TDFs may not be appropriate for many people in the ‘Decumulation phase’
The decumulation phase starts when money is withdrawn from a retirement account to provide regular retirement income. Preparing for retirement and the decumulation phase should begin 10-15 years in advance of retiring, while there is still an opportunity to make changes. The decumulation phase is inherently ‘riskier’ because of aging and other timing issues.
Target Date Funds (TDFs)
A CAP is often the only non-government pension benefit. CAP accounts are similar to a Defined Benefit Plan (DB). Therefore, CAP members need a basic understanding of pension investing and the funding (an implied liability) issues.
CAPs are often incorrectly referred to as pension plans. A DC plan, for example, is not a pension it
Is a savings program. A pension is defined as a retirement plan whereby employers promise to pay a certain defined benefit to employees after they retire. In a CAP, both employers and employees put money in an employer-sponsored investment account however, there is no promise or guarantee of a certain level of pension income. CAP sponsors usually emphasize that the intent of a CAP is simply to help save for retirement, but members often ignore this.
CAPSA Guideline # 8 highlights several key issues for sponsors to consider in the decumulation cycle:
· the payout phase and retirement products.
· the diminished role of the administrator in the ‘payout phase’.
· the investments in the payout phase.
· the need for retirement product information that facilitates informed member decision making; and,
· members should be encouraged to use a financial advisor.
Sponsors have a fiduciary responsibility for education and to communicate in a way the members can understand the issues. Communications and education can be more of a challenge as retirees get older.
Retirement – Decumulation (Payout Phase)
At age 71 members must transfer their CAP accounts to a LIF, LIFA, or RRIF with a financial institution. Decumulation, the payout phase, begins when a member draws funds out of a CAP account. Unfortunately, 24% of CAP members have a poor understanding of their plan and 41% believe the employer is responsible for providing an adequate retirement. What does this mean in terms of risk for sponsors?
The sponsor is a fiduciary and administrator of a pension plan and must always act in the members’ best interests. Sponsors can not waive their fiduciary responsibilities by delegating responsibilities such as education or communications to the record keeper: the sponsor is always responsible and must monitor the actions of third-party service providers and the plan members.
Education and Communication Education and communication are intended to promote CAP member engagement. The sponsor is responsible for determining the information and education that is provided. This requires careful monitoring of the member's concerns and understanding of the pension programs offered.
The specific terms of each retirement account in the plan, demographics of the membership, and the retirement products available must also be considered.
Documenting pension seminars and education sessions attendees, tools and information is also important. Frequently reminding CAP members that they are responsible for planning and managing their retirement, using the tool and information provided, and attending education sessions, will not eliminate risk but it will strengthen your legal position
CAP members are often forced to leave an organization’s CAP upon retiring or terminating. They must be told they are no longer plan members and the sponsor is not responsible for communication and education, etc.
Apparently, only 32% of Canadian men and 43% of women don’t feel comfortable about managing retirement investments (Benefits Canada Nov 2021 - CIBC: Statistics Canada). This is likely an indication of overconfidence given that a majority of people don’t have a financial plan or use an advisor. It also emphasizes the role of education and communication. Communication and education issues are common sources of DC plan and 401(K) litigations in the US.
Fees significantly reduce asset accumulation and retirement savings over time. In most cases, only return (before fees) information is provided for an investment option. Net returns (after fees) are also needed so members can effectively evaluate their investments and performance.
The CAPSA Guidelines recommend that CAP sponsors encourage members to use a financial advisor. This should help members develop a financial plan, set realist saving, return and retirement income goals and reduce sponsors’ legal risk exposure. However, it also results in additional costs. Providing some sort of a subsidy for advisor costs is a way to promote members to hire an advisor.
Employees are often forced out of a sponsor’s CAP programs and transferred to a financial institute upon retirement or termination. Their CAP accounts are transferred to a financial institution where fees are usually higher, and the level of service will decrease. While CAP members are should be informed of the higher fees, for effective financial planning purposes, this seldom happens.
Fee issues are one of the main sources of member litigation in the US. Sponsors are responsible for ensuring that CAP fees are reasonable. Therefore, formal fee reviews should be undertaken as part of the governance process. To minimize this risk, sponsors could simply pay the CAP fees.
Longevity, Time, and Timing
CAP members are encouraged to take a long-term view of investing. This is not necessarily appropriate for retirees: it depends on life expectancy and finances. The CAP Guidelines recommend that sponsors offer investments that reflect the purpose of the plan and the diversity and demographics of the members. CAP investments often do not adequately address decumulation investment needs.
Longevity risk is increasing: 65-year-old males are now expected to live another 21 years and females 24 years. The fact that a spouse often outlives a CAP member is often overlooked. CAP members, therefore, need to consider both their own and spouses’ expected life spans. Up-to-date life expectancy information, by location and industry, should be provided regardless of whether the members use this information or not.
The concept of a personal pension “liability” and how it relates to funding retirement income is usually ignored by sponsors because it is complex and may be confusing for members. Confusing or not, the concept needs to be explained and longer duration investments should be part of the investment options. Long bond funds, that better match duration and funding (liability) requirements and are commonly used in DB plans are seldom available in CAPs. This is a shortcoming in most CAPs.
CAP members often have unrealistic return expectations. A Benefits Canada Survey found that the average CAP member expected annual returns of 15% or higher. However, the median professionally managed fund return over the last 25 years was 8.5%. The Globe and Mail previously suggested that 8% was more realistic.
10-year Canadian government bonds currently yield ~1.7% while 30-year bonds yield ~2. 5%. The median return for Canadian Balanced funds is ~7.7% for 5 years and ~8.9% for 10 years – before fees. Inflation is in excess of 4.7%: the loss of purchasing power is an issue for retirees.
One would assume it is the sponsors’ responsibility to ensure that return and long-term interest rate information is available. However, 15, 20, or 30-year benchmark and investment returns are seldom provided.
The impact of volatility, time, and timing is critical in the decumulation phase. While managing volatility is critical in overseeing DB plans because of solvency funding requirements, this aspect of retirement planning in CAPs is ignored or downplayed. Only 31% responding to the BC Survey indicated they understood ‘investment risk’. Members need to understand that it is difficult it is to recover from losses in retirement. This is due in part because the amount available to invest is less because of the drawdowns. Basic risk information about investment fund performance such as standard deviations, tracking error, and information ratios is seldom provided. Unlike a DB plan, CAP members cannot put more money into their CAP accounts if they have investment losses. This can result in “underfunding” a retirement account. This is a critical difference and shortcoming of CAPs.
In another article, the primary risks in the decumulation phase and target date funds will be discussed.