Among the major decisions we must make in our lifetimes, those concerning retirement are among the most difficult. Retirement represents one of the most significant life-altering events faced by individuals and couples. It is also a decision that many people are ill-prepared to make.
One important key to a person’s well-being in retirement is the income she will have to support herself for her remaining lifetime. In the Canadian pension industry, the “three-legged stool” is used to describe the sources of retirement income commonly available to retirees. It simply means there are generally three sources from which people can draw retirement money. They are the government, personal savings and employer-sponsored pension plans.
In respect of government programs, Old Age Security(OAS) and Canada Pension Plan(CPP)entitlements, a retiree’s choices are essentially limited to determining when to commence her pensions. CPP benefits can commence at any time upon reaching age 60(subject to an adjustment for early or late retirement relative to age 65), while OAS benefits start at age 65. In both cases, retirees must make an application for benefit payments to commence.
The decision to commence a pension under a private pension plan, or turn registered retirement savings plan(RRSP) funds into retirement income, is not so simple. A member of a pension plan can choose to retire as early as age 55, and in some cases even earlier. A key issue revolving around retirement date is the amount of pension income that will be available to an individual at his retirement date. The amount of lifetime pension on a “normal form” (which refers to the basic terms under which a lifetime pension is paid)is fairly simple to determine for anyone who participates in a defined benefit(DB)pension plan, but is quite a bit more complex for participants in a defined contribution(DC)retirement program.
Pension standards legislation requires that retirement benefits paid under a registered pension plan must continue for the participant’s lifetime and for the lifetime of his or her surviving spouse, unless the spouse waives the right to such benefits at the time the pension commences. This may require a conversion from the normal form of pension, which could result in an actual monthly income account that differs from the normal form. Retirement benefits paid out of funds accumulated in a personal or group registered retirement savings plan may be paid in the same manner, but may also be withdrawn partially or wholly as a lump sum. Pension benefits and lump sum withdrawals from registered plans are taxable in the year in which they are received.
Periodic lifetime retirement income(e.g., “pension”) vehicles fall into two basic categories: life annuities and lifetime retirement income funds. DB plans are usually limited to life annuities only, but there are still a number of choices available. Will the annuity be paid for the lifetime of the member only(single life)or also for his or her spouse’s lifetime in the event the spouse survives the member(joint life)? Should the member elect a guarantee period(up to 15 years)over which the pension will continue, even if she or he should die earlier? Depending on the normal form, these choices could add or subtract a noticeable amount to or from the member’s pension income.
A retiree may also be able to choose an indexing option, although also at a significant cost in terms of a reduction in the monthly pension, unless his normal form is already indexed. There is comfort for DB plan retirees, however, to know that once they have selected the form of pension they are to receive it will never be reduced(provided that the plan paying their benefits and the plan sponsor remain solvent). And, if they are lucky enough to have indexing built in to their pension, it will even grow as the cost of living index increases. It may be a concern to retirees, though, that any beneficiaries other than a joint survivor have little expectations for any death benefits, other than the remainder of a guarantee period, which most retirees will outlive.
All of these life annuity choices are also available to DC or deferred profit sharing plan(DPSP)retirees and those with a registered retirement savings plan(RRSP) or locked-in retirement account(LIRA). The starting point for determining the pension from these programs, though, is quite different—it is the total of the account balances available to the retiree for the purchase of a life annuity. He, or his plan sponsor, must request annuity quotations from an insurance company in order to determine the amount of pension income that may be available to him. Relative to these life annuities, all of the choices that are provided to DB plan retirees are available.
On top of these choices, retirees with regular(not locked-in) RRSP or DPSP accounts can choose partial(or full)withdrawals anytime prior to the beginning of the year they turn 70. Alternatively, they can commence a registered retirement income fund(RRIF), which provides for minimum(or higher) monthly retirement income payments from the account balance. Retirees must convert their RRSP to an RRIF no later than the end of the calendar year in which they reach age 69; otherwise, they must receive the full RRSP balance as a cash lump sum.
Similar rules apply to DC or LIRA balances, except no partial or full withdrawals are permitted and a life income fund(LIF)or lifetime retirement income fund(LRIF)applies instead of an RRIF. A LIF/LRIF is an RRIF, but with an upper limit placed on annual withdrawals in addition to the RRIF minimum. The purpose of the upper limit is to ensure funds last for the lifetime of the retiree.
The principal advantages of RRIFs/LIFs/LRIFs are the preservation of capital and the opportunity to earn higher returns than those built into life annuities(which reflect longterm interest rate assumptions). These advantages are, for some people, offset by the continuing exposure to investment risk and the need to continue to manage the retirement portfolio.
For people about to retire, these choices are nothing short of bewildering. As the baby boomers pass into retirement, it will become increasingly important for employers and financial institutions to educate, inform and advise retirees about their options. In this context, employers might also keep in mind that financial institutions and their representatives, agents and brokers are motivated by the opportunities to sell financial products, and perhaps cannot be relied upon to provide balanced advice.
Employers are in the best position to provide, or facilitate the delivery of, impartial, unbiased assistance to employees in navigating their retirement options. Seminars and fee-based retirement/financial counselling services are two options employers might consider offering employees in the years prior to their nearing retirement. Retirement counselling fees, if paid by the employer, are a non-taxable benefit to employees.
Employers can also facilitate effective, and less costly, retirement income solutions for employees. Under new income tax rules, DC pension plans can pay monthly retirement benefits on a “LIF-like” basis, or group LIFs that feature lower investment fees can be established with a provider.
If annuities become more popular, it may also be feasible for employers to establish “open-ended” group annuity contracts, which provide for lower costs through the reduction or elimination of commissions and policy implementation fees. Such arrangements were quite common 15 years ago, but have fallen out of favour as annuities have waned in popularity.
These employerdriven solutions, however, are not without risks. Plan sponsors are still apprehensive about providing too much advice or counselling. Employers will have to balance those risks with their responsibilities, some of which may be fiduciary in nature, to their retiring employees.