Decumulation: The Burning Issue in Pension Plans

Sep 26, 2017

money-2180338_1280Earlier this year I was in Toronto, a city that thumbs its nose at spring and moves right from bone chilling winter to stifling summer. But this June, it was downright boggy while the rainy interior of British Columbia went up in smoke in an alarming start to this year’s wild fire season. Weather doesn’t seem to rest within its usual seasonal boundaries anymore.

Similarly, change is afoot around the drawdown or decumulation stage of retirement assets. This is especially so in an age where the safe harbour of a defined benefit (DB) pension plan has become as rare as a news cycle without a climate disaster.

In this and in future blogs we look at why decision making and risk analysis during retirement is now critical. We’ll also break down some assumptions, see where we are now and look at the forecast for both benefit plan sponsors and for participants.

Typically, there are two seasons, if you will, in a retirement plan: accumulation and decumulation. Neither is completely all one or all the other. Surprised? It’s because we’ve long been accustomed, over the last half century or so anyway, to the notion that we accumulate during our working careers and decumulate in retirement. Simple, right? Well, like our weather and its attendant effects, not so much.

First, a top-level perspective of Canada’s demography: the number of people over 65 doubled over the past 5 decades to 16 per cent. Doesn’t sound so dire at first glance, but look closer. This year there are more people over age 65 than are under 15 – the first time this has happened.

And that’s just the start of the rising gray sea level. The problem lurking below the surface here is this percentage is set to swell because baby boomers, who make up nearly 30 per cent of the population, are only just now moving into their golden years.  Fewer than 20 per cent of them have turned 65.  

Peak Boomer will not happen for another decade when the great silver tide will swamp the stats. And when that happens, the number of people over 65 may reach 25 per cent of the population. The kicker is that most will enter retirement without the peace of mind that may come with a DB pension. Uncharted waters. Hold that thought.

What’s the status quo? Today, many if not most, Canadians accumulate assets over their working careers through either a defined contribution (DC) plan, (DB plans are rarely an option for private organizations), a group RRSP or individual RRSPs. Assets grow, but as you near retirement they are converted from savings to income. The mechanisms for converting tax-sheltered savings are variously, Life Income Funds (LIF), Registered Retirement Income Funds (RRIF) and annuities. The logistical shift from savings to these income products is reasonably simple. But that’s where simple ends.

In fact, the risks and decisions facing retirees during decumulation may be more complex than when they were accumulating. This sounds counter intuitive. But here is the myth: income, therefore accumulation, stops. The decisions and risks of investment selection no longer exist and all that’s apparently left to be done is to move investments over to fixed income where there is less risk.

Take that course and it will be like trying to land a plane this spring at Toronto’s Island Airport. Under water. You won’t yield a high enough return on your portfolio to last the duration of your retirement. Which brings us to your next new risk: longevity.

It means simply a long life. Most of us hope to have one. But there is an inherent irony if we are fortunate enough to live long and prosper. This is because we pay twice. Let me explain. During our working lives, we pay plenty in life insurance to mitigate the downside if we die. Then, in retirement, that same long life becomes a liability. So we pay again during decumulation, either through working longer or lowering our lifestyle to manage funds and mitigate the downside if we don’t die. The universe is definitely not fair.

And here’s another startling fact: 60 cents of every retirement dollar is funded by returns earned after retirement, according to the work done by Bob Collie, Matthew X. Smith and Don Ezra in their book, Retirement Plan Solution: The Reinvention of Defined Contribution. That’s nearly twice as much as the combined impact of all returns realized before retirement. Traditional belief is that most accumulation is done earlier in working life when compounding works its magic. So, what gives? What gives is that clearly, retirement is not the finish line.

Up to now, we’ve looked at how the draw down of retirement assets affects plan members. But what is the issue for plan sponsors? Exactly what is the employer’s responsibility to provide assistance in decumulation options to the plan member?

Currently, plan sponsors follow the guidelines outlined in the Capital Accumulation Plan (CAP). However, these are focused on the informative and education responsibilities of sponsors to members about accumulation. They’re limited in direction on decumulation options.

That said, a review is underway by the Canadian Association of Pension Supervisory Authorities (CAPSA) on the extent and nature of plan sponsors’ obligations concerning employees’ decumulation options for their DC pension plans. Will plan sponsors be obliged to take on yet more responsibility by educating members about decumulation as well as accumulation?

To answer, remember those uncharted waters? Well, these are them. The boomers are wading in and it’s very hard not to be curious about what it will look like as increasing numbers of them retire without DB pensions. Watch this space for an upcoming blog where we explore this issue further and look at how it might affect plan sponsors.

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