A new idea is being floated for a voluntary, national program that would see Canadians aged around 65 start to contribute to a pooled deferred annuity plan, providing them with a type of longevity insurance that will kick in when they turn 85.
The concept is described in a new C.D. Howe Institute report, How to Ensure Seniors Don’t Run Out of Cash before They Run out of Time, written by actuary Bonnie-Jeanne MacDonald.
“Retirement will span beyond age 85 for more than half of 65-year-old Canadians,” MacDonald states in the report. “Retiring Canadians want to protect their later years. We need innovative solutions now – ones that add definitive value but place no new pressures on the Canadian public purse.”
Demise of pension plans
Baby boomers are retiring in growing numbers, but with the demise of many company pension plans there are fewer sources of secure retirement income – money they will need as they get older and frailer and require greater care and support.
Generally speaking, Canadians aren’t fond of annuities where they hand over a great chunk of their savings to insurers, MacDonald said, mostly because they can’t get the same kind of beneficial tax treatment from annuities as they do from an RRSP, for example. Even in the United States where some annuities provide tax advantages, the uptake is relatively low, she said.
“But by making more of a nationalized program, you’re removing a number of barriers that people have with the private market,” MacDonald said in an interview. “And once you get more people doing it, the price will actually go down a lot.”
She said the program, called Canada’s Living Income for the Elderly (LIFE), would not have a guarantee, keeping the price low. It would be aimed mainly at middle-class seniors – those who have $100,000-$400,000 in savings, many of whom have never been to a financial advisor or planner.
Here’s how MacDonald envisions the LIFE program working:
- At 65, Canadians can voluntarily invest money into LIFE according to their personal discretion
- Commuted value cash withdrawals would not be allowed during either the deferral period or the payout stage
- LIFE would feature mortality risk pooling among its members
- Between 65-84, each member’s funds would be invested in a relatively aggressive portfolio that would grow each year (via the investment growth and the mortality premium generated within the 65-84 LIFE group in a certain year)
- After 85, the members’ funds would be moved to a more conservative portfolio. Members would receive a fixed amount for the rest of their lives. At the end of each year, any surplus in the mortality experience of the group and investment return on the accounts would be distributed among members aged 85 and over through lump sum bonus payments.
With mortality risk pooling, those who live longer will profit from the invested capital of those who die earlier. Because of this steeply increasing mortality premium, the payouts from longevity insurance are even more substantial at a later age, considerably larger than those of a traditional immediate life annuity.
MacDonald said the product would have to be somewhat restrictive. For example, having each person decide how long they would like to defer the annuity would make investing unwieldly. Sicker seniors would want to start it earlier, while healthier ones would want to start it later, making the program very expensive.
LIFE would have to be simple – and somewhat restrictive – so no one gets confused as to how it works. “In private industry, they sometimes get too much choice and then end up picking nothing. So in a way this is behavioural – people will have to think it through,” she said. “If it’s made simple, everyone gets the same thing, then it will make it more attractive to everybody and the more people who get it, the cheaper it is for everyone.”
Reaction so far from government and industry to LIFE has been positive, said MacDonald. “People in industry think this is a really valuable option,” she said.
MacDonald said she is currently working with some retired policy analysts from the federal government, looking at the different features of the proposed plan, as well as the tax implications for government and the trade-offs for investors. This process will take the next year or two, depending on interest, estimated MacDonald.
There has also been interest from academics and the industry, but how government reacts will be crucial, she said.
MacDonald said Canada is not the only country looking into this kind of plan. The U.S., the UK and Australia also have their eyes on similar programs.
In the report, MacDonald writes that LIFE will benefit Canadians who have private savings, but who won’t receive enough later-life income from government and employer-sponsored pension plans, and who don’t want to give up flexibility and control over the bulk of their savings.
The LIFE plan would complement the savings Canadians will get from either converting their RRSP savings into a RRIF or purchasing a life insurance annuity.
On top of this, governments would not underwrite any risks and no additional taxpayer funding would be required. All the investment and mortality risks would be borne by the members which means there would not be a situation of an unfunded liability or a solvency deficiency.