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Retirement planning has long faced a key challenge: how can savings be converted into a predictable, sustainable income that adapts to the changing needs of retirees? Traditional decumulation options, such as self-managed withdrawals from registered retirement income funds (RRIFs) or life income funds (LIFs) and individual annuities, each have their drawbacks, including administrative complexity, the risk of error or outliving savings, and uncertainty about retirement income.
To address these concerns, Quebec recently introduced dynamic pension funds, also known as variable payment life annuities (VPLAs). This innovative solution expands the range of decumulation options and will transform the financial approach to retirement. Anyone who has accumulated retirement savings in a registered plan (such as an RRSP, RRIF, LIF or pension plan) will be able to benefit from this new option of transferring part of these savings into a voluntary retirement savings plan (VRSP) offering a dynamic pension fund, thereby converting their savings into lifetime income.
With Quebec positioned as a leader and this model on track to be adopted across Canada, dynamic pension funds represent a major step forward, placing defined contribution (DC) and defined benefit (DB) plans on equal footing in terms of income predictability.
Dynamic pension funds allow members of a DC plan or VRSP to transfer a portion of their savings into the fund. This amount is then converted into lifetime income, based on predetermined conversion factors. Transferred savings cannot be withdrawn from the fund, since they will be used exclusively to pay a lifetime pension.
The amount of the pension changes annually, as it is adjusted based on the fund’s investment performance relative to a predetermined reference rate (e.g. 4%). This allows members to keep benefiting from the investment risk premium offered by financial markets. The pension is also adjusted at least once every three years to reflect the group’s mortality experience. Each adjustment may be upward or downward, which is what enables the fund to offer sustainable income for life.
With the introduction of dynamic pension funds, everyone can have access to a pension plan that pays a lifetime income.
No withdrawal or investment decisions are required with dynamic pension funds, which removes much of the uncertainty, reduces the risk of error in managing savings and simplifies retirement planning. Gone are the days of people guessing what to do with their savings—a common issue with the traditional approach to retirement planning involving RRIF or LIF withdrawals, where the fear of running out of money can lead to living more modestly than necessary.
Fixed conversion factors also help simplify retirement planning and are a key feature that set dynamic pensions apart from individual pensions, whose prices fluctuate with market conditions. Each person knows the initial amount of the dynamic pension that will be paid out in advance.
The predictability in the cost of purchasing such a pension is a major shift that makes it easier to convert the value of savings into retirement income, which should also incentivize people to save.
One of the advantages of dynamic pension funds is risk pooling: with this option, you’re not on your own!
Risk pooling enables the fund to maintain a more growth-oriented investment allocation, even at advanced ages (such as after 70), thereby helping to offer a predictable retirement income superior to that obtained when risks are managed on an individual basis. Pooling also provides access to economies of scale, resulting in fees that are generally lower than those associated with individual savings.
A dynamic pension fund enables more savings to be used each year with the assurance of always having retirement income—equivalent to a RRIF but with more flexibility for spending.
Dynamic pension funds should not be viewed as a one-size-fits-all solution for all savings but rather as one of the tools that can be integrated into a decumulation strategy. For example:
A successful decumulation strategy also relies on effectively coordinating income from public plans. The amounts received annually from these plans can be significantly increased by deferring the start date of benefits. Québec Pension Plan (QPP) payments can be deferred until age 72, whereas Canada Pension Plan (CPP) and Old Age Security (OAS) benefits can be deferred up to age 70.
Deferring these sources of stable, indexed lifetime income can be the key to financial security in retirement. Savings can then be used earlier to meet financial needs before government pensions begin and to supplement guaranteed lifetime income through the purchase of a dynamic pension or an individual annuity.
The introduction of a new option for decumulating savings is a significant step forward that has come at the right time, when more than 13 million people in Canada are over age 55 and the population over age 75 is expected to double in the next twenty years.
Dynamic pension funds offer new possibilities for better structuring the use of retirement savings, in coordination with pensions from public plans. By simplifying retirement planning and providing a higher income without the worry of seeing savings run out, dynamic pensions offer peace of mind for life.
They offer a modern solution to the challenges of decumulation, helping to redefine financial security in retirement and encouraging retirement savings. As a result, DC plans, and savings plans by extension, will become more effective, serving not only as accumulation vehicles but also as a driving force for funding predictable, sustainable and higher retirement income.
Article written by:
Louis-Bernard Désilets, FSA, FCIA
Partner, Pension
