Nevada Retirement Planners

NEW YORK (AP) — Honeywell says its first-quarter earnings slipped almost 3 percent on a pension charge, but the manufacturing conglomerate is raising its outlook for the year.

Read more.

INDIANAPOLIS (AP) — Indiana is among the nation’s five most underfunded teacher pension programs, with the assets to cover just over a third of the benefits it owes by state law, according to a report released this month by school-choice advocates.

Read more.

 

Apparently most Canadians don't agree with me that a "paid-for home is the foundation of financial independence." That line is a recurring one issued by my fictional certified financial planner — Theo Konstantin — in Findependence Day. However, a poll released by Investors Group yesterday found a whopping 56% of mortgage-holders do not consider paying off their mortgage in full as an important factor in deciding when to retire.

Almost two in three (62%) plan to carry debt into retirement or are already doing so. Of these, half say this debt will be the mortgage. Among those not yet retired, 23% expect the outstanding balance to be minimal when they retire: $25,000 or less.

Rose-colored glasses

However, they may be wearing rose-colored glasses on that point. Such expectations "may not be realistic,  says Investors Group vice president banking and mortgage operations Peter Veselinovich. For retired mortgage-holders, the median mortgage balance is more than three times higher at $82,000.  "The road to being mortgage-free is paved with good intentions, but twists and turns along the way can make the trip longer than you'd planned," Veselinovich says.

In its press release, the financial planning giant uses the phrase "strange bedfellows" to describe mortgages in retirement. Over the two decades I've been writing about money, most of my financial planner sources suggest their clients enter retirement free of all debts: certainly high-interest credit cards but also lower-interest mortgage debt. My view is that if your finances are so shaky that you haven't yet even paid for the roof over your head, what makes you think you're able to retire?

A paid-for home is the best financial security you can have, even if you're still working. After all, what can be more comforting than the knowledge  the "rent" is pre-paid in the event one or both spouses loses their jobs? Now it's true that even if a mortgage has been fully paid off, there is still plenty of property tax to be paid out, and that's with after-income-tax dollars. Property tax doesn't cease to be a liability in retirement, nor do normal maintenance costs, heating, utilities and other expenses. Given all that, why would you want to still be making mortgage payments in old age, perhaps living on a fixed income?

50% Replacement Ratio argument assumes a paid-for home

The more marginal the "Replacement Ratio"  you have in retirement, the less you'll want to carry debt of any kind. The Replacement Ratio has long been debated by financial planners and the investment industry. The latter, who admittedly have an interest in this, traditionally suggest retirement income should be at least 70% of what was earned in one's working years. Some, like fund company Fidelity Investments Canada, argue the ratio should be 80% or even 100% or more — especially in the early years of retirement that feature frequent travel and pent-up demand for various costly hobbies like golf or mountain climbing.

At the other extreme is the much-cited opinion of actuary Malcolm Hamilton that Canadians can get by with just a 50% replacement ratio. His view is that once you've raised the kids and educated them,  paid off the mortgage,  and finished saving for retirement, you don't need so much income, nor do you need to pay as much income tax to generate that income. But note that one of his three reasons for citing the 50% ratio is that the principal residence is fully paid for.

Clearly, the Investor Group poll reflects a mentality born of ultra-low interest rates. The thrust of the rest of the poll revolved around the confidence debtors have that they will indeed be able to cope with higher interest rates, now that mortgages have started to rise.  The poll also found a third of the 4.8 million Canadians holding a mortgage are "not concerned" about their ability to make their payments when rates rise; 41% said rates would have to spike 3% or more before they'd lose sleep over it.

Well, retirement can last 30 or 40 years, so it's hardly a stretch to imagine interest rates rising much more than 3% over the coming decades. I still recall paying 11.75% on a mortgage in the late 1980s and I know others who were paying close to 20% earlier that decade. If you're retired, you don't want even the possibility of losing sleep over rising interest rates. So I'm sticking with Theo's mantra that a paid-for home is the foundation of financial independence.

If your home is not yet fully paid for, you don't have financial independence.

It's as  simple as that.  

(Photos by Getty Images and Fotolia)
 

 -30-
 
 

Source The Wealthy Boomer : Retirement

Harry Wilson, a Republican contender for state comptroller, says New York needs a Wall Street veteran like himself to oversee its $129.4 billion pension fund.

Read more.

COLUMBUS, Ohio (AP) — State records show that Ohio’s public pension funds took a $480 million hit to investments managed by Lehman Brothers as the banking giant collapsed.

Read more.

SACRAMENTO, Calif. (AP) — The chief investment officer of California’s giant pension fund said Monday he is disturbed by the allegations of wrongdoing against investment firm Goldman Sachs.

Read more.

DES MOINES, Iowa (AP) — The more than 2,000 state employees who plan to retire early could mean more savings for state government, a spokesman for Gov. Chet Culver said Friday.

Read more.

Today's column in the paper looks at the once-again-topical subject of pension reform. As I point out, there's a range of opinion out there as to whether the system needs radical overhaul or just a tweaking of existing rules.

Generally, the financial industry is in favor of the latter course: raising RRSP limits and maybe TFSA limits or even like Thursday's blog indicates, just changing the tax rules to get more mileage from existing retirement savings.

But with the continued decline in corporate Defined Benefit pensions — or the disappearance of firms that formerly sponsored them, like Nortel Networks — there's also a school of thought that thinks more radical reform is necessary. This camp believes in building on the existing Canada Pension Plan, since it's available to most workers and the closest thing to the corporate Defined Benefit Plans that so many lack.

Among the leading plans to supplement the CPP is a proposal by consultant Keith Ambachtsheer, who is  director of the Rotman International Centre for Pension Management and adjunct professor of finance at the University of Toronto's Rotman School of Management.

A few weeks ago, Ambachtsheer published in his The Ambachtsheer Letter a 4,000 word essay entitled High Noon for Pension Reform: From Debates to Decisions. A smaller version ran in the March issue of Policy Options under the title Pension Reform: How Canada can lead the world and this week a concise 800-word version ran in the Globe & Mail: Can Canada own the pension podium?

With his permission, we're running the original long version in this blog. Because of the length, I've not italicized it but all the text that runs across from and below the photo was authored by Keith. All subheads and formatting have been retained.
 

 

 HIGH NOON FOR PENSION REFORM:

FROM DEBATES TO DECISIONS

By Keith Ambachtsheer

 

Traditional problem-solving follows a linear
model: gather data, analyze it thoroughly, formulate a solution, implement it.
Designers follow a decidedly non-linear model. While they also begin by trying
to understand the problem, they almost immediately move to formulating
potential solutions, and then jump back to refining their understanding of the
problem. Far from orderly, the line plotting their thinking looks more like a
seismograph for a major earthquake. Designers know that understanding of a
problem can only arise  from
creating possible solutions, and that this understanding continues to evolve
until the very end of the process."  — Roger Martin, Rotman School of Management, University of Toronto

                                 

                       From Debates to Decisions

Over the course of the last five
years, Canadians have engaged in (or have been observers to) an increasingly
intense debate about pension reform. Three major themes have emerged:

Pension adequacy: It is a fact that ¾ of the private sector workforce does not have an
employment-based pension plan, and that proportion is rising. At the same time,
the need for retirement income is growing, as we continue to live longer. The
debate is about whether this constitutes a problem, and if it does, how the
problem is best addressed.

Cost-effectiveness:
It is a fact that every percentage-point of additional annual costs charged to
manage retirement savings (i.e., related to investment, administration, advice,
or distribution) reduces the ultimate pension by some twenty percent. It is
also a fact that the total cost of pension/retirement savings management and
administration varies greatly (i.e., there can be a two percentage-point
differential between the annual cost of managing a large-scale collective
pension plan and the fees individuals pay when they place their RRSPs in
actively-managed retail mutual funds). The debate is about whether this is a
problem, and if it is, what should be done about it.

Defined Benefit
pension plan sustainability: some 4.5 million workers are still members of
DB plans (2.5 million in the public sector, 2 million in the private sector).
The debate is about whether these plans are sustainable in their current forms,
and if they are not, what should be done about it.

At their pre-Christmas meeting in Whitehorse, the federal
and provincial finance ministers and their officials announced that they would
engage in intensive consultations on these challenges, leading up to their next
meeting sometime late May of this year, which in turn is a precursor to a
full-fledged Federal-Provincial meeting on pension reform with the Prime
Minister and Premiers in August. The Federal Government formally joined this
consultation process on March 24, announcing it would conduct a series of
coast-to-coast town-hall and roundtable meetings in April. A recent survey by
TNS Canadian Facts indicates that ⅔ of Canadians agree that "the current system
does not meet the needs of the average Canadian and should be reformed".

In short, 2010 could see Canada
moving from debates about pension reform to making actual decisions. We have
had the good fortune to be an active participant in this process since the
beginning both as a contributor, and as a listener. Here, we offer our updated
thoughts on each of the three major issues set out above, and how they might
best be resolved. In doing so, we are mindful of Roger Martin's observation
that the discovery of better answers should continue until the very end of the
design process.

Four Recommendations

Before commenting on the three
major challenges set out above in some detail, we summarize our recommendations
on how they can best be addressed immediately below:

Simplify and modernize
the current rules and regulations governing workplace and individual
pensions to create greater flexibility.

Graft a national
supplementary pension plan unto the current CPP/QPP in a way that enhances
pension adequacy while maintaining employer and employee flexibility at the
same time. This could be combined with some modest, targeted CPP/QPP expansion.

Create a task force
mandated to find the best way for all Canadians to have the opportunity to
access low-cost, but still expert pension management services.

Require ‘fair value'
accounting and positive risk buffers in defined benefit plans in order
bring their sustainability and transparency up to the same prudential standards
OSFI sets for insurance companies and other financial institutions.

Together with their public
pensions (CPP/QPP/OAS/GIS), the adoption of these four measures would give
Canadians the best retirement income system in the world.

Pension Adequacy

While there is broad agreement
that ideal pension systems allow people to maintain their standard of living
after they stop working, the debate about how to translate that ideal into a
target earnings replacement rate continues. Is it the traditional seventy
percent embedded in many DB plans and in the sales literature of the financial
services industry? Or is fifty percent a better norm in the presence of a
mortgage-free family residence, and the absence of work- and child-raising
expenses? This is not a trivial question. For example, a new C.D.Howe Institute
paper by Dodge, Laurin, and Busby calculates that a worker aged thirty who
earns an inflation-adjusted $60K per year over thirty-five years will have to
save about fourteen percent of pay to achieve a seventy percent earnings
replacement rate (including the public OAS/CPP pensions). The required savings
rate drops to eleven percent for a sixty percent earnings replacement rate, and
further to nine percent if the worker retires at age sixty-seven rather than
sixty-five. There is a growing understanding that seventy percent is
unnecessarily high for many people, and that sixty, or even fifty percent may
be more appropriate in many cases.

Just as there is still a debate
about the ‘best' earnings replacement target to use for planning purposes, so
is there a debate about whether Canadians are saving enough to achieve it.
Everyone agrees that some are, and others are not. The debate is about the
respective proportions of the ‘are' and ‘are not' groups. In an important
sense, the debate is moot. Yesterday's retirement savings behaviour, what ever
it may have been, is not necessarily a good reflection of tomorrow's.
Similarly, the almost ideal investment environment of the 1980s and 1990s did
not continue in the decade just ended, and may not in the years ahead. In this
context, a more relevant policy question is: what can we do today to ensure adequate
savings rates tomorrow? Or more specifically, what can we do today to give all
workers a reasonable chance to achieve a post-work income target in the fifty
to seventy percent range of working years earnings?

Three Possible Responses

The public pension combination of
OAS/GIS/CPP by itself achieves high earnings replacement rates for low-income
Canadians. For example, a couple, both aged sixty-five, with maximum government
pension benefits, receives an inflation-indexed annuity of $34,218 today. This
implies ‘adequacy' policies should focus on Canada's middle-income workers
without pension plans. This group of some 3.5 million Canadians is likely to
work in the private sector for medium- and small employers, or be
self-employed. A supplementary pension arrangement that is automatic and
low-cost would likely be a useful tool to help these workers achieve post-work
income adequacy.

Three proposals have emerged to
achieve this goal:

Allow ‘the market' to
work: Many in the financial services industry believe that the adequacy
problem can be solved by removing the legal restrictions that prevent providers
from offering the large-scale, multi-employer, multi-provincial plans that
currently do not exist in Canada. More education and advice would lead to more
informed participant decisions, and ‘auto-enrolment' into these types of
plans  would materially enhance
coverage.

Create a national
supplementary pension plan: Advocates see this plan operating under the
CPP/QPP legal umbrella, on an ‘arms-length' basis from government. It would be
low-cost, set a ‘default' earnings replacement rate target, a consistent
‘default' contribution rate, and a ‘default' age-based investment policy. All
workers without a pension plan would be auto-enrolled to enhance coverage. Workers
own their pension accounts. The plan is voluntary in the sense that workers and
employers could override any of the ‘defaults' if they wish, including
opting-out altogether.

Expand the CPP/QPP:
Advocates see this is the simplest way to enhance adequacy. Participation in
the CPP (or QPP) is already mandatory, and all of the relevant low-cost
investment and administration machinery already exists. There is still debate
about what form any expansion should take beyond the current target to replace
twenty-five percent of earnings up to the YMPE ($47K in 2010). Some believe the
replacement rate up to the YMPE should be doubled; others believe the
replacement should stay at twenty-five percent, but that the YMPE should be
doubled; still others believe both should be doubled. There does seem to be
consensus that, whatever the formula, it should be phased in over time on an
actuarially-fair basis.

We assess the pros and cons of
each proposal next.

Weighing the Pros and Cons of
the Three Proposals

We see the pros and cons as
follows:

Allow ‘the market' to
work: Letting ‘the market' sort it out sounds like a strong ‘pro' in
principle. However, it requires motivated, knowledgeable consumers for it to
work in practice. With its ‘Free Choice' legislation, the Howard government set
Australia on an ‘allow the market to work' route in 2004. A 2008 study titled
"Choosing Not to Choose" (Fear and Pace, The Australia Institute) found the
legislation is not producing the desired results (e.g., it has not lowered
member costs). The current Rudd government has acknowledged this market
failure, and has launched a commission to study how the mandatory Australian
superannuation system can become more cost-effective. The Super System Review
report is due mid-2010.

Create a national supplementary
pension plan: On paper, this approach promises extended coverage,
targeting, flexibility, and low cost in one package (see our 2008 CSPP
proposal). In fact, the above-cited survey by TNS Canadian Facts indicated that
eighty percent of respondents liked the idea of supplementing CPP/QPP benefits
with additional contributions on a voluntary basis. A potential ‘con' is that
this kind of arrangement has never existed in Canada on a large scale.
Fortunately, there are operational models to learn from. For example,
Saskatchewan's Cooperative Superannuation Society Pension Plan (CSSPP) has
successfully operated a similar structure since 1939. The Turner Commission in
the United Kingdom came to the conclusion in 2004 that this was the right
approach to extending pension coverage to seven million British workers without
a pension plan. Legislation was passed in 2007. The Pension Accounts Delivery
Authority (PADA) began implementation work in 2008, which continues as we write
this. Operational testing is scheduled for 2011, followed by a full system
rollout in 2012. If Canada decides to go this route, it could learn a great
deal from the experience in the United Kingdom. At the same time, the CSSPP
already has decades of successful operating experience in Canada. Finally,
there is no reason why some of the proposed national supplementary pension plan
functions could not be outsourced to the private sector.

Expand the CPP/QPP:
This approach also promises increased adequacy and low operating cost in one
package. But as it requires mandatory participation, it cannot offer
flexibility; whatever specific ‘expand' strategy is chosen will have to apply
to all. However, some targeting is possible. If middle-income, private sector
workers without pension plans are the right target group, expanding the current
CPP /QPP benefit (i.e., twenty-five percent earnings replacement) beyond the
current YMPE ceiling (e.g., doubling it from $47K to $94K) would serve them
best, and would require a six percent of pay contribution rate on income
between the old YMPE and the new one. Of course, middle-income earners with
pension plans would be equally impacted, requiring equivalent benefit and
contribution rate reductions in those plans to ensure overall pension benefits
and costs remain the same.

All considered, it seems to us
that: (a) simplifying and modernizing pension rules and regulations is a ‘no
lose' proposition, (b) the most direct, targeted but flexible route to
enhancing future pension adequacy in Canada is to graft a national
supplementary pension plan to the CPP/QPP foundation, and (c) step (b) could be
combined with some modest, targeted CPP/QPP expansion.  Neither (a), (b), nor (c) requires any
major upfront expenditures.

The Cost of Managing Canada's
Retirement Savings

Just as enhancing pension
adequacy in a targeted manner is an important pension reform goal for Canada,
so is ensuring that retirement savings are converted into pension payments in a
cost-effective manner. Recall that every percentage point of additional annual
cost in managing retirement savings reduces the ultimate pension by some twenty
percent. So what is the actual cost structure for managing and
delivering pensions in Canada today? Table 1 provides some benchmarks. We
divide total accumulated Canadian retirement savings into ‘wholesale' and
‘retail' channels. The ‘wholesale' channel holds the accumulated assets of the
CPP and QPP, and those of public and private sector employment-based pension
plans. The ‘retail' channel holds the retirement savings of individuals in such
categories as RRSPs, RRIFs, LIFs, and LRIFs. These savings can be invested
through a variety of sub-channels ranging from segregated funds, mutual funds,
deposits, and self-directed accounts.

What does participation in each
of these two channels cost? There is surprising cost variability within each
channel. For example, the CEM Benchmarking Inc. database confirms that some
pension funds operate at very low cost (e.g., under 0.25 percent per year),
while others incur higher costs (e.g., over 0.5 percent per year.). Data from
other sources confirm that the range of cost experience within the retail
channel is even greater. At one end, Canadian ETFs and index funds may charge
fees in the 0.3 percent-1.0 percent area, while at the other end, the fees of
actively-managed mutual funds can exceed 3 percent. Having made this important
point, it suffices here to focus on the average cost differential between the
two channels. In the Table 1 calculations, we assume a 0.4 percent average cost
for the ‘wholesale' channel, and a 1.6 percent average cost for the ‘retail'
channel. Based on available information, we believe these are reasonable
assumptions (see for example, a recent paper by Jog for the Research Working
Group on Retirement Income Adequacy).

Using 2007 Statistics Canada estimates for accumulated
retirement savings and our own average cost estimates, Table 1 indicates
Canadians are spending almost $15.6B per year (0.9 percent of assets) to have
their retirement savings managed, the bulk of it spent for retail channel
services. What if the millions of retail channel savers could pay wholesale
rates? Table 1 indicates their costs would decline by $8.4B per year., or
equivalently, their retirement savings would grow by an additional $8.4B per year.
Stated still differently, the resulting 1.2 percentage point reduction in
annual costs is equivalent to a 24 percent boost in the ultimate pension the
retirement savings can purchase.

Table 1   The Annual Cost of Managing Retirement Savings in Canada

 

 Sources: Statistics Canada for Amounts of
retirement savings (2007), author for cost estimates

Wholesale or Retail? A
Question of ‘Value for Dollars'

Table 1 raises the important
question of why all retirement savers should not have the opportunity to
pay wholesale fees. Addressing it requires recognizing the financial services
industry is the beneficiary of the current annual $11.2B ‘retail' channel
cash-flow, which calculations show would fall by $8.4B to $2.8B with
‘wholesale' pricing. The financial services industry argues that surveys show
their clients are satisfied with current arrangements, and that the additional
$8.4B per year represents unavoidable costs (e.g., daily valuation and
liquidity). More importantly, the money buys their clients valuable advice and
almost unlimited choice.

In response, we question why long
term retirement savers should have to pay for services they do not need (e.g.,
daily valuation and liquidity). The ‘valuable advice' argument would be more
persuasive if there was evidence that this advice is actually producing higher
risk-adjusted returns for clients. In fact, the evidence points the other way.
Empirical studies in Canada, the United States, and Australia all confirm what
theory predicts: the higher the average costs of investing, the lower average
net returns. Finally, behavioural studies confirm what common sense tells us:
retail investors have far too much choice. In fact, most do not want to choose
at all.

So from a design perspective the
question is clear: how can we best help millions of Canadian retirement savers
who want adequate pensions at affordable savings rates, but who don't want to
get mired in the complexities of investing? There are two broad possibilities:

A retail approach
involving hundreds of investment choices and tens of thousands of financial
advisors.

A wholesale approach
based on a series of automatic ‘default' settings (e.g., for auto-enrolment,
auto-escalation of contribution rates, and age-based auto-investment policies).

Too often, we frame choices in
‘either or' space when the right question is ‘why not both?' People should
have the option to go the retail route. Indeed, it is possible to go this route
and pay wholesale fees (e.g. 0.4 percent per year). However, it is equally true
that many retail savers are steered to high-cost options without understanding
the consequences. These people would benefit from an automatic, low-cost,
collective alternative.

Designing the Wholesale Option

Canada is fortunate to be home to
some of the best-managed pension plans in the world. By ‘best-managed' we mean
that by global standards, they score well on a ‘value-for-dollars' basis. These
plans have five common characteristics:

Arms-length: close
alignment of interests between the plan and plan participants.

Well-governed:
plan oversight is a provided by boards of trustees/directors who (a) have
appropriate skill/experience sets, and (b) are motivated to represent the
interests of plan participants.

Sensible investment
beliefs: they do not engage in value-reducing trading strategies, but
instead focus on acquiring sustainable cash flows at reasonable prices.

Scale: are large
enough to assemble the requisite resources at low unit costs.

Competitive: have
compensation structures that permit them to attract top talent.

In addition to producing value
for plan participants, organizations with these characteristics also produce an
important positive ‘externality'. They are both motivated and well-equipped to
act as responsible shareowner stewards with respect to the corporations they
invest in. Research confirms that responsible corporate governance action by
knowledgeable long-term investors improves corporate behavior and long-term
profitability.

The current pension reform
dynamic creates an opportunity to examine how millions of Canadians needing a
low-cost, expert management option for their retirement savings could be
connected to Canadian pension plan organizations already providing such a
service. At the same time, we should recognize that commercial organizations
also have valuable experience and expertise to bring to the table. The
challenge is designing a structure that delivers that experience and expertise
at wholesale pricing. All this leads us back to the British decision some years
ago to create a working group (PADA) to create an expert, low-cost personal
pension account delivery design suited to the United Kingdom context. Canada
should undertake a similar initiative to examine how this could best be done in
a Canadian context, in concert with the decision to create a national
supplementary pension plan.

Defined Benefit Plan
Sustainability Problems

Over the course of the last fifty
years or so, the pension promises in defined benefit plans have evolved from
voluntary gratuities without advance funding, to enforceable financial
contracts with advance funding. Defined benefit plan regulation has lagged in
responding to this reality. This lag has had two types of consequences:

Solvency problems in
the private sector: the regulation and supervision of defined benefit(DB)
plans in Canada continues to be fundamentally different from the regulation and
supervision of insurance companies and banks. Our regulation/supervision
processes ensure that these financial intermediaries can meet their payment obligations
by requiring them to carry prescribed levels of risk capital on their balance
sheets. We do not hold the sponsors of DB plans to the same standard. First,
our regulation/supervision processes allow sponsors to understate the ‘fair
value' of accrued pension payment obligations. Second, we allow sponsors to
undertake material balance sheet mismatch risk. And third, we do not require
that sponsors hold prescribed levels of risk capital on their balance sheets as
buffers against adverse events. These realities created the recent Nortel and
General Motors Canada debacles, and will likely create similar debacles in the
years ahead.

Cost problems in the
public sector: a 2009 study by the British-North American Committee
recalculated the net pension liabilities owed by Canada's federal and
provincial public sectors on a ‘fair value' basis. Instead of the reported
$190B in net liabilities (twelve percent of GDP), the amount jumped to $422B
(27 percent of GDP) when the yields on inflation-linked government bonds were
used to discount future pension obligations. On the same discount basis, the
most recent actuarial report of the federal Public Service Plan estimates plan
benefits cost 34 percent of pay, well above the current 18.5 percent
contribution rate. This systemic understatement of pension liabilities and
costs is problematic. It leads to a material overstatement of the fiscal
soundness of Canada's public finances, and to a material understatement of the
true cost of public sector compensation.

Below we describe how the Dutch
came to grips with these defined benefit plan sustainability problems.

A Dose of Dutch Logic

The Dutch Central Bank (DNB)
supervises all financial institutions (i.e., banks, insurance companies,
pension plans) in the Netherlands. Prior to the bursting of the equity market
bubble in 2001, the DNB had been lax in its supervision of pension plans, as
Canada continues to be to this day. The 2001 market crisis led DNB to the
conclusion that there is no logical basis for treating promises to pay pensions
differently from promises to pay insurance claims, or promises to pay interest
and repay principal on term deposits. DNB issued a letter to Dutch pension
plans to that effect in September 2002. It stated that it would commence
regulating pension plans using the same principles as for insurance companies
and banks (e.g., ‘fair value' accounting and positive risk buffers) starting
January 1, 2004.

For a while, the letter caused a
great hue and cry in the Dutch pension management community. DNB was accused of
everything from destroying the vaunted Dutch pension system, to sheer
pig-headedness. In the end, DNB prevailed, although it did push back the start
date of the new regulatory regime to January 1, 2005. The result has been a
significant shift in Dutch pensions from ‘hard' to ‘soft' promises, contingent
on ability to pay. The rethinking of the nature of the pension promise in the
Netherlands continues to this day, with the recognition that fuzzy pension
contracts lead to fuzzy property rights, which in turn continue to threaten
pension plan sustainability in difficult economic environments.

What are the lessons in all this
for Canada? We should start by accepting the reality of the ‘from gratuities to
financial contracts' story. Then we should discuss the implications of
that reality. For example, hard guarantees are neither afforadable nor
sustainable today. Once we accept that, then we can move on to the difficult
but necessary discussion about how we transition DB plans from a hard
guarantees regime to a softer, more sustainable one. We should not  fool ourselves into believing that DB
plan sustainability can be achieved with band-aid solutions such as tweaking
the solvency funding rules, or the rules governing bankruptcy proceedings. Nor
does the answer lie in creating a new pension insurance scheme, as some
suggest. The financial difficulties of America's Pension Benefit Guaranty
Corporation are increasingly visible to all. Only the prudential requirements
of ‘fair value' accounting and the maintenance of positive risk buffers can
create genuine defined benefit plan sustainability. Canada could achieve
this sustainability goal after a transition period if it chose to follow in the
prudent footsteps of the DNB.

The Best Pension System in the
World

The research, discussions, and
debate that have taken place over the course of the last five years have now
placed Canada in a position to lead the world in pension system design. In the
spirit of our Olympic ‘Own the Podium' campaign, we should aim to move from
having the world's #4-ranked pension system in terms of quality, to #1. The
reforms of the 1990s have already given us a strong public pensions component.
We now know where Canada needs to do better in its supplementary pensions
component. In our view, four steps would lead Canadians to the top of the
pension podium:

Simplify and modernize
the current rules and regulations governing workplace and individual
pensions to create greater flexibility.

Graft a national
supplementary pension plan unto the current CPP/QPP in a way that enhances
pension adequacy while maintaining employer and employee flexibility at the
same time. This could be combined with some modest, targeted CPP/QPP expansion.

Create a task force
mandated to find the best way for all Canadians to access expert, low-cost
pension management services.

Require ‘fair value'
accounting and positive risk buffers in defined benefit (DB) plans
in order bring their sustainability and transparency up to the standards of
insurance companies and other financial institutions.

The question now is: can we
muster the collective will to actually do this?

We could find out this year.

 

 

 –62–

 

Source The Wealthy Boomer : Retirement

CHICAGO (AP) — The days of counting on a company pension and Social Security to assure financial well-being in retirement are over.

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There are plenty of complex proposals on how to help Canadians who lack employer pension plans and who haven't saved enough on their own. Most consist of supplementing the CPP in some fashion; we'll be looking at these in the coming days.

But there's a simple enough fix that Ottawa could do with the stroke of a pen, or its electronic equivalent in the Income Tax Act. It was suggested by Andrew Dunn, Managing Partner Tax for Deloitte at Wednesday's Standing Senate Committee meeting on how Canadians are savings in RRSPs and TFSAs. 

Dunn [pictured left], told the committee that as things stand right now, when you withdraw money from an RRSP, it's included in income at the same top rate as interest or earned income — even if the underlying investments were generating dividends or capital gains. Because of this current policy, dividends and capital gains lose the favored tax treatment they get in non-registered or taxable investment accounts.  

As anyone preparing to file their 2009 taxes well knows, someone in the top tax bracket (Ontario) pays about 46% tax on interest or earned income outside an RRSP or TFSA. Dividend income from most Canadian stocks is taxed at about half that level, as are capital gains. 

Stocks in RRSPs shouldn't lose capital gains and dividend tax status on withdrawal

Unfortunately, if you hold Canadian dividend-paying stocks in an RRSP, they lose this tax status. As long as they stay inside the RRSP, all income generated by them — whether interest, dividend or capital gains — is deferred. But when it comes time to withdraw the money from the RRSP — perhaps as a forced RRIF withdrawal — then the investments lose their identity from a tax point of view. It's all treated as the equivalent of interest income and taxed at the top marginal tax rate.

Dunn's suggestion is quite simple, although the senators to whom he described it seemed totally baffled by it. In essence, he's suggesting simply that any dividend income generated inside an RRSP be treated as dividend income on its withdrawal, and similarly for capital gains. He describes this as "preserving the underlying character of what caused the income to accumulate."

Seems like a common sense suggestion to me, although no doubt there would be complications for financial institutions in keeping track of it all. When a senator asked him for an example, Dunn gave one of $1,000 in an RRSP invested only in preferred shares. Over that time, the $1,000 grows to $10,000 because of reinvested dividends. Currently, the eventual $10,000 withdrawal would be taxed at 46% for many in the top bracket. But by allowing the preferred shares to retain their underlying character as a tax-advantaged investment (outside RRSPs), $9,000 of that withdrawal would qualify for the dividend tax credit, just as it would have had it never been placed in the RRSP in the first place.

Policy change would encourage more growth investments in RRSPs

Apart from providing seniors with more after-tax income in retirement, this strategy would likely also boost the absolute amount of money in RRSPs because investors would be encouraged to put more of their RRSPs in the asset class most likely to do well in the long run: equities. As things stand, they tend to be overweight fixed income, which are likely to generate more modest returns in the long run.

The same applies for TFSAs, which are overwhelmingly invested in fixed income in part because investors are misled by the word "Savings" that makes up the name, said The Bank of Montreal's head of retirement strategies, Tina Di Vito [pictured right.] She told the senate committee much the same thing as Dunn did, referring them to a recent article she wrote in Policy Options that went into the idea in some detail.

In the March 2010 issue — which also contains a half dozen other great articles on pension reform — Di Vito explained it this way:

Withdrawals from RRIFs are taxed as interest/salary income — even if the growth in the plan was derived from a combination of dividends and capital gains. Had this growth been achieved outside a registered plan, the income would receive preferred tax treatment resulting in a lower tax rate.

In our view, only RRSP contributions themselves should be taxed as "deferred employment income." The investment returns (i.e. the growth in the plan) should be taxed at a lower rate that mimics the tax rate that might have been paid if the investments had been held outside a registered plan.

How current policy skews investment behaviour

To Dunn's point, Di Vito added that the loss of the preferred tax status for dividend income and capital gains held in RRSPs "may skew one's investment behaviour."  The very nature of the tax treatment is an incentive to opt for an abundance of interest-bearing securities in one's RRSP portfolio; at today's all-time-low interest rates, such investments will grow very slowly and one's retirement savings may not even keep up with inflation on an after-tax basis.

On a related point, Di Vito also suggests something CARP and this blog have long pushed for: lowering the rate of forced minimum annual RRIF withdrawals, which are taxable even though a senior may not need the income. Typically, seniors have to withdraw and be taxed on annual RRIF withdrawals in excess of 7%, a percentage that grows to 20% a year in one's 90s. Such withdrawal rates were set during a time when interest rates were much higher. These days, the policy raises the likelihood that seniors will be destitute if they reach their 90s, a fact that's more likely as longevity increases and medical science advances.

Do these simple changes now and extensive reform can be done properly at leisure

Note that these two ideas are the furthest thing from radical pension reform. They don't even entail raising RRSP or TFSA contribution limits although both Dunn and Di Vito think that's a good idea as well. Another good suggestion at the hearings came from Doug Andrews, Fellow of the Canadian Institute of Actuaries. To the point that many Canadians don't use up the RRSP room they already enjoy, Andrews suggested that Ottawa make it easier for Canadians to contribute large lump sums into RRSPs and TFSAs  when windfalls arise: typically from severance, inheritance or the sale of a house.

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Source The Wealthy Boomer : Retirement