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How to guarantee income in the last years of your life

If you are saving for your own retirement, one of the biggest issues is not knowing how long you are going to live.

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The world of retirement income security is rapidly changing – and leaving most Canadians without a security net.

In 1986, 39 per cent of the labour force had an employer-sponsored pension, and most of these (92 per cent) were defined benefit (DB) plans, where workers knew clearly the income they would have post-retirement. By 2010, only 29 per cent of workers had a workplace pension and only 75 per cent of these were DB plans.

In the private sector, matters are even worse. Only 25 per cent of private-sector workers have a workplace pension and a little over half of these (56 per cent) are DB.

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This means that of the private-sector workers who are lucky enough to have workplace pensions at all, 44 per cent have defined contribution (DC) plans, where the only thing that is known for certain is the size of contributions that go into a retirement accumulation fund. Normally, the worker is responsible for choosing how these funds are invested. And when the worker retires, the benefit is the number of dollars in the fund, not a set monthly income.

For the remaining 75 per cent of private-sector workers who have no workplace pension at all, they are dependent on their own RRSP savings. They have the dual challenge of choosing how to invest these funds and then how to provide post-retirement income out of the funds.

If you are saving for your own retirement, one of the biggest issues is not knowing how long you are going to live.

It is true that one can buy a life annuity to remove this longevity risk, but they are an expensive option, largely because interest rates are at an all-time low and insurance companies price workers on an assumed five-star life expectancy.

So, what's the solution?

In mid-April, the government of Quebec released a report from an expert panel chaired by Alban D'Amours entitled Innovating for a Sustainable Retirement System . While the 220-page report contained a large number of proposals, there was one that was truly new and highly innovative: the concept of "longevity pensions."

Here's how they work. If the Quebec government went forward with the report's proposal, workers would contribute 1.65 per cent of their earnings, matched by their employer, into a fund from ages 18 to 74 (when they had no earnings, there would be no contributions). Benefits would accrue on these same earnings at the rate of 0.5 per cent per year, for a total potential benefit of 28.5 per cent of credited earnings.

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These benefits would become payable annually starting at age 75, and continue for life (but guaranteed for at least five years). Both contributions and benefit accruals would be capped at the Year's Maximum Pensionable Earnings (YMPE), or $51,100 today (indexed to wages).

To illustrate more clearly, a worker earning exactly the YMPE would contribute $843 a year (matched by the employer) and would be eligible for a pension of $14,564 a year (indexed), starting at age 75 and going for life (and guaranteed for at least five years).

For workers in a DC or RRSP world, this proposal has huge potential. Instead of being forced to plan your retirement income to cover your unknown life expectancy, you could plan your drawdown much more accurately knowing that at age 75 an extra benefit of $14,564 a year would kick in. This would be on top of your Canada Pension Plan, Old Age Security, and possibly some Guaranteed Income Supplement benefits.

Bottom line: Individuals would only have to provide their own retirement income from the point of retirement to age 75. Not to infinity as is necessary today (that is, to some unknown limit defined by your life expectancy).

This idea deserves serious consideration by our federal government. It could be enacted tomorrow without any approvals required from the provinces (unlike amending the Canada Pension Plan). And the infrastructure is already there: Benefit administration could be assigned to the Canada Pension Plan and the investment of accruing assets to the Canada Pension Plan Investment Board.

Quebec has not yet endorsed the proposal. Predictably, it has been opposed by the Canadian Federation of Independent Business because its members do not want new expenses of $843 per employee per year. And you can expect opposition from the financial institutions that profit from your present dependence on their products.

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That said, it is my sincere hope that Canadians can debate this innovative idea fully and openly. It deserves nothing less.

Robert L. Brown is an adviser with EvidenceNetwork.ca and a fellow with the Canadian Institute of Actuaries. He was professor of Actuarial Science at the University of Waterloo for 39 years, and a past president of the Canadian Institute of Actuaries.

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