While you may ask, “What took them so long?”, the Ontario government recently published a description of the proposed regulations to permit variable benefits to be paid from defined contribution (DC) pension plans. The variable benefits provisions in the Ontario Pension Benefits Act (PBA) would permit a pension plan that provides DC benefits to offer Life Income Fund (LIF)-like payments directly from the plan through the establishment of a variable benefit account.
Believe it or not, plan members of an Ontario DC pension plan currently must transfer the balance in their DC account to a financial institution in order to receive a retirement income. It’s unfortunate that when DB pension plans were first being replaced by DC pension plans that the laws of the land didn’t keep up. Even today, DC pension plans are still forced to live within the Ontario PBA which is very DB-centric; and the same can be said of the Federal Income Tax Act (ITA).
We therefore ended up with DC pension plans that only address the first half of the problem – how to contribute, invest and accumulate a (hopefully) sufficient nest egg for retirement. The second half of the problem – how to continue to invest the funds while drawing them down – was left for individuals to fend for themselves. While the ability to periodically adjust the income withdrawn from a LIF is a very nice feature that allows members to react to changing spending patterns in retirement, the low level of financial literacy among the general population often results in poor decisions being made as individuals manage their assets.
In the retirement industry, we’ve been talking about decumulation for a long time. Unfortunately, until recently it’s been mostly talk as the regulations severely limited any creative solutions and we were essentially left with only two choices:
1. Give the DC account balance to an insurance company in exchange for a seemingly expensive and inflexible annuity.
2. Transfer the DC account balance away from the cost-effective and institutionally-managed DC pension plan into the scary world of retail investment management, and leaving the member hoping that they don’t run out of money before they die.
Over 10 years ago, the ITA was amended to permit variable benefits from DC pension plans, and slowly since then various provinces have amended their laws; however, even these new laws are restrictive and don’t permit much creativity in payout options. I would like to see plan members have the ability to purchase variable annuities – where the monthly amount can go up or down based on investment performance. Another interesting annuity variation (that’s not yet allowed) is using a portion of the DC account balance to purchase an annuity that is deferred far into the future, such as to a starting age of 80 – this can be viewed as a form of longevity insurance to protect against outliving your retirement savings.
I would also like to see more incentives for employers to sponsor DC pension plans instead of Group RRSPs/DPSPs which are far less regulated. In my view, DC pension plans are superior mostly because the funds are “locked-in” and must generally be withdrawn slowly over a member’s retirement years. The flip side is that DC pension plans are more heavily regulated and therefore employers are strongly incented to go with the easier and cheaper Group RRSPs/DPSPs. If there were “safe harbours” in the laws to protect employers, plus the ability to offer assorted decumulation options, I could see more employers offering DC pension plans to their members.
In fact, what’s the incentive for employers to amend their DC pension plans to allow former employees to leave their money in the plan? Given that the new rules will be optional, the lawyers will probably say that only bad things can happen if/when retired members sue the plan sponsor for allegedly not doing something right (in hindsight!). I submit that governments should encourage a more holistic view that employers have a responsibility to provide viable decumulation options within the pension plan; plus, with economies of scale, it’s to everyone’s advantage to maximize the amount of assets to keep fees low. Moreover, if I’m a plan sponsor making contributions towards my employees’ retirement, I would feel better if the money was locked-in.
So, long story short, the new rules in Ontario to permit variable benefits from a DC pension plan are a step in the right direction. The ability for plan members to leave their assets in the employer-sponsored pension plan after retirement will be welcomed by many in order to continue benefiting from low fees and institutional oversight – let’s hope that employers do the right thing and amend their DC pension plans to permit this option. However, this is only the first step and we need to keep innovating on decumulation solutions!