Should you have a savings plan that's similar to having your own Defined Benefit Pension Plan?

As the Canadian postal workers union (CUPE) continues to negotiate with Canada Post over their contract and in particular the issue of phasing out of Defined Benefit (DB) plans in favour of Defined Contribution (DC) plans as was recently discussed on the CBC, I've been wondering why we're not hearing any discussions about guaranteed retirement income solutions that are already a huge market for many Canadians without DB pensions and have been available through a variety of Canadian insurance providers right across the country for many years.

In our practice we speak with many Canadians who have saved and/or are saving for retirement and find that most people have the common desire to have at minimum, a rock solid core retirement income that's guaranteed to keep them in the lifestyle they prefer. I would suspect that the postal workers union and their members probably have the same goals in mind.


From the outside looking in, the main problem in this dispute appears to be that even though DB plans are often the best guaranteed retirement income solutions available for employees the financial risks of DB plans are considered too high for most of today's corporate managers to take on. So the compromise of a simple DC plan offers similar ongoing financial support for workers but eliminates the corporate capital requirements required by pension regulation and future retirement income risks of employees away from the corporation.

A few of the key differences between DB plans and some of the available guaranteed income plans such as with variable annuity plans also known as GMWB's are:
a) savers maintain access to their savings in the event they need the money.
b) plans can be portable when people change jobs.
c) some plans offer lifetime income that is based on deposits plus 4-5% during your savings years (or market value which ever is higher).
d) lifetime retirement income might not be indexed to inflation.
e) savers can choose from a wide variety of investments.

Guaranteed income for life solutions that combine some of the DC plan attributes with some of the DB plan attributes such as these are often a good compromise that suits a majority of retirement income needs.

That's because in our experience we find that clients who integrate guaranteed income solutions into their financial plans tend to do so for a variety of common reasons. These often include such things as:

a) peace of mind comes from having a core part of retirement income that's provided for life that's above and beyond meagre CPP and Old Age Security (OAS) payments.
b) as a passive supplemental guaranteed income above small or insufficient existing DB plans in order to guarantee anticipated lifetime income needs.
c) create as close to a DB plan equivalent with RRSP's, RRIF's and DC plans as possible so the requirement for taking on additional investment risks are reduced or eliminated in savings years and most importantly, during retirement risk zone years.
d) smooth out or eliminate the negative effects on incomes that are often caused by volatile markets or savings that would otherwise be exhausted when needed during retirement years.















It's also important to note that the various guaranteed for life income solutions currently available are implemented to suit the specific needs of groups, couples and individuals on a case by case basis.

Will I have enough income?

For those of us who don't have a defined benefit plan to rely on when we retire (or have a plan that won't be enough to satisfy our financial needs) we require different investment strategies to fulfill our family's financial needs that will last throughout our retirement years.

In addition, low interest rates are making our investment decisions even more challenging because it takes significantly longer for our savings to grow and a much larger savings base from which to pay our expenses. Some people can afford to take more risk by investing in assets like mutual funds that are not secure, but if you are relying on this money to pay your way as you approach your retirement years is this really a good idea?

The short answer is a qualified maybe. Here's why.

For years we've been told by people who sell riskier investments that taking on a 'balanced approach' or just a little more risk means you'll get a higher return on your investments. They also tell us that when the market goes down it's a buying opportunity because the markets will recover and in time we'll get better over-all returns. The idea is that the longer you are invested, the higher the probability you will end up with above average returns.  In general this is good advice when you have a time horizon of many many years and/or you have invested excess money you won't need to depend on.

In his book Pensionize Your Nest Egg, Moshe Milevsky calls the five years before retirement and the five years after retirement the Retirement Risk Zone. During this time the most basic problem with risky investments is that there are no rate of return guarantees. Market corrections will occur at various random times before, during and after the risk zone years and these corrections will decrease the value of your nest egg. As you take money from your savings and your capital erodes at the same time, it becomes a very serious negative compounding problem that can spiral to zero values extremely quickly. 

In a very basic example of this, let's say you've just retired and have $100,000 in savings which then grow to $105,000. You then start withdrawing an expected $5,000 a year. The market corrects by 20% and your savings become worth $80,000. Do you stop taking income and wait for the market to recover? How long will that be for? Can you afford or even want to wait?  (Today the S&P/TSX60 is about at the same level it was in 2008!)

Though the future is unknown you know that the average return of the S&P/TSX60 over the past 10 years or so has been a little under 5%. If that rate of return continues your savings would grow to somewhere around $78,500 before you take out another $5,000. Leaving you with $73,500.  And so on until the next correction. I'm sure you can see that, unless you stop taking income for a period of time, it's unlikely your savings will ever catch up and you'll run out of money much faster than you'd care to worry about.

If you wish to avoid this kind of risk or this has already happened to you what are some of the more common solutions available?

Like with most things financial, unfortunately there are no one size fits all solutions because everyone's family, finances, current and future needs and wants are quite different from each other so proper solutions really depend on the outcomes you want and can afford. 

In general though, if your retirement income is too low for your needs, or you'd prefer a higher after-tax income, it's time to explore whether your nest egg should be rearranged somewhat to provide a higher after tax income stream and to do so without taking on any risk.  

In my practice, I find that it often makes sense to initially explore whether it makes sense to create a core income that's guaranteed for life. When it is appropriate, guaranteed income for life is really something that you can rely on and can effectively plan around.

Next...Financing your retirement living.

Jack Bergmans, Certified Financial Planner/Founding Partner
Bequest Insurance
Personal financial planning for life!™
jack@bequestinsurance.ca
Books:
Ripple Effect
Multiplying Generosity