New solutions give DC plan members options for decumulation while giving employers the opportunity to help plan members achieve income solutions for their golden years
New solutions will give defined contribution plan members options to help them design their decumulation strategies while giving employers the opportunity to fulfill their obligations as sponsors of retirement savings plans by helping their plan members achieve income solutions for their golden years.
More than ever, defined contribution (DC) plan members need help in both saving for retirement and in the decumulation process, says Kendra Osenton, principal, DC consulting with TELUS Health. Speaking at Canadian Pension & Benefits Institute (CPBI) Saskatchewan’s webinar, titled Innovations in DC Plans, she said, “The increased cost of living has forced many families to adjust their household budgets…. A quarter of Canadians over age 50 say that their income is not enough for them, either that they are stretched or that they are having a hard time. The growth of capital accumulation plans (CAPs) at a time when the ability to save is diminished by inflation and budgets are being stretched makes it even more important to help participants make the best of their savings.”
Osenton says that helping plan members with their decumulation strategy is an important step for employers to assist as part of the overall strategy of offering a retirement savings plan.
“During accumulation, the formula is fairly straightforward: you enroll, you set a goal, you use a retirement modeling tool, you decide on your contribution rate, and you choose your investment approach. Then you sit back and monitor your progress and tweak your strategy as you go. In addition, you're supported through that process.
Members need help understanding choices
“But in retirement, members need help with understanding and managing the choices that they have managing longevity risk and making optimal decisions about how to use their DC balance.” She says this offers an opportunity for employers to create loyalty. “Helping employees to understand the options they will have at retirement is a very important element in a member achieving the financial lifestyle that they want, so, a good pension plan will provide employees with a reliable source of income during retirement. [Such a] plan demonstrates that the company or employer values its employees’ wellbeing and long-term financial security. This leads to increased employee satisfaction and engagement. When employees feel that their employer is invested in their future, they're more likely to be loyal, motivated, and committed to the company's success.”
While DC plan members have had tools for decumulation – mainly annuities and RIFs – there are now new tools coming up that will provide them with more options, especially to deal with longevity.
Decumulation is a complex period in people’s lives. When plan members exit their DC program, they must navigate the myriad sources of income they have and figure out how long they may require a pension income. Indeed, a big problem with retiree income is living longer than expected and losing the income stream.
New solutions for lifetime retirement income
One new solution to allow retirees to better manage and customize their income streams I the advanced life deferred annuity (ALDA), which is a form of longevity insurance.
“An ALDA is a type of annuity with a regular payment that can be deferred but must be started before the end of the year in which you turn 85 years of age,” says Osenton. “Up to 25 percent of an individual's DC account balance in a registered plan can be used to purchase an ALDA and it is payable for as long as you live or, if you have a joint lives annuity, for as long as you or your partner lives. It can be very helpful because it allows you to take variable benefits in the early part of your retirement, but then secure some guaranteed income, a longevity protection later in life. So, it can help to protect against the risk of running out of retirement savings later in life.”
Another new solution is variable payment life annuities (VPLAs). “VPLAs are another type of lifetime annuity that can be provided from a pension plan. The pension received each year varies based on actual investment returns and mortality experience versus assumptions. Although variable benefit provisions in DC plans can provide former employees the advantages of staying in a DC pension plan during their retirement years, VPLAs go further. By pooling retired employees’ investment risk and longevity risk with other retired employees who elect the option of the VPLA fund within a DC pension plan, the plan converts the account balance of the retiring employee into a monthly pension payable for the remainder of their lifetime. Based on assumptions about investment and mortality experience, the retirees’ monthly pension income is variable in that it is adjusted periodically to reflect the actual mortality and investment experience of the pool of retired employees who have chosen this option. Their income could go up or down depending on the investment returns that the VPLA fund achieves and the mortality experience of the members invested in the fund. This risk pooling is similar to an annuity, but the VPLA does not provide the same level of guarantee since the monthly pension can increase or decrease over time.
“The sponsor, however, does not bear any financial risk from the investment or mortality experience. Another advantage of the VPLA is that there's likely to be fee savings for the members that choose it as they benefit from the reductions that come from remaining part of a group arrangement. It's very early days for the VPLA; plans are only just starting to design in these options. But they do have potential to be a good cost-effective solution that can significantly reduce the chance of a retiree running out of money.”
