Senate Weighs in With Some Useful Retirement Savings Suggestions but ...

Canada's Senate committee on Banking, Trade and Commerce announced a half-dozen recommendations on how the government could enhance retirement savings in its Oct.19 report Canadians Saving for Their Future: A Secure Retirement.

The recommendation that would likely have the most beneficial effect is the suggestion to establish a Canada-wide plan for retirement saving and investing. The new plan would entail setting up five or so professionally-managed, competitively-sourced investment funds into which savings deductions/contributions of Canadians 18 and over would go. It's a pretty good but incomplete plan. Why?

1. Auto Enrollment - the report calls the plan "voluntary" but that means an optional opt-out, which few people will do. As the famous book Nudge explains (and as the use of the word in the report slyly suggest that the Senate committee is aware of the idea), the difference between voluntary opt-in and opt-out is huge and participation rates will be as good as universal, up in the 90+% range. Goodbye to the costly sales and marketing overhead cost of retail funds because it's a captive market.
2. Fiduciary Duty Governance and Management and Competitive Sourcing - they call it a commitment to avoid "real and perceived conflicts of interest". Professional managers can add diversification, discipline and net value when the fees they charge are restrained - i.e. the gross investment return isn't sucked dry by the fees. Hello to much lower fees from the powerful negotiating position that such a massive plan will have and hello to a resulting much higher net return to investors with much higher end value retirement savings.
   
3. Optional RRSP or TFSA - it is valuable to have the flexibility of being able to contribute to the right account for one's tax situation / income level (the familiar question about whether your tax rate will be lower in retirement - RRSP better, or whether your absolute income is low - TFSA better) and retirement goal (if legacy desired, TFSA better).

The report does not address a few key issues related to this idea:

• Savings Deduction Rate? - how much should it be? Maybe 9% would do, the same as for CPP, which aims to replace about 25% of pre-retirement income, so such a contribution rate in this plan would provide another 25%. A less desirable method would be to allow the contribution rate to be chosen by the contributor but then the new plan should have a default rate with option to change it (another nudge).
  
• Sequence of Returns Risk - the danger of a market plunge, such as happened in 2008, at the intended time of retirement is that the total available to purchase an annuity is vastly reduced and permanently low retirement income would result. The alternative of withdrawals from a RRIF would see much lower sustainable withdrawals. Of course, nobody would retire after a market crash if they possibly could and they would deal with the market returns risk by continuing to work however long it took for market and retirement savings recovery. That's not the only way to deal with this risk though. The method of the CPP is to have a defined benefit payment coming no matter what the state of the market - did the CPP announce a reduction of payments in 2008 even though its investment portfolio dropped about 20%? The reason the CPP can maintain payments is that it can, as a fund with a very long term investment horizon, smooth out market humps and bumps, knowing that savers continue to provide cash inflow. There is time risk sharing going on within CPP that the Senate's proposal lacks, which to my mind is a very important feature of making retirement saving feel secure and actually be so.
• Conversion to Retirement Income, Inflation Risk, Longevity Risk and Annuities - a retirement savings plan, such as the one proposed, must be converted into an income stream and the report does not consider how this will be done, except for brief off-hand references to buying an annuity. Yet the income conversion vehicle, its cost and its effectiveness in countering inflation and longevity risks determine the success of the whole retirement income exercise. This cannot be considered apart from the savings phase method with the assumption that all will be well. Choose an annuity and even low, normal 2% inflation eats away a huge portion of the value of a fixed payment annuity over the longer and longer retirement periods of today. Real constant-value CPI-adjusted annuities are almost absent from the Canadian marketplace. Most annuities on the market in effect provide income for life at a fast (high inflation) or slow declining standard of living. I bet that's not what people want or need. There is also the problem that the market is lop-sided - the people who want to buy annuities are those who figure they will live longer and not those who will die off sooner and whose cash helps maintain a higher standard of living for the survivors. (Those who believe this is unfair could be reminded that sharing the risk means everyone gets higher payments than if no one shares) The annuity-selling insurance companies know about likely-to-live longer annuity buyers of course, and so annuity payouts are even lower. Contrast that with CPP where everyone, early and late deceased, automatically and without choice to opt out, gets into the annuity payment stream. Choose the other option to generate income, a RRIF from which withdrawals are taken, people have the very hard job to figure out how much to withdraw given their uncertainty how long they will live and need income. Live too long and you run out of money. There is no longevity risk sharing. People can either be very cautious, withdrawing slowly, and perhaps live a much more restrained lifestyle than they might have liked, or they can live high, perhaps to discover that they must drastically reduce their spending later on. Pooled assets with no opt out (i.e. with longevity risk sharing) during withdrawal means higher payments for everyone and much less worry along the way. The prime example of a successful end-to-end solution is the CPP - you pay in a certain amount per year and you are guaranteed (by the most stable provider around, the Federal government) a certain inflation-adjusted amount for however long you live.

The report includes several other worthwhile but less significant suggestions:

• Set a TFSA lifetime contribution limit of $100,000, which could be used immediately in full any time e.g. for an inheritance; helps present-day retirees with taxable accounts
  
• Remove the effect of RRSP withdrawals on means-tested benefits; makes things less complicated and less punitive
  
• Defer RRSP conversion age to 75; helps those who work longer
  
• Have the Financial and Consumer Agency of Canada do financial education and monitor investment advisors (I think they mean financial advisors, which is much broader than investment advisors) - pretty wimpy, they could and should have recommended that fiduciary duty for financial advisors be put into law with some body given policing powers