Are your retirement years really secure? One of the realities of our roles as advisors is that we have the opportunity to ask clients and prospects many questions about their plans and objectives. Often, I (John) have had conversations that looked ahead to retirement, and inquired about what activities and lifestyle would look like in retirement years. We have a dream of retirement, but do not have a plan as to what our retirement years will look like. This article doesn’t look at lifestyle, but rather looks at retirement funding, and in particular pension plans.
The current market chatter centres on solvency issues surrounding Defined Pension Plans (DPP). A pension is a promise but not a guarantee to pay an income at retirement in consideration of past services, age, merit, injury or loss. During the last few months, we have been reading articles that highlight certain risks associated with DPP’s and Defined Benefits. In our June 2013 market commentary, we wrote about the solvency ratio, which is the ratio of a pension plans assets against its liabilities. A recent Statistics Canada report states:
- Close to 3550 retirement pension plans reported actuarial information for a three year period and over 84% of these Registered Pension Plans are underfunded.
- The median solvency funded ratio is estimated at 85%
- 97% of Registered Pension Plans have a solvency deficiency of some sort
- There is a $400 Billion shortfall of funding
The key points we gleaned from our reading are:
- DPP’s are a promise to pay a fixed guaranteed income at retirement. What is that promise worth?
- Persistent low interest rates and overall historic poor performance by pension fund managers are causing changes to DPP and Defined Benefit Plans and “solvency” has become a serious issue.
- There is an apparent disconnect occurring between what employees are planning and expecting and what their employers are realistically prepared to (and able to pay).
- Corporations will be more active in “buying-out” employees DPP and benefits, by offering them a one-time cash incentive, off-loading the future liability or retirement funding to employees.
In one of the articles, the Ontario Federation of Labour recommended actions to solve pension fund deficits which included a need to trim employee benefits. Pension promises create more expense for companies and force them to raise the amount of money that both the employer and employee pay into pension plans, or else reduce benefits.
In June, an article discussed the Ontario Municipal Employees Retirement System (OMERS), one of Canada’s largest pension funds, which faces a $10 billion pension-funding deficit. OMERS is an umbrella fund for more than 900 employers and their workers in Ontario which include paramedics, transit workers, firefighters, police and city workers. It represents almost 429 000 active and retired members. OMERS is considering multiple ways to reduce its pension deficit. One proposes to reduce pension payouts, reduce benefits paid to retiring workers or even to force them to work years longer for the same retirement income.
Changes to the pensions overseen by OMERS are considered annually, but this year’s proposal to reduce the “multiplier” rate at which workers rack up retirement payouts (ie: from 2% to 1.85%). Simon Archer, a pension specialist at law firm “Koskie Minsty LLP in Toronto, stated after looking at the proposal: “This is more drastic”, “This is the one (proposal) that made my eyebrows go up”, “Usually, plans try not to touch that (the multiplier) if they can avoid it!”
On May 29, 2013 there was an article in the Toronto Star, titled: “Widow Fights GM’s 80% cut to benefits”. The article is about a class action suit (3300 retired GM managers and executives), which is suing GM for breach of contract, claiming $500 million in damages over the auto makers’ decision to cut their post-retirement benefits starting in 2007. According to the statement of Claim, General Motors of Canada say in its statement of defence that the cuts to the retirees’ benefits were made to ensure the company’s long-term survival. Retiree benefits are provided by the company voluntarily and it reserves the right to modify or terminate them, GM’s statement of defense states.
Pension funds are affected by many various issues, including employee and employer contributions or the multiplier rates (mentioned earlier), or assumptions as to average life-span of retirees, and expectations of average return over various time periods. The OMERS website indicates as asset mix of 53% invested in public markets which includes both equity and fixed income (bond) markets. Assuming 50% of these public investments are invested in bonds, then a rising interest rate market can have a negative impact on asset valuations. Awareness of low interest rates and lower real returns “does not seem to have spurred plan sponsors (DPP) into addressing long-term sustainability strategies as they struggle with short-term financial pressures.” AON Hewitt said in a survey released in early May.
As mentioned at the beginning of our discussion: “Does Your Pension Have A Plan?” we did not want to alarm our readers. We prefer to provide perspective over sensationalism. In this light, let us share some additional analysis complied by Professors’ Ian Lee and Vijay Joo, the Chancellor Pro-fessor at the Sprott School of Business at Carleton University reported as a special to the Financial Post dated May 15, 2013 (we have shortened it).
“The Claim that Canadians are not saving enough for their pensions ignores how smart Canadians actually are and what the data is telling us. Behavioural economists and pension advocates should analyze the empirical savings behaviour of Canadians more closely:
Statistics Canada analysis of National Households Balance Sheet reveals some important data. Cana-dians have gross assets of approximately $8.8 trillion of which $3.5 trillion is held in primary and secondary residences and raw land, $3.7 trillion is invested in cash, mutual funds, and equities.
Approximately, $1.6 trillion is in registered pension plans. When the much debated indebtedness of Canadians of $1.7 trillion (of which two thirds is mortgage debt) is subtracted, the personal net worth of Canadian households, is approximately $7.1 trillion or $200 000/ per capita, and not only the $1.6 trillion pension savings claimed by pension critics. More importantly, principal residence assets can be transformed into tax-free income that can be used during retirement through “downsizing” to a less expensive home or community.
The exclusion of non-pension investment personal wealth from the determination of pension adequacy has been recognized by Statistics Canada in an article on Income Adequacy in Retirement by John Baldwin et al: “income as normally measured captures only part of what is available to seniors if households possess assets. Indeed, when after-tax estimates are used, the potential income per adult-equivalent in senior households exceeds the income of household headed by younger adults.”
There are two questions that we always need to ask and assess responses to:
1. If there is a former employer and a pension plan is partially funding retirement, what is the potential for that employer to become insolvent during retirement or that a retirement pension could be modified or eliminated altogether.
2. If real estate assets and in particular the primary residence forms a significant part of the overall wealth of client, when and how will this principal residence be liquidated to provide retirement funding?
We need to recognize what risks exist to identify those risks that need to be mitigated or those risks that are acceptable to any financial projection. Having a more complete picture of where retirement income will come from, and what risks exist to that income, are critical to any reasonable discussion of retirement years and help form perspective. We have recently had an influx of opportunities to look at pension fund projections either due to retirement or employment severance. We encourage all of our clients, readers and friends to engage in the conversation.