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Financing retirement represents a looming crisis for both Canada and Canadians, since huge numbers of baby boomers are shifting into retirement and we are living considerably longer lives than we used to.
Unfortunately, like the motionless frog in a pot of water slowly brought to a boil, we too often react with a simple shrug to crises that incrementally creep upon us. Longevity risk is by its nature gradual, and fully interpreting it requires statistical thinking skills that many of us have not honed. Still, with more focus and access to the right set of financial tools, Canadians can solve this problem themselves.
Retirees face uncertainty on multiple fronts: market returns, cost inflation and their own physical health. Yet it’s the unknown length of an individual’s ultimate lifespan that creates a labyrinthine financial planning challenge.
Consider that a 65-year-old woman entering retirement can expect to live on average to age 87. This average hides variability: she still has a 10-per-cent chance of living past 100, a one-per-cent chance of living past 105 and a tiny chance of reaching 110 or even beyond that (the oldest Canadian on record passed away at 117 years and 230 days). This variability makes determining how much to safely spend from her nest egg rather tricky.
Many people quite rationally play it safe and avoid drawing down their retirement accounts, but there are steep costs to that sort of self-insurance: namely, not fully enjoying these special retirement years while we can. Others, perhaps inspired by the you-only-live-once ethos, spend freely as they set into retirement, revealing a callous lack of empathy for their future self, who may someday suffer as a result.
In other areas exposed to existential financial uncertainty, we find ways to mitigate that risk. We buy insurance policies so that house fires, car accidents or medical emergencies while abroad don’t financially wipe us out. The impact of living a decade longer than average — something that will happen to almost one in four retirees — creates a liability of similar proportion, yet one that few of us protect against today.
Nonetheless, Canadian employers continue to steadily transition away from the defined-benefit (DB) pension structures that offered comfortable, confident retirements to previous generations. Less than nine per cent of private-sector workers today have access to a DB pension, far from the peak in the late 1970s when approximately half had such plans.
Corporate leaders did not jettison these programs because they weren’t effective or popular; indeed, they remain coveted as the gold standard today. Rather, chief financial officers shunned them because of the financial risk that guaranteeing them put on the company’s balance sheet (it will come as little surprise to many that they remain widely available to government employees, where the risk is backstopped by the public).
We face a number of formidable challenges today, several of which conspire to drive up living costs (thereby decreasing living standards). In response, some are giving up, viewing a secure retirement as an unattainable goal. Surveys show many people have curtailed saving (rather than cut back on current spending), effectively shifting future consumption to today. Consumer spending patterns support this observation, with the average price of a new car hitting $61,000 in 2022, the same year that 59 per cent of Canadians said they were saving very little for retirement or nothing at all.
The financial services industry has not done enough to address this challenge, so we are left to attack today’s problems with yesterday’s tools. As DB pensions sunset before our eyes, we need alternative methods to achieve sustainable income at the highest possible level from our savings, and protected against the chance we live a long time.
Lifetime annuities, offered with a wide variety of options, provide such protection. But the set of trade-offs inherent in their design makes them suitable only to certain situations and preferences, and, as a result, only a small minority of Canadians use them. Imagine for a moment if people only had access to either investment portfolios or secure savings accounts, not both; this lack of choice would create all sorts of inefficient outcomes.
We need further innovation, access and adoption of a robust set of tools to shape our desired financial outcomes. Look at what Wealthsimple Inc. and the emergence of low-fee, dynamically managed investment accounts have done to help Canadians accumulate wealth during their working years. A similar evolution is now essential for the decumulation phase.
Last year, the Organization for Economic Co-operation and Development (OECD) updated its pension-program guidelines, recommending that member countries provide their retired populations access to income-for-life options, including “by non-guaranteed arrangements where longevity risk is pooled among participants.”
The federal government is incubating one form of such a program (commonly referred to as VPLAs, or variable payment life annuities), which will create an option for certain employers, while some innovative companies are introducing novel product designs to reach beyond registered pension plans for all Canadians to access. Yet the path remains largely untrodden, and much work remains.
If our governments, private-sector firms and non-profit organizations work together constructively, Canadians can have the needed baseline education and a complete set of tools to solve the decumulation problem for themselves. This will require ambitious thinking at all levels, not just innovative product ideas: clearing the path for real-world adoption of new products, building software to visualize the downstream effects of possible choices and ensuring distribution fee structures don’t steer retired investors down a sub-optimal path.
In addition to our obvious interest in solving this for our own families, we share a collective interest in addressing this problem at a national level. Every Canadian who can comfortably navigate their own retirement finances is one less person requiring expensive subsidized care from the public purse, which must come from either increased taxes, additional borrowing or reduced spending elsewhere. The fourth option would be to simply not provide aid, creating tremendous suffering among our vulnerable elderly population and a stain on our national conscience.
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Fortunately, Canadians are not frogs. Canada’s symbol (and national cliché) is, of course, the beaver, an animal fully capable of assessing the situation and, quite literally, engineering the future environment it seeks for itself. Castor canadensis creates this secure future through stunning hydrologic manipulation and its resulting moated lodge, but we must apply similar thinking to our retirement income security.
Fraser Stark is president of the Longevity Pension Fund at Purpose Investments Inc.