Retirement planning does not usually get much attention in federal budgets or election campaigns, where personal finance issues tend to focus on income taxes and social programs. But there are a number of reasons why the topic deserves to be a hot button political issue in 2019 and beyond.
We all know that baby boomers are causing a shift in demographics. Retirement policies need to reflect this evolution and adjust to our aging population. Registered Retirement Savings Plans (RRSPs) and the Canada Pension Plan (CPP) evolved as young baby boomers were growing up, and now new measures need to be introduced as they continue to retire.
Among the more interesting recent developments in U.S. retirement plans is the 2014 introduction of the Qualified Longevity Annuity Contract (QLAC). QLACs allow U.S. retirees to use the lesser of 25 per cent of their qualified retirement savings plans or $130,000 to purchase a deferred annuity that makes guaranteed monthly payments to them for life. Payments must begin by no later than age 85, and the QLAC purchase lowers their required minimum withdrawals from their retirement plans, thus increasing tax deferral. A spouse or someone else can be a joint annuitant.
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A similar option in Canada could have some merit. Although the minimum Registered Retirement Income Fund (RRIF) withdrawal rates were decreased in 2015, the percentages may still exceed the sustainable withdrawals for some retirees.
Even if the current withdrawal rates are sustainable for many people, a tax incentive to purchase longevity insurance and protect against the risk of living too long may have other benefits. For example, retirees who opt in may feel more secure and may be less likely to spend less than they can afford to because they are afraid of running out of money. Enhanced annuity demand may also help to develop Canada’s somewhat inefficient annuity market.
In addition, retirees may choose to invest their remaining retirement savings more aggressively and avoid the occasionally counterintuitive practice of investing overly conservatively to avoid the risk of loss in retirement. While this may help preserve a retirement nest egg in the short-term, a low exposure to risk assets may inhibit preservation of an investment portfolio in the long-term.
“Retirees would be better off pooling the risk of outliving their savings with other retirees facing the same risk exposure,” according to a recent C.D. Howe Institute study entitled Making the Money Last by David Don Ezra.
Introducing something like the QLAC in Canada may also benefit retirees with more modest savings the most. Wealthy investors with large RRIFs could be limited by a dollar ceiling for an annuity purchase and would most likely have more assets outside their RRIFs anyway.
Policies to level the playing field between public sector retirees with defined benefit (DB) pensions and private sector retirees with defined contribution (DC) plans and RRSPs may also be a necessary political consideration, according to the C.D. Howe’s Alexandre Laurin. The main issue relates to maximum annual contributions.
“The current rules for calculating equivalency between DB and DC pension plans or limits for RRSPs are badly out of date, putting people with DC plans and/or RRSPs at a major disadvantage relative to those in DB plans.”
A Fraser Institute study released this month raises another DB pension issue that current or future governments will need to address. Philip Cross and Malcolm Hamilton found that taxpayers are subsidizing government employee pensions by an estimated $22 billion per year.
Their paper entitled Risk and Reward in Public Sector Pension Plans does not question whether government employees should have DB pension plans, but rather, how much they should contribute.
“There is nothing wrong with government workers having good pensions — as long as they pay a fair price for these pensions,” says Cross.
While not everyone has a government employee retiree pension, most Canadian retirees will be eligible for the CPP and Old Age Security (OAS) government pensions. Both pensions allow retirees to defer the starting age to as late as age 70, and benefit from lucrative enhancements.
CPP recipients who delay their pension after age 65 will see an 8.4 per cent annual increase in their entitlement. For OAS, the annual pension is enhanced by 7.2 per cent per year of deferral. However, less than 2 per cent of pensioners delay these pensions to age 70, even though many 65-year old retirees could benefit.
In particular, those who expect a long life expectancy, have a low risk tolerance, or who have little to no other DB pension or annuity income should consider deferring their pensions.
Anecdotally, I can share that the most common reasons I hear from people who choose not to defer CPP or OAS is that they are reluctant to draw down their investments or to die before receiving these pensions. In much the same way governments have encouraged people to save and contribute to their RRSPs using tax refunds, they may need to consider similar financial and tax incentives to help Canadians focus on the long-term in their retirement planning.
1) An enhanced CPP death benefit and the introduction of an OAS death benefit for those who delay their pensions past 65 but die before 70. This may encourage pension deferral, with a relatively small cost given how few people die between 65 and 70.
2) Tax incentives for the purchase of annuities such as an up-front tax credit or an annuity income amount similar to but distinct from the current pension income amount.
3) Corporations can claim a tax deduction for the fees paid related to an employee’s retirement counselling. Individuals can only claim a tax deduction related to investment counsel fees related to non-registered investments, but not for retirement counselling.
Retirement planning needs to be a political issue in this country. Demographics will make it so. I will be surprised and disappointed if the upcoming Liberal budget and next year’s federal election campaign do not include retirement planning policies as key personal finance issues.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.
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