The next generation of DC investment products.
Despite the success of lifecycle funds and related products globally, there are two improvements that would greatly enhance their effectiveness for DC pension plan members.
1) Increased customization – With traditional lifecycle funds, members with a common target retirement date will be directed to the same asset mix even if they have drastically different financial circumstances. Let’s consider two 40-year-old employees with a common target retirement date.
A traditional lifecycle fund will calibrate the asset mix decision solely based on the target retirement date, placing both Jane and Bill in the same fund despite the significant differences in their capacities for risk. A new generation of funds has been developed to address this problem, combining the beneficial features of a TDF with a risk overlay. These matrix funds offer multiple glide paths for investors with different risk profiles. A risk capacity questionnaire helps the member to identify the appropriate glide path.
2) Longer time horizon – Most DC retirees will remain invested for many years after retirement, using their investment balances to support regular withdrawals in retirement. Despite this trend, DC investment products have structured portfolio allocations to maximize asset accumulations at retirement. Many lifecycle funds have fallen into this same trap, employing optimization models and glide paths that terminate at, or near, the target retirement date. This suboptimal, two-tiered planning process can result in misalignment of the asset mix strategy as the member approaches retirement age; exposure to significant mistiming risk on the purchase of annuities; and exposure to higher retail investment fees in retirement.
Future DC investment products will incorporate glide paths that extend well beyond the target retirement date and introduce flexible income options to accommodate a range of investor needs.
The Retirement Investment Continuum
As shown above, the lifecycle fund of the future will incorporate a matrix structure. The member selects the TDF based on the desired retirement date and uses a risk questionnaire to determine the optimal glide path. Within five years of the target retirement date, the member meets with an education specialist to discuss retirement income needs and preferences. Together, they structure a customized de-accumulation strategy using one or more of these income tools: the existing matrix fund (to determine the optimal self-managed income level); annuities (to provide fixed income payments); a guaranteed minimum withdrawal benefit (GMWB) wrapper around the investments (to limit the impact of adverse market movements); and longevity annuities (to protect against the risk of outliving retirement assets).
A few obstacles currently complicate the implementation of this type of investment structure in Canada, including the need for broader decision support for members transitioning to the de-accumulation phase (which would be aided greatly by a legislative safe harbor for the provision of unbiased investment advice); more flexible retirement savings vehicles built to accommodate both accumulation and de-accumulation; and more robust annuity and GMWB product offerings.
However, such a structure would make it easier for the growing population of DC plan members to implement personalized solutions designed to accommodate individual needs over a lifetime and target a better financial future.
Colin Ripsman is vice-president at Phillips, Hager & North Investment Management Ltd.
© Copyright 2009 Rogers Publishing Ltd. This article first appeared in the April 2009 edition of BENEFITS CANADA magazine.