Larry, a hypothetical defined contribution plan member, is facing a difficult calculus as he prepares to retire.
Between his personal and DC plan savings, he’s accumulated $620,000 in savings for his retirement and is also expecting roughly $1,000 a month from the Canada Pension Plan and $650 in old-age security benefits. He has to determine how much he can withdraw from his pension per year. If he withdraws too little, he risks not getting the full possible enjoyment out of his golden years; pull too much and he might have to significantly cut back partway through his retirement. And to make matters more complicated, it’s incredibly challenging for anyone to estimate how long they’ll live.
“There are extreme choices you have to make and it can be very difficult for plan members,” said Pat Leo (pictured left), vice-president of institutional investments at Longevity Retirement Solutions, during Benefits Canada’s 2023 DC Investment Forum in late September.
Read: Pension stakeholders call on feds to remove barriers to longevity risk pooling
Longevity risk pooling within variable lifetime income funds can help address those concerns, said Fraser Stark (pictured right), president of Longevity Retirement Platform, also speaking during the session. Long the domain of defined benefit pension plans, longevity risk pooling means sharing individual lifespan uncertainty with a large group of others to produce positive financial outcomes for the whole group. It also creates a source of alpha.
Sharing the example of a plan member who’s invested in a fund similar to what Longevity Retirement Platform offers, he said they can expect a modest annual return from the fund’s investments. As well, “while you’re living and you’re invested in a fund like this, your portfolio is receiving longevity credits from others who are leaving the fund. From an investment perspective, this behaves like a source of alpha . . . because it’s not subject to market volatility.”
While mortality is low in the age range of 65 to late-70s, with fund participants who pass away having most of their funds go to their estate, longevity credits start to pile up in the 80s and 90s, noted Stark. Using the example of hypothetical DC plan member Larry, he said longevity risk pooling can add almost 40 per cent to his drawdown ability.
But given the inherent tradeoff in variable lifetime income funds — investors receive the longevity credit alpha while invested in the fund and contribute it when they leave — he said these types of funds are appropriate for a portion of someone’s portfolio rather than the entirety. “It’s the portion they choose to decumulate.”
Read: High inflation supercharging decumulation challenges
Returning to the hypothetical plan member, Leo said that if Larry decided to invest roughly a third of his accumulated pension assets into a longevity risk pooling investment, he could receive another $1,000 a month on top of his government benefits. With both CPP and OAS indexed to inflation and the longevity risk pooling investment implicitly indexed, parts of his retirement income would grow with time and he’d have the flexibility to manage the remaining portion of his DC assets however he liked — such as by putting it in an interest-bearing account, drawing on it when he needed to and leaving some of it for his estate.
More innovative solutions that incorporate longevity risk pooling are starting to come to market, said Leo, but in the meantime, as DC plan sponsors start to think about decumulation, they can help members paint their retirement income picture by simply giving them the option to remain in the plan after retirement or offering more sophisticated solutions like variable benefits.
Read more coverage of the 2023 DC Investment Forum.