As Canada's 1st DC participants begin to retire, many wonder what problems they'll encounter
The first wave of retirees from Canadian defined contribution plans is expected in the next five years. And many plan executives and service providers are worried that not only are plan participants not ready, but also the regulatory regime might be making things worse for them.
Issues that are in the spotlight as DC plans begin to mature in Canada include:
- federal and provincial rules that do not allow for lump-sum or variable withdrawals from defined contribution plans directly to participants;
- requirements, both national and provincial, that retirees make all their own investment and asset withdrawal decisions, without any advice provided through plan sponsors;
- few rollover options for retirees leaving DC plans, causing them to use the limited products offered by their plan's mostly single provider, predominantly insurance companies;
- high fees for post-retirement investments provided by insurers and financial services firms; and
- the lack of a holistic approach to retirement that incorporates DC assets with benefits received from the country's national pension plan, the C$298.1 billion ($223.6 billion) Canada Pension Plan, and from other sources like defined benefit plans, Old Age Security (Canada's income-tested version of Social Security) and public aid.
The cause of many of the problems, sources said, is that the defined contribution market in Canada is far less mature than those in the U.S., the U.K. and Australia.
“Defined contribution is a fairly new phenomenon,” said Martin Leclair, vice president with investment and benefits consultant Proteus Performance Management, Toronto. “I think we're in for some hardcore education in the coming year for both” DC plan participants and government regulators at the federal and provincial levels.
Added John D'Agata, director, pension administration, at McGill University in Montreal: “The big issue today is that a person who's retiring is going into an arrangement where, after someone provided the plan oversight and investment strategies, now suddenly that person leaves the plan and has to figure out what to do. This is one of the most important decisions they'll ever make.”
Katherine Strutt, general manager of the C$450 million Saskatchewan Pension Plan, Kindersley, said DC participants at or near retirement age “are looking to someone to help them get through all of this. All we can do is lead them to where they can make the best decisions for (themselves). But they own the decision. It's all up to them.”
Canadian DC plans generally “do a good job of accumulating (assets), but I don't think there's a lot of preparation for when people reach retirement,” Ms. Strutt said. “It's often just turned over to the insurance provider. There's also a lot of limits to decumulating DC plans from a legislative perspective.”
Late to the game
Some defined contribution plans, particularly in Saskatchewan, have existed for 30 years, but most in Canada are relatively new, in existence for the past 10 years or less. Public defined benefit plans in the country, by contrast, have generally been established for at least 20 years.
The number of DC plan participants is far surpassed by those in DB plans, both public and corporate. As of Dec. 31, 2015, the latest data available from Statistics Canada, the Ottawa-based federal data and survey agency, 4.38 million Canadians participated in public and corporate DB plans that had a total of C$1.416 trillion in assets, compared with 1.1 million in DC plans that had a combined C$66.94 billion in assets.
Canadian federal pension law makes it tougher to use DC plans as the predominant source for retirement income, Mr. Leclair said.
While retirees from a shuttered DB plan would need a 20% combined annual employer and employee contribution to a DC plan to maintain the same income at retirement, Canadian tax law has a DC contribution ceiling of 18% — 2 percentage points below what would be needed, Mr. Leclair said.
“The first observation is that we're in for some tough discussions” on defined contribution decumulation, “maybe not immediately because few Canadians have spent their entire working life in a DC plan, but in 15 years, the picture will be different,” Mr. Leclair said. “It will require a hard look at plan design. In 10 years, the current design is not going to work.”
A March 27 report, “Decumulation, the Next Critical Frontier: Improvements for Defined Contribution and Capital Accumulation Plans,” from the Association of Canadian Pension Management, a Toronto-based organization of pension funds and retirement service providers, recommended the following changes in the Canadian DC market:
- Create default options that provide managed withdrawals, longevity protection, access to lump sums and inflation protection if retirees desire;
- Allow retirees to have a wide selection of individually registered decumulation products, including risk-pooled options;
- Improve disclosure of costs and conflicts to allow retirees to make better choices — although the report does not suggest the establishment of a fiduciary standard as in the U.S.;
- Reassure plan executives on the extent of liability responsibility to encourage the creation of risk-pooled defaults; and
- Incorporate flexible product designs and regulatory frameworks to take into account retirees' other sources of income.
To annuitize or not?
Decumulation options for Canadian DC plans generally are to annuitize or roll over assets into a federally approved retirement vehicle such as a registered retirement income fund or a life income fund, said Kathryn Bush, partner at the law firm of Blake, Cassels & Graydon LLP, Toronto, chairwoman of the ACPM's National Policy Committee and chairwoman of the association's decumulation subcommittee. While a select few DC plan sponsors are now allowing participants to leave their balances in the plan and withdraw assets directly from their plans as needed after retirement, most DC plan sponsors are fine with relinquishing control of participants' assets at retirement, leaving the retiree to figure out which of the options to take, she said.
“In the Canadian market, (decumulation) hasn't been a plan concern at all,” Ms. Bush said. “The option you're supposed to offer participants is annuity purchase. The issue is, do you want to force people into annuities if they don't want to make that choice?”
But Tom Reid, senior vice president of group retirement services, Sun Life Financial, Toronto, said the “vast majority” of Canadian retirees are not in annuities. “Less than 5% of people who leave DC plans get annuities,” Mr. Reid said. “We don't annuitize enough, for a lot of behavioral reasons. If you've been in a DC plan for 30 years and got, say, C$600,000 saved for retirement, you might be more worried about being hit by a bus when you're 68 or 69 than you are worried about whether you'll live to 95 or 100. But living longer is the higher risk.”
Mr. Reid said most retirees don't annuitize because of low interest rates, “but it depends on your perspective. You may have to take on more risk to make everything last longer, because people are going to live longer. That's what people tend to forget. In a DC context, how much do they need to retire? What do the numbers need to look like if you live to 100? That's our job, to talk to people about income generation.”
The simple solution, Mr. Reid said, would be to mimic what's been done in the U.S. But Canadian tax rules limit how much the DC industry can do, he added.
“There are a lot of innovations we could use in Canada that we see in the U.S., and with some adaptation we could make it work ... One thing growing in the U.S. is advanced life deferred annuities. Retirees who don't want to hand all their retirement assets to an insurer can only put in a partial amount — say, C$100 million out of C$1 million — and set it up to start paying out the annuity at age 85 or whatever. It's a form of a deferred annuity where you're actually insuring the tail risk, so to speak. That's allowed under U.S. rules, but it's not allowed in Canada. As an industry, we'd like to advocate for something like that if there was enough consumer interest. The number of consumers in a position to do that from DC plans is small, but it will be growing.”
A costly transfer
Transferring assets from a DC plan to products from insurers, banks and other financial services firms can come at a high price for retirees, said Idan Shlesinger, Toronto-based senior partner in Morneau Shepell Ltd.'s retirement pension consulting practice and managing partner of Morneau Shepell's capital accumulation plans services practice. Post-retirement products “have much higher fees” than were paid when the assets were in DC plans, Mr. Shlesinger said. Sources said that while fees for participants in a DC plan could be around 50 basis points, the retail equivalent paid as a retiree would be up to 200 basis points.
Added ACPM's Ms. Bush, “The real problem isn't the investment choice, but ... the fees given current low returns ... Insurers and banks argue that they're providing investment advice to these individuals, so the fees are higher. Now, two to three years ago, plan fees fell because of competition; we think that's where the market will move with more retirees rolling out of their DC plans. More people will mean more competitive fees.”
James Pierlot, founder and principal, Pierlot Pension Law, a Toronto-based law firm that advises pension plan sponsors and administrators, sees high fees as a greater risk to plan sponsors than providing investment advice or other risks. He also suggests plan sponsors pay the fees for participants and retirees as opposed to passing costs on to them, which is common practice in Canada.
“If an employer pays the fees, that takes it off the table for lawsuits,” said Mr. Pierlot. “Providers like it when employees pay fees, because no one's minding the store. But if employers want to maintain a good relationship with their retirees, paying their fees is a way of helping them. And employers also can tax-deductthe fees. There's no lawsuits, no employee negotiation.”
Morneau Shepell's Mr. Shlesinger said one reason fees are so highfor retirees is “because the market is unaware. The fees are hidden in overall costs. There are new regulations requiring clearer disclosure of fees, but those don't apply to the group space or insurers. Securities regulators have no oversight of insurers; they're generally self-regulating. But slowly, attention is coming to this. There are ways around this — investing through (exchange-traded funds), for example — but in general these retail products have a very high cost. Because of that, rollover plans are very profitable for insurance companies.”
Matthew Mayer, senior vice president, Northern Trust Canada, Toronto, said the one-provider model for DC plans often used in Canada looks more like the traditional Canadian DB model, but to mirror a DB plan “you need the trusteed model. Since most DC retirees aren't in unbundled, trusteed DC plans, they end up staying with the same insurance company that managed their DB investment.”
Mr. Pierlot said a big concern in decumulation is current withdrawal limits. Under federal law, participants must withdraw an annual minimum of 4% of retirement assets at age 65, 5.82% at 75, 10% at 85 and 20% at 95. (Maximum withdrawal limits vary by province.) But those limits do not take into account other retirement sources like Canada Pension Plan, Old Age Security or defined benefit plans.
“The withdrawal rule keeps you from having a holistic strategy for retirement,” Mr. Pierlot said. “These lock-in rules keep people from planning for retirement by incorporating other sources of pension income. Based solely on these limits, you can't retire on that.”
Retirees are also hampered by plan sponsors' reluctance to provide investment advice to retirees, fearing they'll be liable for any investment losses resulting from that advice.
“I don't buy into that,” Mr. Pierlot said. “There are examples of pension plans, both defined benefit and DC, that offer advice post-retirement. There's the Saskatchewan Pension Plan, the (C$4 billion) Co-operative Superannuation Plan in Saskatchewan. Even (the C$19.5 billion) OPTrust — their CEO, Hugh O'Reilly, said they will now provide post-retirement advice. And that's a DB plan.
“I think there's a shift in mentality,” Mr. Pierlot said. “My belief is large employers should get into advising retirees. It's good business for them. They may be concerned about potential litigation but I don't find that to be a rational argument. I can't think of any case in Canada of any lawsuits over investment advice or fees. We have a different litigation culture in Canada (vs. the U.S., where there have been a flurry of lawsuits over plan sponsor-provided investment advice). Employers here do have this fear, but in practice, it's not happening. By offering advice, they're actually protecting against lawsuits. It's more difficult here to convince a judge that someone did something bad. I just don't see the litigation risk there.”
At McGill University, participants in its C$1.47 billion hybrid DB/DC plan receive education sessions on decumulation but with no investment advice provided. Mr. D'Agata said sessions with retirees discuss what options they have for their assets post-retirement — McGill offers group life income funds and group registered retirement income funds — along with how to calculate their life expectancy and where to find out how much in assets retirees will receive from the C$57 billion Quebec Pension Plan, Quebec City, the province's mirror version of the CPP.
Are the education sessions enough? “It's too early to tell,” Mr. D'Agata said. “We're still looking at feedback we've received from members. But the bottom line is most people want us to hold their hand and tell them what to do, which we can't do. But we can direct them to what they need to do.”
This article originally appeared in the May 1, 2017 print issue as, "Growing pains and some fears of trouble".