 Feb 2018 00:01 With respect to the question of what happens if there isn't enough money, CRA has published commentary on still being able to proceed and not automatically being offside. This has been their position since 2012. (Up until they changed their position - and I had a hand in this - one could not have proceeded.)
Lea, thanks for the clarifications.
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Re: Copycat Annuity

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Lea Koiv wrote: 19 Feb 2018 16:46 I am dealing with a number of clients who are in poorly funded plans sponsored by companies who are not in good shape. Who wouldn't want to bail in a situation such as this?
Unfortunately, in QC, bailing out might not change much for the individual anymore:

http://www.benefitscanada.com/pensions/ ... ding-77211
The new law also affects the minimum rights employees have when they leave their jobs and, therefore, their pension plans.

When employees leave the plan, they can choose to receive a lump sum reflecting the value they’ve accrued. Plan sponsors now have the option to pay the transfer value based on the solvency ratio of the plan. As a result, they no longer have to provide a 100% payout if the plan isn’t fully funded on a solvency basis, says Dickner. For example, if the plan is at 90% funding on a solvency basis, the employee will receive 90% of the commuted value.
At the same time, the new QC law removed the solvency requirement for the plan itself!
Bill 57, which took effect on Jan. 1, removes the requirement to fund private defined benefit pension plans on a solvency basis. A valuation on the basis of solvency assumes the plan folds suddenly and looks at whether or not it holds enough assets to pay out all obligations accumulated until that time immediately.
...
Under the new rules, employers will have to fund their plans on a going-concern basis. A going-concern valuation assumes the plan will exist indefinitely and therefore lessens the impact of short-term market fluctuations on its funded status.
In other words, the solvency ratio is now only used to reduce the commuted values of members quitting the plan. So, members of badly funded plans will only crystallize an otherwise theoretical deficit, losing any chance of future funding improvements.

Even if copycat annuities were/are (?) available in QC, they might not be very useful. :(
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Re: Copycat Annuity

Post by Peculiar_Investor »

Lea Koiv wrote: 19 Feb 2018 16:46 With respect to copycats, I am quoted by Alexander Macqueen extensively in the article in The Globe.
Welcome to FWF and thank you for joining the discussion.
Flights of Fancy wrote: 21 Feb 2018 03:37 Lea is the expert here and is much more qualified to answer your questions than I. There is *almost nothing* published on copycat annuities so it is difficult to validate or verify information. The numbers given in the piece are an accurate reflection of an existing, real-life case.
Welcome back from an extended absence and thank you for joining the discussion as well.
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Re: Copycat Annuity

Post by Flights of Fancy »

So, members of badly funded plans will only crystallize an otherwise theoretical deficit, losing any chance of future funding improvements.
Yes and note the corollary as well: members of badly-funded plans *where there is no requirement to calculate the commuted value based on solvency ratios* are able to "escape" the less-than-fully-funded pension by commuting -- but remain in a DB environment by commuting to an annuity. (Note the comment about the Sears pensioners in the original article.)
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Re: Copycat Annuity

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Flights of Fancy wrote: 21 Feb 2018 08:56
So, members of badly funded plans will only crystallize an otherwise theoretical deficit, losing any chance of future funding improvements.
Yes and note the corollary as well: members of badly-funded plans *where there is no requirement to calculate the commuted value based on solvency ratios* are able to "escape" the less-than-fully-funded pension by commuting -- but remain in a DB environment by commuting to an annuity. (Note the comment about the Sears pensioners in the original article.)
Effectively. I guess that the QC law stopped this because letting people flee with the full commuted value, when the solvency is low, worsens the solvency ratio and forces remaining DB members to assume not only their own share of the deficit but also that of those who leave the plan. It's probably a good law for pension plans, but it closes the door to those who wanted to take advantage of the impact of low interest rates to flee with an inflated commuted value, or with a better-funded copycat annuity when the DB plan solvency ratio is low.

Individuals in badly funded plans (outside of QC) who are able to escape with a full commuted value have a definite advantage to do it, especially if they can keep all of it sheltered from taxes by buying a copycat annuity. They keep the advantages of the pension while removing the funding risk.
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Re: Copycat Annuity

Post by fireseeker »

Hoping one of the experts can answer this:
Can a copycat annuity be set up to match CPP bridging?
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Re: Copycat Annuity

Post by cnicole »

Just a note that i did get an annuity quote for my commuted value and the amount was almost exactly equal to my pension. The issue is i doubt it included indexing.
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Re: Copycat Annuity

Post by brucecohen »

cnicole wrote: 23 Feb 2018 11:58 Just a note that i did get an annuity quote for my commuted value and the amount was almost exactly equal to my pension. The issue is i doubt it included indexing.
A few years ago the chief actuary of the Ontario Teachers' Pension Plan told me that the indexing commonly available in public employee plans adds about 25% to the cost of the pension.
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