Buried deep within this week’s federal budget is an announcement that can substantially improve Canadian retirements.
It has to do with annuities – not exactly a sexy area for most of us, but one that deserves attention as millions of baby boomers march into retirement.
The retirement wave is becoming a growing national concern. The problem? At the same time as many Canadians are reaching retirement age, traditional corporate pensions are becoming an endangered species. More and more employers are turning away from defined-benefit plans, the once-standard type of pension deal that guaranteed you a set monthly cheque for as long as you lived.
Many employers have now shifted to defined-contribution plans, where workers tuck away a certain amount of savings every month. These plans can help an employee accumulate a substantial stash over the course of his or her career. The problem is that once the employee retires, it is entirely up to him or her to figure out how to transform those accumulated savings into a steady stream of income that can last a lifetime.
This would be a tricky job even for a pension pro. It’s an entirely unrealistic demand to make of individual retirees, many of whom are anything but expert investors.
One of the biggest challenges is that individual retirees no longer have an easy way to pool risks with other retirees, the way they do in traditional defined-benefit plans, where those who live an exceptionally long time are subsidized by those who don’t live quite so long. Without that backstop, many individual retirees face the risk of running out of savings in retirement.
What would be better? An arrangement that would allow retiring workers to put some or all of their defined-contribution-plan savings into an investment pot that would pool their contributions with those of other people. It would be professionally managed at low cost, with sustainable withdrawal rates set by an actuary. This arrangement would produce a monthly cheque that might vary somewhat depending on investment returns, but would be guaranteed to last for life.
This is not a fanciful notion. The University of British Columbia faculty pension plan has been successfully running such a system for its defined-contribution members since 1967. But the UBC plan has been an aberration, because of later legislative changes that blocked other plans from following in its footsteps.
Now, those legal barriers are falling. Much of the thanks go to a coalition of retirement experts spearheaded by Bonnie-Jeanne MacDonald, director of financial security at Ryerson University’s National Institute on Aging, and Keith Ambachtsheer, a pension consultant and director emeritus of the International Centre for Pension Management at the University of Toronto. Together with others, they prodded Ottawa to open the door to new types of annuities.
The most significant change in this week’s federal budget is a promise to revise rules to allow what are known as variable payment life annuities, or VPLAs. Forget the unlovely name: Think of these plans as a way for members of defined-contribution plans to efficiently convert the savings they have built up within the plan into an actual pension – one that would last for life, be professionally managed at low cost and pool risks across a large number of people.
In effect, these new types of pooled-risk pensions would go a substantial way to restoring what employees lost with the demise of defined-benefit plans.
How soon will we actually see VPLAs in workplaces? Prof. MacDonald says it won’t happen overnight. First, Ottawa must put the new rules in place, then provinces will have to pass similar legislation. Once the legal framework is complete, large companies and quasi-public plans such as universities will likely be the first adopters. From there, the idea is likely to spread.
Other new annuity products could play a growing role in retirement planning, too. For instance, the budget opens the door to advanced life deferred annuities (ALDAs), which are products that would allow a purchaser to buy a guaranteed stream of income for life that would commence at the age of 85.
A retiree in her early 60s could invest a small amount in an ALDA as a form of longevity insurance – protection against the possibility that she will live to 100. With that guaranty in her pocket, she could invest and spend more aggressively during her 60s and 70s.
Ian McGugan