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Retirement Ottawa should consider this simple solution for curing retirement anxiety

Ottawa could radically simplify Canadian retirement planning with a few simple, low-cost changes to the tax code. The potential winners would include everyone who worries about running out of money in their old age.

All that is required, according to a new C.D. Howe Institute report, is minor tinkering with existing tax regulations. The changes would open the door to “longevity insurance” – a financial product that would buffer people against the high cost of living to 90 or beyond.

The financial challenge of funding exceptionally long retirements has become more imposing as guaranteed pensions have become rarer and lifespans expand. "The single thing that retirees without a defined-benefit pension plan worry about the most is the possibility they will run out of money before they run out of life,” said Don Ezra, author of the report, in a phone interview. “They have no idea how to cope with that problem.”

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Many retirees address the issue by building buffers of excess capital. They save more than they need, spend less than they could and leave a pot of money behind. But that forces them to endure a more spartan retirement than they could actually afford in retrospect.

What’s needed, but what isn’t now available, is a product that could allow a 65-year-old to purchase a guaranteed-for-life stream of income that doesn’t actually begin for another, say, 20 years. In one stroke, this longevity insurance would convert the great unknown of retirement planning – how long must I make my money last? – into a known quantity.

A person who was able to purchase longevity insurance could feel free, in an extreme case, to spend every penny in their portfolio between the ages of 65 and 85. The buyer would know that at the age of 85, their longevity insurance would start paying them a regular income, and that income would last for the rest of their lives.

In many ways, this ideal product would resemble the annuities now on the market, but with one key difference: The annuity products that currently exist start paying out money immediately, but longevity insurance wouldn’t start paying out until a couple of decades in the future.

Mr. Ezra, a former co-chair of global consulting at Russell Investments, acknowledges the long delay before payments start would make longevity insurance a tough sell at first. Someone buying such a product today would face the risk they might never collect on the insurance if they die before the date that payments begin.

But that risk would be offset by the obvious positives, especially for people with reasonably large – but not huge – retirement portfolios. For those people, longevity insurance would offer a relatively cheap way to offset the chance they will live to an unusually advanced age. While the exact pricing would still have to be determined, longevity insurance would nearly certainly be far less expensive than accumulating the mountain of money that would otherwise be required to ensure a couple can live comfortably until the age of 100 or even beyond.

“A typical non-smoking couple, husband age 65, wife age 60, faces a one-in-four chance of having at least one of them live to be 100,” Mr. Ezra said. Longevity insurance could provide peace of mind for such a couple, at relatively small cost.

So why isn’t longevity insurance already available? The problem is Canada’s tax code. Its punitive approach to taxing deferred-payment products has deterred annuity providers from coming to market with such products.

Under existing rules, buyers of longevity insurance would be forced to pay tax on gains in the underlying portfolio even in the years before they started collecting money. As you can imagine, nobody is going to buy a product that would require them to pay tax today on future income – especially since they might never receive that income if they don’t live long enough.

Fortunately, it would not take much to make longevity insurance a viable product. The rules would have to be altered to tax the income from longevity insurance only when it actually gets paid out. Longevity insurance products would also have to be made exempt from the minimum-withdrawal rules in tax-sheltered accounts.

But changing the tax code to reflect those shifts shouldn’t cost other taxpayers much, if anything. The same total pool of money would still wind up being taxed; it would only be the timing that would shift.

The result would be a fascinating and useful new product for consumers concerned about the possibility of outliving their money. For that reason, we should hope policy makers listen to Mr. Ezra’s notion.

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