Saturday, August 28, 2010

"Innovative" retirement savings plans

Over the past several years there has been a growing demand for "innovation" in retirement savings and pension plans. As the private sector reduces its commitment to defined benefit plans and people are placing more reliance on individual retirement savings, the feeling has emerged that innovative plan designs will allow individuals to replicate both the benefits and security previously afforded by traditional designs. These are good thoughts, but the question remains - how do we know that the new design will actually do the job? Here are a few questions that might help analysis:

- how should we measure the effectiveness of ‘innovation’ or what would be a minimum requirement for a credible innovation - increased benefit, lower cost, improved security, clearer communication/understanding/transparency?

- what might constitute an acceptable expense level? A minimum requirement for such a plan might be an annual cost of less than 0.5% of assets for a balanced portfolio (the CPP cost is of the order of 0.3%). A slightly higher cost might be justified due to smaller scale and some additional administrative costs - but the total has to be way lower the expenses typically charged today . Should the cost be federally or provincially regulated - say, by something similar to a rate board?

- what are reasonable income drawdown strategies during retirement? Does the innovative design allow for the construction of portfolios to achieve this? What are the trade-offs between investment risks and return? Can these be easily explained? When or should annuitization occur? Is the approach supported by the annuity marketplace?

- what tools could be made available to specify on an ongoing basis the required contributions to achieve some level of retirement income, as well as the expected retirement income given current level of contribution? Is guidance and feedback continuously available? Do the tools explain what are the risks and what can be done about them?

- is a longevity insurance option available to protect against exhausting assets if one lives too long? Should a new retiree purchase a life-contingent lifetime income stream starting at, say, age 85? Does the new design provide such an option or does it offer a better alternative?

- would TFSAs be a better choice than RRSPs (or RPPs) as a saving vehicle? Does the new design allow for such funding choices?

The intent of the above is to push the discussion from generalities to specifics. I hope others will take up the challenge.

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