An emerging focus on the payout phase could mean a greater fiduciary role for DC plan sponsors
A DC plan member’s retirement plan cycle can be said to have two phases. The first is the “accumulation phase” and relates to the period of active plan membership where retirement savings/capital are accumulated. The second is the “payout phase” (or decumulation phase) and relates to the period where retirement savings are paid out to the member. In simple terms, it’s the time when a DC member transitions from being a saver to a spender with respect to their pension savings.
DC retirement plans have traditionally focused almost exclusively on the accumulation phase—these plans by their very design do not typically provide for a predictable retirement income. However, recent trends suggest that legislators, pension regulators and plan sponsors in Canada are turning their eye towards decumulation options and products.
This increased focus on decumulation can be a double-edged sword: on the one hand it will enhance the decumulation options/strategies currently available to DC plan administrators, particularly for those employers that wish to provide DC plan members with greater benefit predictability in retirement. On the other hand, this shift may extend the reach of their fiduciary duties to plan members and, in particular, may require plan administrators to “up their game” with respect to the tools and information currently made available to members regarding the payout phase.
What decumulation options/strategies are currently available in Canada?
Pension standards legislation requires certain portability options to be offered to former members on termination of employment. In Ontario these options include transfer into a prescribed retirement savings arrangement (e.g. a LIF; RRIF; LIRA). Purchase of a life annuity used to be a mandatory portability option in Ontario, but is now optional. Unless offered under the plan terms, these portability options are not available on retirement.
Individual annuities (insurance contracts) have been the traditional decumulation vehicle relied upon by DC pension plans. From a strictly legal perspective, purchase of annuities is not viewed as being particularly risky (although in Ontario, a statutory discharge for the plan administrator does not exist unless the annuity purchase is made in conjunction with a former member’s portability election). However, from a plan member perspective, one concern with annuitizing is that it can be expensive and the “amount of pension” that a member’s DC account can buy is highly subject to prevailing interest rates at the time of purchase. Through the purchase of individual annuities, members are also unable to benefit from cost efficiencies due to scale. This raises the inevitable question, what other options are there?
In a number of jurisdictions, pension standards legislation has not yet been amended to permit payment of pension to a member from a DC pension plan (despite the fact that the Income Tax Act (Canada) was amended in 2005 to permit a DC pension plan to pay such “variable benefits”). On April 25, 2014, Ontario’s Ministry of Finance released a proposal regarding changes to the regulations to the Pension Benefits Act (Ontario) (PBA) that, if enacted, would permit this “self-annuitizing” option. The proposal envisions payments being permitted from a variable benefit account that are the same as those currently permitted from a life income fund (LIF). At a high level, this means minimum and maximum withdrawals would be prescribed to ensure that money remains in the account until the owner is 90 years old.
Since most plan administrators have the resources and expertise to manage ongoing risks (e.g., longevity risk, investment risk), self-annuitizing (within the plan) may produce a more favourable result for plan members. However, it comes with a legal price—keeping employees/retirees in the plan means that a plan administrator will continue to have ongoing fiduciary obligations, including the selection/oversight and monitoring of service providers and investment options, as well as the communication of information to former members. Employers who wish to permit this option must be prepared to embrace this expanded scope of their legal responsibility.
Other guaranteed decumulation products have started to become more broadly available in recent years—for example, guaranteed minimum withdrawal products (GMWP) offered by insurance companies. While GMWPs are complex and can have a variety of features, the typical product offers guaranteed income for plan members during the payout phase (based upon the amount of the initial “deposit”), with the opportunity to increase the benefit guarantee as a result of positive investment performance. While GMWPs (and other new products coming online) are designed to provide members with predictability and certainty in retirement, they come with a cost—members will typically be required to give up returns or pay additional fees for this protection.
Use of these options also place a high burden on the plan administrator with respect to disclosure (e.g., disclosure of all fees/added costs associated with the given product). In addition, if GMWPs and other similar products are offered within the DC plan, the plan administrator will have ongoing legal duties to monitor its performance and to ensure that fees charged are competitive and reasonable. It is also noteworthy that a plan administrator’s fiduciary duties with respect to investments will continue to apply, whether or not such investment is guaranteed. There is currently ongoing litigation in the U.S. where participants are bringing a class action to recover investment losses they claimed resulted from the offering and performance of a “stable value fund” (which offered principal and interest guarantees) as an option within the plan. Participants are claiming that this was an imprudent investment because it was too heavily weighted on money market and couldn’t keep up with inflation (i.e. because it was too conservative to produce a robust return).
The duty to communicate
The Ontario Court of Appeal has confirmed now on several occasions that plan administrators have a legal (fiduciary) duty to communicate with members information that is “highly relevant” to them. What is “highly relevant” in the context of a pension plan?
According to the courts this is “information that is likely to influence the conduct of plan members” and, at least in relation to DB pension plans, this includes: (i) up to date information about the current plan terms and options (note: can include both investment options and retirement income options), and (ii) information about the consequences of any members’ elections or decisions under a retirement plan that can have an impact on their benefits. Could one characterize information about decumulation options this way? Recent regulators’ policies suggest that this is information that would form part of an administrator’s fiduciary duties.
On March 28, 2014, the Canadian Association of Pension Supervisory Authorities (CAPSA) released Guideline No. 8: Defined Contribution Pension Plans Guideline. While CAPSA’s guidelines do not have the force of law, these guidelines may be used as a benchmark by the courts and/or regulators to assess whether a DC plan administrator has fulfilled its fiduciary obligations. Included in the Guideline is an expectation that plan administrators “will provide information regarding all of the retirement products available to members with respect to the payout phase”. Such information should allow members to make “informed decisions which strike a balance between protection from the risks inherent in the various products and achieving target replacement rates”.
Regardless of what decumulation strategy is pursued, plan administrators would be well advised to revisit their member communications and consider whether they live up to the standards articulated in the Guideline.
Paul W. Litner is the chair of and Jonathan Marin is an associate in the pensions and benefits department at Osler, Hoskin & Harcourt LLP.
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