The coronavirus pandemic could be the most devastating crisis of most Canadians’ lifetimes.
In the past two months, efforts to prevent the spread of the coronavirus has led to shuttered cities, event and travel cancellations, job losses and extremely volatile financial markets. And without a doubt, the global pandemic is negatively affecting retirements.
Like those who found themselves trapped in contaminated cruise ships and nursing homes, retirees and wannabe retirees quickly discovered there’s no safe harbour for their accumulated retirement savings during a stock market crash.
When it comes to managing their retirement savings, Canadians are generally left to fend for themselves. Unless they’re among the few with a defined benefit pension plan or who have accepted the meagre pension paid by a guaranteed life annuity, retirees typically face longevity and investment risk alone during the decumulation phase. This is a daunting task made more difficult by a prolonged period of low interest rates, prohibitively expensive life annuities, high investment management fees, inexperience and decreasing cognitive ability due to advancing age.
This has to change. Governments must recognize the decumulation problem and create alternatives that allow retirees to protect the retirement savings they’ve accumulated throughout a lifetime of hard work. While some solutions already exist, they’re not yet widely available.
What’s happened so far?
A pandemic-induced global stock market crash began in February. By late March, many records, including daily point and percentage plunges (or gains) and worst monthly and quarterly declines had fallen or come very close to falling. During the month, global markets experienced declines of between 25 and 30 per cent.
In April, the International Monetary Fund issued a stark warning about economic damage from the coronavirus, saying “the global economy faces its worst downturn since the Great Depression as shuttered factories, quarantines and national lockdowns cause economic output around the world to collapse.”
The toll that the pandemic will take on retiree finances has yet to be determined but, given the low interest rate environment in which the devastation has taken place, it’s safe to assume many won’t have been well-positioned for the storm with their retirement portfolios likely overweight on equities.
While many investment gurus encouraged “buying the dip” or warned against “crystalizing losses,” it’s impossible to predict how inexperienced retirees have reacted to the market carnage. If they lost their nerve and tried to cut losses by selling, it could take years to recoup crystalized losses, with the associated trauma potentially inhibiting them from trading equities in the future — a significant obstacle to wealth creation when alternatives pay only a percentage or two annually.
Retiree risks and responsibility
With the steady decline of DB pensions, the majority of today’s retirees must manage their own retirement accounts. As a result, they must navigate longevity and investment risk throughout their retirements.
Due to the low interest rate environment since the 2008 financial crisis, few retirees have purchased guaranteed life annuities. And with near-zero returns on money market and similar investments, the allure of bull market-driven, double-digit returns has been hard to resist. This places retirement accounts at risk during a severe market downturn.
It’s time to devise mechanisms that ensure retirement savings remain protected throughout retirement. Canada has to offer retirees a cost-effective means of pooling longevity and investment risk beyond the expensive and inflexible traditional guaranteed life annuities offered by Canadian insurers.
Alternatives to consider
A number of alternatives are available that address longevity and investment risk, and would also provide retired Canadians with a safer harbour for their retirement savings. For example, variable payment life annuities, Government of Canada annuities and supplemental Canada Pension Plan benefits.
- Variable payment life annuities:
A variable payment life annuity provides monthly payments for life that vary based on the investment performance of the underlying fund and mortality experience of all the VPLA’s annuitants. Rather than self-insuring, a retiree insures across a group, pooling longevity and investment risk to provide what’s essentially an annuity except that the monthly payment can vary — up or down — depending on the pool’s investment and mortality experience. For someone who doesn’t need or want a life annuity’s absolute, iron-clad guarantee or the associated cost-inefficiencies, the process should be more cost-effective.
The 2019 federal budget proposed tax rule changes to allow for variable annuity structures. It said administrators of defined contribution and pooled registered pension plans will be permitted to establish separate funds under their plans to receive transfers from retiring members in order to provide variable payment life annuities.
While welcome, the proposal is too narrow, since it’s limited to DC plans and PRPPs. Given the large number of Canadians who save for retirement using registered retirement savings plans, registered retirement income funds and tax-free savings accounts, the proposed changes should be expanded to permit retirees with those accounts to take advantage of the risk pooling offered by VPLAs. This would offer them a safe way to convert their retirement savings into a more secure predictable income for life, thereby improving their financial independence and peace of mind.
- Canadian government annuities:
Few readers will be aware of the Government Annuities Act or the existence of a Canadian Government Annuities Branch. The Annuities Act represents one of the earliest pieces of Canadian social legislation designed to encourage Canadians to save for retirement through the purchase of government annuities. With the development of the CPP and old-age security, the government discontinued the sale of government annuities during the last half of the 1970s. The annuities branch was established to oversee the sale and administration of government annuities and continues in operation today to administer those annuities that were purchased.
The federal government could revitalize the Annuities Act, offering Canadians cost-efficient life annuities or VPLAs using the investment prowess of the Canada Pension Plan Investment Board. With some legislative changes, Canadians could have the option of transferring retirement savings from DC-type accounts, RRSPs, RRIFs and even TFSAs to the annuities branch in exchange for a life annuity or a VPLA guaranteed by the Canadian government and invested by a world-renowned investment manager.
- Supplemental CPP benefits:
The CPP delivers a reliable indexed lifetime pension to retired participants. Since most retired Canadians receive CPP benefits, it’s logical to provide participants with the option of purchasing supplemental benefits financed through accumulated RRSP, RRIF, TFSA or DC-type account balances. The CPP’s investment and administrative infrastructure is already in place and its actuaries could easily determine the cost of providing a supplemental pension to retirees using historical CPPIB returns. Retirees could rest easy knowing their retirement savings have been converted to indexed supplemental CPP benefits, protected from the ravages of future market crashes and the twin evils of longevity and investment risk.
For many retirees, what took a lifetime of hard work to accumulate can be devastated in a matter of days when market destabilizing forces such as the coronavirus pandemic arise. Those who rely on accumulated savings to fund their retirements need safe harbour options for their savings where they can mitigate risk and still, if desired, participate in the long-term upside of equities markets.
Expansion of the 2019 federal budget’s VPLA proposals to include RRSPs, RRIFs and TFSAs would represent a new safer harbour option for retirement savings. Revitalization of the Annuities Act to permit the purchase of low-cost Canadian government annuities, including a VPLA option, would address the cost-inefficiencies of the current annuity industry and add the risk-pooling benefits of a VPLA option. And, despite recent enhancements to CPP, an option to purchase supplemental CPP benefits with retirement savings would be welcomed by many. These options could mitigate risk and help vulnerable retirees who have for too long been left to fend for themselves throughout retirement.
Time is of the essence here. Canadian retirees can’t afford to await the next pandemic for solutions to the financial risks they face during decumulation.