The Wonders of Variable Payment Life Annuities

I figured that since Joe has been writing a lot about DC plans and annuities lately, and earlier Dean provided his commentary on the recent Federal Budget which introduced the public to terms like Advanced Life Deferred Annuities (ALDA) and Variable Payment Life Annuities (VPLA), maybe I should also take a shot at making annuities sound interesting and wonderful!

The recent attraction to annuities largely stems from the increased focus on the very important ‘decumulation’ phase in life (aka retirement) as one draws down their savings – which have been accumulated in a Defined Contribution Registered Pension Plan (DC RPP), RRSP, TFSA, or the like.  More and more Canadians are retiring with these pots of money which they are then responsible for managing rather than receiving predictable monthly pensions from defined benefit pension plans which were more popular in the past.  The trick is successfully living off this pot of money for the remainder of your lifetime – which mostly means managing the investment risk and the risk of outliving the funds.

While a traditional annuity sold by an insurance company can do an admirable job in delivering guaranteed monthly income for the remainder of your life, these can appear costly as you’ve fully transferred the investment and mortality risk to the insurer.

On the other hand, VPLAs do not insure the investment and mortality risk but instead pool these risks across a (hopefully) large group of people so that the risks are not borne by an individual but the group as a whole.  The good news is that the monthly pension under a VPLA will usually be higher than under a traditional annuity because there is no insurance company collecting premiums in exchange for a fully-guaranteed promise (these are expensive promises given today’s low interest rates and the fact that life expectancies keep increasing).  The bad news is that the monthly pension will be somewhat volatile as actual investment returns and mortality experience differ from the long-term assumptions.

The UBC Faculty Pension Plan is the poster child for a successful implementation of a VPLA option within a DC pension plan.  Note that as members retire from that plan they are not forced to choose a VPLA – it is only one option along with the other usual options like transferring your funds to a locked-in retirement account or purchasing a traditional annuity.  UBC spends a lot of time and energy making sure that plan members make an informed decision if they decide to choose a VPLA.  It’s an irrevocable decision and members need to understand that their pension will go up and down depending on the pool’s experience.  My understanding is that the members who choose the VPLA are reportedly very satisfied with their choice, even during the ‘bad years’ when their monthly pension suffers a significant cut.  To me it all comes back to clear communication to ensure that the plan members understand the fundamental nature of the promise – plus presumably the comforting fact that they are not suffering the pain alone – keeps the satisfaction levels very high.

So, given all of this, should all DC pension plans rush out to add a VPLA option for their members?  Not so fast!  First of all, VPLAs were only just announced in the 2019 Federal Budget – we now need the final rules and regulations from the Federal Government.  Then, the provincial pension laws and regulations will also need to be updated to allow for VPLAs.  Who knows how long this will take.  (FYI, UBC’s VPLA offering has been around since 1967, but was grandfathered under the Income Tax Act and no new VPLAs have been permitted for some time.)

Secondly, in my view a DC pension plan will need to be sufficiently large and sophisticated in order to appropriately take on the responsibilities to successfully administer a VPLA.  There will be a significant setup cost to establish the communication materials and administrative practices to support the VPLA offering.  Plus, the risk pooling will only work well if there is a sufficiently large pool of plan members.  The recent Federal Budget has set a floor of 10 members, but this seems way too small to me.  You probably want at least 100 retirees in the VPLA option in short order, which means you will need a very large DC plan with lots of retirees every year and a significant number of those choosing the VPLA option.

While I firmly believe that VPLAs can be a perfect decumulation option for many retiring Canadians with accumulated assets in a DC pension plan, unfortunately I envision that based upon the current proposals it will only be available to the lucky few in the largest DC pension plans in Canada.  It would be much better if other financial institutions, insurers, and even large pension funds were permitted to setup VPLA pools which could accept transfers from anyone’s registered funds (i.e. DC pension plans, PRPPs, RRSPs, DPSPs, etc.).

I look forward to the day when I’m able to buy a VPLA (and an ALDA) to secure my retirement income!

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