The Public Employees Benefits Agency, which administers the pension plan for public sector employees in Saskatchewan, has been looking at how to support members around decumulation for several years.
“It’s a big issue. If you think about it, many people in a defined contribution plan go into a default fund and stay there forever. So they’ve never had to make a decision, but all of a sudden they retire and they have a big pot of money,” says John Hallett, assistant director of pension programs.
Ten years ago, the organization introduced a variable benefit program that allows members to keep their money in the pension plan after retirement and withdraw from it as they wish. They continue to benefit from the lower fees a group plan provides and stay in an arrangement they’ve grown accustomed to for years, says Hallett. “Otherwise, they have to go out to the marketplace and search for products or an advisor. If you’ve never done it before and all of a sudden you have to do it, you’re a little nervous.”
And because there’s no maximum for withdrawals, the organization provides members with decumulation guidance and financial planners who can answer questions about retirement, says Hallett. “We try and inform them as much as we can about the different risks. We’ve seen people who have made $20,000 a year and, when they retire, they figure they can take out $40,000 and the money will last forever. We give them an illustration showing that’s not the case.”
Decumulation remains a concern for Canadian policy-makers, notes Jillian Kennedy, leader of defined contribution and financial wellness at Mercer.
“I think when we take a look at decumulation, our biggest sense of worry and discomfort comes from the fact that we don’t really have much out there that an employee can take advantage of,” says Kennedy. “We kind of drop them back into the retail market, and it becomes this whole slew of products that employees have to choose from.”
Canada isn’t alone, as policy-makers from other countries with maturing industries for capital accumulation plans are still unsure about how to handle the issue, notes Kevin Wesbroom, principal consultant at Aon Hewitt in Britain. “Nobody has the answer to this. Nobody’s cracked the problem.”
In 2015, Britain introduced legislation to discontinue mandatory annuities. “We went from this position where we had a very inflexible system . . . to one that was complete free market,” says Wesbroom.
The British government likely made the change because it was facing pressure from retirees who didn’t want to buy annuities under poor economic conditions, says Mazen Shakeel, vice-president of market development for group retirement services at Sun Life Financial. He notes the government would also profit from more retirees taking out a lump sum because it can capture additional tax revenue.
But while Britons now have more flexibility, they’re also more vulnerable because they have to make important decisions upon retirement, says Wesbroom, noting the country’s decumulation phase conflicts with its approach to accumulation, which has automatic enrolment as the standard.
While employees can often afford to skip making big decisions about their pension plans because of the defaults available, there’s a lack of similar options after retirement, says Wesbroom. “With decumulation, you have to involve the individual. You have to tell me: Do you value certainty or do you want flexibility? . . . What’s your personal circumstances? Because only then can we come up with something sensible to decide what the best strategy is for you.”
So as Canada and Britain struggle with the issue, what are other jurisdictions doing about it?
Like Britain, Australia has an established defined contribution pension system in which employers must contribute 9.5 per cent of wages, says Nick Callil, the Melbourne-based head of retirement solutions at Willis Towers Watson.
But decumulation is starting to come to the forefront, says Callil. “It’s only now we’ve seen substantial money starting to emerge in retirement, and that’s clearly going to accelerate in the next 10 to 20 years. So now there’s this recognition that we haven’t really sorted out decumulation and we really need to.” Indeed, a recent Willis Towers Watson study showed Australia had surpassed Canada at the end of 2016 as the world’s fourth-largest pension market, with US$1.6 trillion in defined contribution assets.
But contrary to Britain, most retirees in Australia withdraw their funds in a lump sum or use account-based pensions that provide a stream of regular income. According to Callil, the latter option is popular because it’s more flexible than annuities and, apart from adhering to an annual minimum withdrawal amount, retirees can determine how much they take out.
That option doesn’t offer longevity protection, however, says Callil. He notes while research has shown people don’t misuse their plans and often withdraw just the minimum amount, that could change in the future. “There’s an argument that the coming generation of retirees, who would have accumulated more money, will also have more desire to maintain the lifestyle they’re used to and may be inclined to draw more than what the account can sustain.”
But the alternative, annuities, isn’t very popular in Australia, says Callil. For one, many people see them as bets against insurance companies, he says. “If they don’t win that bid, in other words — if they die early — then they lose and the money stays behind.”
The annuity market is also small, and there hasn’t been much variety in the types of products available, says Hazel Bateman, professor and head of the school of risk and actuarial at the University of New South Wales. For instance, deferred or variable annuities aren’t available because Australia’s regulations require them to provide fixed payments, except in the case of indexation, says Bateman.
Due to decumulation concerns, there has been pressure on the government to make the annuity market more competitive and explore other retirement options, according to Bateman. In 2014, the Australian government reviewed the financial sector and recommended a new comprehensive product that Bateman says would provide “longevity insurance but would also have the flexibility of an account-based option.”
While the government has yet to finalize the concrete details for the product, it’s looking to launch it by next year, says Bateman, noting the annuity market will likely grow as a result.
Callil notes countries with maturing markets for capital accumulation plans can learn from Australia about the importance of planning ahead. “The design of decumulation should be done at the same time as you’re setting up the accumulation phase. It would have been good to get onto this decumulation phase earlier, because we’re now in a stage where we have people retiring and it’ll take some time to establish a proper system,” says Callil.
Chile is another country that has had a mandatory occupational pension scheme in place for some time. But unlike Australia, employees are the ones who contribute. In their case, contributions are 10 per cent of their salary.
But the contributions are still not enough to sustain many people through retirement, says Andrés Velasco, Chile’s former finance minister and a professor of professional practice in international development at the school of international and public affairs at Columbia University.
Not only is 10 per cent too low, according to standards set out by the Organisation for Economic Co-operation and Development, many Chileans also have gaps in their employment history, says Velasco. “You will have a contribution history in which somebody works for five years and stops because he went to school or had a child and then comes back to work 10 years later,” he says.
When it comes to options after retirement, the majority of Chileans buy annuities through an online auction held by the pension regulator, says Velasco. Insurance companies place their bids, and the system will then automatically choose the provider that can offer the largest payments according to the person’s savings, he says. The online system, he notes, has made the annuity market more competitive and accessible. “People know exactly what offers they’re getting and they could pick the best one.”
But while annuities guarantee retirees a lifelong stream of income, they’re also expensive and provide meagre payments due to the current environment of low interest rates, says Velasco. “If interest rates are low, the [insurer] is going to offer you a low annuity payment. And we’ve seen with the passage of time, as interest rates dropped for the same size pot of money, the value of annuities has dropped, too.”
At the same time, annuities in Chile don’t allow for inheritances, says Velasco. “If you die unexpectedly and you have chosen the annuity option, there’s nothing you can leave behind,” he says.
For retirees who want to leave bequests, the planned withdrawal system allows them to do so, says Velasco. Under that framework, the pension regulator will calculate the monthly payments a retiree receives after considering life expectancy, age, gender and health history and will then provide a fixed schedule of payments, he says. “The regulator is going to calibrate it so that, if you live as long as the mortality table predicts, you’ll more or less exhaust the funds.”
But planned withdrawal is riskier because it relies on conjecture and it doesn’t guarantee lifelong income, says Velasco. As well, the regulator can adjust monthly payments every year, depending on factors such as fluctuations in life expectancy or interest rates.
While retirees have traditionally opted for annuities, more Chileans, especially low-income retirees, have started choosing planned withdrawals in recent years, says Velasco. “Chile has a system of guaranteed pensions for low-income people. So if you are a low-income pensioner and you go for planned withdrawal and you run out of money, you can apply for a state guaranteed pension.”
Velasco notes that although the state pension isn’t generous, it still provides low-income pensioners with more income than an annuity.
Along with other countries, Chilean policymakers are trying to address decumulation in light of longer life expectancy. Last year, Chile’s president, Michelle Bachelet, proposed reforms that would require employers to contribute five per cent, effectively boosting total contributions to people’s pension plans. But Velasco says while the reform is a step towards boosting contributions, there’s a need for more “heavy lifting” during the accumulation phase because interest rates have significantly affected retirees’ outcomes.
Singapore’s retirement system rests heavily on a public defined contribution plan that dates back more than 50 years ago to when the country was still a British colony, according to Marcus Kok, principal pension consultant at PricewaterhouseCoopers in Singapore.
Apart from retirement savings, Singapore’s Central Provident Fund allows workers to also withdraw money for housing and health care during their working years, says Kok. He notes the fund is unique in that it has a very high contribution rate. Employees must contribute 20 per cent and employers put in 17 per cent. Plan members should also have saved a minimum amount in the fund by the time they reach age 55.
Prior to 2009, Singaporean retirees were able to withdraw funds or use them to buy an annuity from a private insurer, says Kok. But with the majority of Singaporeans choosing a lump-sum payout, the government became increasingly concerned that many people would outlive their money. So in 2009, it introduced a mandatory deferred annuity plan called CPF Life.
Now, members use their minimum sum to choose from deferred annuity plans that vary in costs and monthly payouts, says Kok. The cheapest option requires a minimum sum of about 83,000 Singapore dollars (about $79,000), while the most expensive option demands 249,000 Singapore dollars. Members can also choose whether they want an annuity that pays less in monthly income but allows them to set aside a certain amount for bequests. For those at the lowest level, retirees get a monthly payment of 700-750 Singapore dollars for life once they reach the age of 65. Those who put down the maximum will get up to 2,000 Singapore dollars a month. They must put down the minimum sum by age 55.
Workers who have saved more than the minimum sum can withdraw the remaining balance in a lump sum, while Singaporeans who haven’t saved enough can make up the difference by pledging their properties, says Kok.
But while the government administers the fund seamlessly, other options should be available, says Mukul Asher, professorial fellow at the Lee Kuan Yew School of Public Policy at the National University of Singapore.
He notes the country falls behind in not providing a social safety net for people who haven’t saved enough for retirement to fall back on. And while fund members can pledge property or use cash to meet the minimum sum, only 50 per cent who can’t reach it have the means to fill the gap, says Asher. As a result, many people continue working to make ends meet but they often encounter difficulties in the job market due to their age, he says.
Only a handful of multinational companies sponsor pension plans for employees, says Kok. He suggests the government should update pension regulations and strive to give organizations an incentive to offer such plans.
So far, Singapore has tried to boost private pension savings by introducing supplementary retirement schemes. The effort, however, has fallen short, says Kok. Not many people have opened those types of plans and the few who did have contributed sporadically, he says.
“I would like to see more conversation about how we can create a more conducive environment for people to save more on top of and beyond CPF and not just have them depending on it,” he adds. “It’s good but it just supplies you with basic needs. They need to relook at and consider things like employer-sponsored schemes like the 401(k) plans in the U.S. and DC plans in Canada.”
Kok suggests a review and expansion of pension regulations, which date back to 1993, in order to make them more appealing for employers to set up private pension plans. “Once we have that set up, then I think we will have a variation pillar to CPF.”
Get a PDF of this article.