Running out of money before running out of life is a classic fear for retirees. But many Canadian seniors end up running out of life well before they’ve run out of money, and so may be shortchanging themselves out of a more enjoyable retirement.
People without defined-benefit pension plans have few options — apart from annuities, which can be appropriate for many retirees — in creating a guaranteed income stream in retirement. The Canada and Quebec Pension Plans, as well as old age security (OAS) benefits, provide regular income streams that are indexed to inflation, but don’t provide enough money to fully fund retirement expenses for most middle- and high-income retirees.
GICs are far less attractive than before, given that nominal interest rates are at unprecedented lows and negative real returns are the norm. Guaranteed lifetime withdrawal benefit products, a form of annuity introduced by insurance companies in the early 2000s, offered guaranteed payments and liquidity. After the 2008-09 financial crisis, however, these products essentially disappeared from the market. And Toronto-based Sentry Investments (now owned by CI Financial Corp.) launched three real income retirement funds in 2016 that closed in 2019 with less than $12 million in net asset value among them.
A handful of new products aim to address the retirement income gap. A new mutual fund from Toronto-based Purpose Investments Inc. offers lifelong, regular (but not guaranteed) annual payouts and the promise of liquid capital.
The Purpose Longevity Fund, launched in June, is both innovative and ancient. One of the first of its kind in Canada, this fund is based on a concept similar to that of a centuries-old financial vehicle: the tontine. Members of a tontine, the concept for which dates back to 17th-century Europe, would pool their money and later receive an annual interest payment until death. As investors in the pool died, payments to survivors would increase proportionally (creating mortality credits) until the last surviving investor “won” the remaining cash.
The Purpose fund incorporates the longevity pooling and mortality credits associated with tontines, offering a lifetime annual payment of 6.15% of the fund’s capital to investors beginning at age 65. As participants age, payments increase incrementally. Unlike a tontine, however, payments are not guaranteed.
“Guarantees are expensive,” said Alexandra Macqueen, a certified financial planner in Toronto who specializes in retirement planning and pensions. She noted the lack of a guarantee is counterbalanced by the Purpose product’s liquidity — investors can cash out and keep their original investment, minus any payments they have received and their investment returns — and potentially higher returns as well as higher risk levels.
Moshe Milevsky, finance professor with the Schulich School of Business at York University in Toronto, has written extensively about tontines and is a strong advocate of putting more of what he calls “tontine thinking” into Canada’s financial landscape.
The introduction of the Purpose fund, Milevsky said, is a product of at least three driving forces: historically low nominal and real interest rates; lack of knowledge of decumulation strategies among retirees; and the fact that “people hate annuitization. They hate the process of handing over their money to an insurance company irreversibly. So, any fund that enables them to solve those three problems will be appealing.”
However, Milevsky would welcome tontine-like levels of transparency: “How exactly will these funds decide what my income dividend cash flow will be next month, or next year? What will they pay if the market goes down 20% or if we have a pandemic and [the fund] lose[s] half the [investors]?”
According to a Purpose spokesperson, the company developed a proprietary model — subject to third-party actuarial review — that uses “very conservative” assumptions to determine the fund’s target returns. For example, the model assumes long-term investment returns of 3.75% and voluntary redemptions of 2% annually, as well as longer-than-average lifespans for investors. Changes to these variables will inform actual distributions, Purpose’s spokesperson said.
Suitable candidates for longevity funds are the 75% of Canadian workers without a defined-benefit pension, said Milevsky, as well as people who don’t want to lock their capital in an annuity. However, participants in longevity funds must have enough capital to invest in the first place.
Longevity funds may be less suitable for retirees who want to leave a large estate. And, Milevsky said, “Somebody who is not in good health would not be a very good candidate.”
On the other hand, a longevity fund’s structure holds some appeal for a once-healthy retiree who is diagnosed with a life-limiting condition after investing in the fund, Macqueen said. That client can choose to cash out and forfeit future payments in order to pay for expensive home nursing or palliative care, for example, or take their family on one last vacation.
Two other products may soon be available in Canada. Advanced life deferred annuities (ALDAs) and variable payment life annuities (VLPAs) were proposed in the 2019 federal budget and received the go-ahead in June 2021 with the passage of Bill C-30.
ALDAs permit retirees to move up to 25% (to a maximum of $150,000) of the money held in registered retirement accounts into an annuity with drawdowns deferred until age 85 (as opposed to age 71, which was the latest age retirees could begin receiving payments from their annuities). The goals of an ALDA are to manage longevity risk, reduce the likelihood of OAS and guaranteed income supplement clawbacks, lower income taxes by reducing RRIF payments and hedge against the risk of a retired ALDA-holder outliving their savings — all while providing a guaranteed income stream.
VPLAs, currently limited to defined-contribution and pooled registered pension plans, incorporate mortality credits and longevity pooling into pension plans. VPLAs aren’t entirely unheard of in Canada; the University of British Columbia, for example, has been running such a plan for going on 60 years, Milevsky noted.
Still, provinces will need time to develop legislation pertaining to these and other products, including longevity funds, and for insurance companies to begin offering them. Insurers may need consistently higher interest rates before they’re willing to invest in development and marketing for such products, Milevsky said.
Regardless, Canadians clearly desire retirement products “that go beyond traditional solutions,” Macqueen said. “They want something that’s in between ‘I’m giving all my money to the insurance company and it’s guaranteed, but my capital is gone’ and ‘I’m keeping it all and managing it myself, but that means I have all the risk.’”