Changes are needed to allow CAPs to be effective retirement vehicles.
Employers, looking to minimize their pension costs and cash flow risks, have been switching to CAPS: more money is now going into DC than DB plans. Employers have also encouraged members to transfer from a Defined Benefit (DB) to Defined Contribution (DC) account. Individual Pension Plans (IPPs) are also popular and a type of ‘personal’ self-managed DB plan. IPPs are only available to professionals and business owners.
A DC or RRSP (CAPs) is a simply a ‘personalized’ DB plan, managed by the employee. DCs and RRSPs have the same objectives as corporate DB plans, unfortunately they do not same advantages as DB plans or IPPs. The switch to CAPS has shifted the responsibility for managing pension outcomes to employees without the advantages and flexibility of a DB plan or IPP.
The collapse in the equity markets has damaged CAP retirement accounts. Governments need to level the DB vs. CAP playing field to assist CAP members in rebuilding their retirement accounts.
Corporate DB plans and IPPs make additional contributions to offset investment loses: if investments are not sufficient to cover solvency or going-concern liabilities additional contributions must be made. These additional contributions are tax deductible. The ability to make additional tax-deductible contributions to offset investment loses is the most consequential difference between DB plans and DCs and RRSPs.
Read: DC Plans: Fatally Flawed Canadian Investment Review February 29, 2012
DCs and RRSPs are simply personalized DB plans that must also be adequately funded to be effective. The funding is effectively a personal ‘liability. The objective of a CAP is to have sufficient investments to provide a future pension income i.e. the objectives of DC and a DB plans are the same.
Record keepers (financial institutions) can track the book value of the investments (purchase cost net of withdrawals) and, current market values. The difference between the net book and market values represents a loss i.e. a funding or contribution shortfall.
Allowing CAP members to make additional contributions to offset losses would increase the likelihood of having sufficient pension assets and income at retirement. Additional contributions should be optional and based on the ‘loss’ at that time the additional contribution is made. This added flexibility would allow CAP members to top up their accounts if they have additional cash.
Allowing additional contributions would reduce governments’ tax intake for the year but, the tax would be recovered in the future when money was withdrawn from an account. Sponsors would also benefit by having this added feature as part of their CAP programs.
Mandatory Withdrawals – RRIFs, LIRAs, and LIFs
At age 71 you must withdraw a specified amount from a RRIF each year. The rate increases each year peaking at 20 % at age 95.
Forcing retirees to make withdrawals may requires selling securities at a loss. These forced sales undermine the investment base and long-term effectiveness of a retirement account.
Minimum withdrawal requirements ensure governments receive a certain level of tax annual revenue. In some cases, however, the minimum withdrawal requirement will reduce the overall tax paid. The larger the amount in a RRIF account at death the greater the amount the tax payable i.e. the amount of tax collected is a timing issue.
In the long run, reducing RRIF withdrawal rates could be an advantage for the government.
Following the recent collapse of the equity markets and low interest rates, 2020 RRIF withdrawal rates were temporarily reduced by 25%.
A permanent 50% reduction in the withdrawal; rate should however be implemented to facilitate building and maintaining retirement accounts.
Management Investment FEES (Fees)
The Management Investment Fees (fees) paid by CAP members decrease their total savings but CAP members have no control over these costs.
Read: The Impact of Fees on CAP Members Canadian Investment Review June 1, 2011
Fee costs are often overlooked: recordkeepers seldom disclosed the total annual amount paid by the members, to the sponsor or pension committees. CAP sponsors have a fiduciary responsibility to act in the members best interests. More attention needs to be focused on fees.
Sponsors could simply pay the management fees. This would effectively increase the employer contribution rate but reduce one potential legal risk.
Sponsors should be required to review fees frequently. Provincial legislation should add legislation that includes formal fee reviews at least every three years.
Knowing what you pay for a service is important and common sense. However, disclosure of the total annual fees deducted from a CAP account is not mandatory. Disclosure of the total fees deducted from a DC account should also be a requirement. BC has this (Section 30 (3)- BC PBSA Regulations) but, it is not enforced.
GST/HST – Pooled Funds
Fund managers pay GST/HST on pooled funds. This cost is recovered by fund managers by deductions from a fund. Members therefore pay this GST cost through reduced investment unit values.
The governments should eliminate GST/HST on pooled funds.
Consolidation - CAP Investment Vehicles
There are more DC and RRSP pension programs and members in Canada than DB plans or members.
CAP sponsors are required to provide members with investment choices, education, information and, investment performance information on an on-going basis. Selection and monitoring investment options requires time and expertise. Many CAPs are small and only have a few members. Sponsors often have to rely on servicer provides to oversee the investments which may include the service providers proprietary funds.
The provinces should create an investment vehicle (CAPVs) for all CAP sponsors. Most plans would benefit from this approach:
1) Diversified and only ‘best in class’ investment options could be available to small plans
2) Investment options would be selected and monitored by professionals
3) Much low fees would be possible because of the volume of the investments
4) Sponsors could easily replace investment options within the CAPV if their plan needs change
5) Standardized investment information and communications could be provided
6) A single Statement of Investment Policies and procedures would be available for all stakeholder
7) Each participating plan could be represented in a CAPV investment committee
8) Individual plans would continue to exist and would be tailored to a specific organization’s needs
Existing ‘not -for-profit’ organizations such as CPPIB, BCIC, AIMCo, or provincial WCB Investment organizations, etc. have expertise in managing investments and would be candidate CAPV managers.
Good governance is the key in managing a CAP and fulfilling fiduciary responsibilities. A formal governance process is essential in administering a CAP and, it minimizes certain legal risks. Many CAPs make the mistake of not having a formal governance process in place and assume the recordkeeper is responsible for all aspects of administering their plan.
BC and Alberta have emphasized the role of the sponsor and governance by adding governance requirements
Read: BC Puts Spotlight on Pension Governance- Canadian Investment Review-June 19, 2012
The BC PBSA requires that a written governance policy that outlines the criteria for overseeing and administering the plan. For example, the administrator (sponsor) must develop and follow a statement of investment policies and procedures. The plan administrator must be independent of the sponsor and act in the best interest of plan members. A formal funding policy is also required.
Good governance benefits all stakeholders. Provincial governments should include governance requirements in legislation and regulations.
Changes are overdue!
While sponsors and governments have promoted CAPs as retirement savings vehicles, they have not included similar features, and advantages, available in DB plans.
The current equity market collapse has damaged the retirement saving accounts of many CAP members. They need help rebuilding their retirement accounts. The governments should change legislation and regulations to assist in rebuilding retirement accounts and provide long-term solutions to level the DB vs. CAP playing field.
G. Wahl, Managing Director, The Pension Advisor