A Message for Employers
If you are an employer who sponsors a defined contribution (DC) pension plan for your employees, or maybe a group RRSP, give yourself a pat on the back. You are ensuring that your employees are among the “haves” in a land that is too heavily populated with “have-nots” when it comes to pension coverage. Barely 20 percent of employees in the private sector are covered by a pension plan, be it defined benefit (DB) or defined contribution.14
Never mind the barrage of criticism from labour groups and academics that DC plans are inadequate because they subject employees to too much risk. This is the 21st century and individuals need to shoulder some responsibility for their own welfare. What you are offering your employees with your DC plan is much needed help to achieve retirement income security. Moreover, as I showed in Part II, a DC plan can come close to providing as much predictability of income as a DB plan if one uses a good decumulation strategy.
To be clear, I do not criticize employers for having pulled out of DB pension plans over the past 30 years; DB proved to be unsustainable in the private sector. The problem I have with DC plans is that too many sponsors think their role ends when an employee retires.
In your role as plan sponsor, you provided significant support during the accumulation phase. You made regular contributions to the pension plan, offered a variety of investment options at an attractive low cost, and provided ongoing education to plan participants. With the emerging role of auto-enrolment and improved default options, employees don’t even need to understand investment basics or retirement planning to accumulate an impressive account balance by retirement.
This is commendable, but why stop there? At the present time, employer support is usually restricted to the accumulation phase. When an employee retires, he finds himself on his own when it comes to finding someone to manage his monies. As the former employer and sponsor of the DC plan the money came from, you could help the new retiree to assess the suitability of the options being made available by the next service provider, or the fees being charged. But for the most part, you don’t. The retiring employee is given no communication or decision tools to guide him. Instead, he is given a deadline by which time his monies must be moved out.
The accumulation phase is certainly important, but as I have emphasized time and again in this book, the decumulation phase is just as crucial and a lot more challenging. Consider the words of William Sharpe, professor of finance, emeritus, at Stanford University, who is one of the originators of the capital asset pricing model, the creator of the Sharpe ratio for the analysis of risk-adjusted investment performance, and the 1990 winner of the Nobel Prize in Economics. In a speech at the 2014 CFA Institute annual conference, Professor Sharpe said retirement income planning “is a really hard problem. It’s the hardest problem I’ve ever looked at.” If Nobel Prize winners have trouble with retirement planning, how can you leave your employees to pursue it unaided?
It is the rare individual who can navigate the dangerous waters of decumulation alone. And in far too many cases, that individual may not be much better off in the hands of a financial advisor or mutual fund salesperson whose interests are not aligned with those of the retiree.
As an employer, it can be useful to remember why your company established a pension plan in the first place. If it was long ago, it may have been to attract and retain employees, but these reasons no longer hold water. In a defined contribution world, a pension plan is not much of a retention tool since departing employees can bring their account balances with them. And the ability of a pension plan to attract talent is overrated; far more important to prospective employees are salary, non-pension benefits, and prospects for advancement.
So why do you still sponsor a pension plan? I suspect the main reason is inertia, or perhaps we can call it the path of least resistance; it is easier to keep a plan going that was started decades ago than to terminate it and deal with employees’ inevitable disgruntlement.
You have a better reason to continue sponsoring a pension plan than inertia, even if it is a DC plan: you want to see your employees do well after retirement. This is not altruistic sentiment. It is good business.
Imagine an employee who has worked diligently for your organization for 20 or 30 years. If there was no pension plan and she did not save enough on her own, she would be facing a significant drop in her standard of living. Most likely, she would be forced to sell her home and move to a smaller place in a less attractive area. She might even resort to relying on handouts from church groups or family members to make ends meet.
If this was the typical fate of employees in your organization, your company’s public image would take a beating. Equally important, you couldn’t expect to get the best performance out of your employees who are still active. They might not have given the company pension plan much thought when they were first hired, but they are unlikely to give you their best work effort later in their careers if they feel you do not care about them. So ultimately, sponsoring a pension plan is about enhancing the corporate image, boosting morale, and improving productivity. As reasons go, these are very good ones.
Given the above business case for maintaining a pension plan, it is easy to see that your role should not end at the point of retirement. If you really want your employees to retire well and ensure they do not outlive their money, you should continue to guide them in the decumulation phase. Yet the norm is still to focus only on the accumulation phase and to leave employees to their own devices at the point of retirement.
Employers are leery about taking on fiduciary liability for the period after retirement, since it might expose them to litigation. In my opinion, though, the exposure is minor relative to the reward. It is also minor relative to the financial risk to some DB plan sponsors in terms of the volatility of their pension expense. In any event, safeguards can be put in place to limit the employer’s exposure even further in this regard, as will be shown below in the solution section.
Another reason not to act has to do with legislative restrictions, but this has become more of a historical problem. Until recently, some provinces did not allow employers to offer in-plan decumulation solutions. The remaining legal barriers toward in-plan decumulation have been taken down, and it is only a matter of time before plan sponsors start to do more to support their retirees. No other scenario can be justified. If this book has shown anything, it is that individual employees are not going to stumble onto a smart decumulation strategy on their own.
A third reason that most employers have not yet acted is they are getting little pressure from their employees to help more. Is this surprising? There is little awareness that alternatives exist, and in such a vacuum it is human nature to accept with some forbearance the circumstances in which we find ourselves. I remember when I was 13 that it took me longer to copy work from the blackboard than my classmates. I also missed more fly balls when I was out in the schoolyard. I had become quite myopic but, until I put on a pair of glasses, I didn’t realize it. Until retiring employees put on their decumulation glasses and see the fresh possibilities, they are in the same position.
The fourth and final reason that employers have been slow to act is that the solutions have been slow to present themselves. This is changing. Effective solutions are now being created, and the good news is that they do not have to result in additional costs to the employer. Employers are using their buying power to give their employees access to institutional-level fees, which is quite a godsend. The fees that retiring employees incur for actively managed investment funds can be slashed to less than a third of what they would be charged in the retail market for traditional mutual funds.
Employers are in a unique position to assist their retiring employees. They have the benefit of economy of scale to provide investment options at institutional rates that are a fraction of retail fees. They can do the same with making annuities available. And they can employ outside expertise at reasonable cost to offer unbiased, cutting-edge decumulation solutions, such as the ones presented in this book.
Some Canadian organizations have already shown leadership in this area and have implemented decumulation options within their retirement programs. Those options range from payment of variable pensions out of the plan to the establishment of group LIFs and group RRIFs. This is only the beginning.
Companies like Morneau Shepell are on the threshold of a next-generation response to the decumulation challenges faced by retirees. The solutions being proposed include some or all of the following elements: