Bonnie-Jeanne MacDonald is the director of financial security research at the National Institute on Ageing (NIA) at Ryerson University, fellow of the Society of Actuaries, associate of the Canadian Institute of Actuaries and resident scholar at Eckler Ltd.
As private-sector defined-benefit (DB) pension plans continue to struggle, defined-contribution (DC) plans are emerging as the most common option for providing retirement income. Of the three million Canadians in private-sector pension plans today, those in DC plans will soon outnumber those in the traditional DB model.
But when it comes to retirement income, DC plans lack one important element: They don’t actually provide pensions. It’s up to the individual to manage a pot of money so it lasts for the rest of their (probably long) lives – and most seniors don’t have the necessary skills or desire to take on that challenge.
The good news is, there’s a great option that would give these Canadians a more financially secure retirement: the pooled-risk pension.
But here’s the bad news, it’s been blocked by legislation. That’s why we at the National Institute on Ageing at Ryerson University, along with leading seniors’ and pension advocacy organizations across Canada, have come together in an unprecedented coalition. In a letter to Finance Minister Bill Morneau, we formally asked the Government of Canada to change the legislation and allow workplace DC plans to offer pooled-risk pensions to their members.
What needs to change
With legislative change, DC pension plans could offer pooled-risk pensions – meaning retiring members could voluntarily choose to buy a secure pension income until death, using some (or all) of their DC savings.
Since these retired plan members share the risks, it’s possible that their pension payments could fluctuate from one year to the next. For example, if investment returns don’t pan out as expected (think of 2008, or even 2018), everyone’s pension could be reduced. But adjusting to some fluctuations in retirement income is better than shouldering the financial market risk alone – and far better than having your retirement plans derailed because you’ve outlived your savings.
Safety in numbers
Look at it from the plan member’s perspective. If you have a DC plan, once you retire, it’s up to you to decide how to manage your retirement savings – a pot of money that will increase in an unknown way, to pay for unknown expenses, over an unknown time horizon of up to 40 years or even more. And you need to accomplish this within the complicated context of the Canadian tax and social-benefit system, as well as your own changing personal circumstances (for example, declining health).
Sound daunting? It is, even for the experts. That’s because the known unknowns of retirement financial planning – investment returns, inflation, evolving personal circumstances (such as widowhood, health declines) and, most of all, how long we live – are very risky at the individual level.
The purpose of a pension plan is to enable workers to pool their money together and protect those who live to advanced ages. The risk of not knowing how long you will live becomes a lot less risky with a big enough group because the law of large numbers tells the actuary what to expect each year, allowing him or her to calculate the highest “safe” pension income for everyone.
A secure income stream provides financial independence and peace of mind, removing the burden of managing financial assets at advanced ages when declines in cognitive abilities may impair your ability to make good financial decisions. Having large levels of savings at advanced ages can expose seniors to bad advice, or even fraud.
Not only do pension plans offer a safer way to turn retirement savings into lifetime pensions, but they also have greater investment power – meaning the amount of money you get is much higher than you could likely achieve on your own.
Pension plan members pay significantly reduced fees for asset management and administration compared with what is available on the retail market, and they generally achieve higher investments returns (owing to economies of scale, better asset purchasing power and better capacity to diversify investments, across asset classes and over time). Left to their own devices, people tend to be overly conservative or aggressive in their investment choices, without the added investment return for taking that risk.
In short, staying in a pension plan benefits everyone. You get lower fees and better returns (meaning more money in your pocket), while the plan gets to add your money to its larger pot, creating a self-perpetuating upward spiral of investment power.
Canadians today are going to live longer than any previous generation, and more secure pensions will help them enjoy this extra time without exposing themselves or their families to financial burdens. Tweaking the legislation so that DC plans can provide pensions is a relatively easy and effective solution – and we’re not alone in this perspective.
Respected Canadian actuary Malcolm Hamilton once said, "We’ve created workplace pension plans that do not provide pensions.” Along with the National Institute on Ageing, signatories on the letter to Mr. Morneau include foremost voices for pensions plans and seniors across Canada. A forthcoming 2019 research report with the National Pension Hub (Global Risk Institute) and the National Institute on Ageing (Ryerson University) will provide insights for employers around the benefits of pooled-risk pensions.
The big question
If pooled-risk pensions were allowed, would they even work? That’s the big question, but fortunately a proof of concept exists right here in Canada. Since 1967 – long before DC plans became the norm – the University of British Columbia’s faculty pension plan has been successfully running a pooled-risk pension option for its DC members. (UBC was grandfathered under old legislation.)
The reality is, DC plans are going to start turning out major numbers of retirees – many of whom have a DC balance as the only source of employer-provided retirement benefits. It’s time to roll back the clock and help workplace pension plans do what they do best: provide pensions to the workers who clearly need them.