Lasting Legacy

Plan sponsors recognize that TDFs offer members a “hands-free” investment solution, allowing individuals to select a fund matching the retirement date and recognizing that the fund’s asset mix will change (i.e., become more conservative) as they near retirement.

However, TDFs have come under fire in the U.S. recently, as these funds were not immune to the market meltdown. The issue here is equity exposure. Although the equity exposure in TDFs decreases over time, some exposure at retirement is still necessary to allow some capital growth into the retirement years. Individuals close to retirement may not have understood the level of equity exposure in their funds. Therefore, the real issue may be one of transparency rather than exposure.

GMWBs: Too Good to Be True?
Guaranteed minimum withdrawal benefit (GMWB) products were launched in Canada in 2008. These products feature preservation of capital during the accumulation phase with a minimum annuity-like payout at retirement.

With a GMWB, an individual is essentially purchasing insurance on some or all of his or her account within specific investment funds. The insurance ensures that the individual’s capital base is protected as long as the individual retires under the plan. There is also the advantage of exposure to market gains based on valuation at regular intervals without being exposed to losses if, at the time of the valuation, the fund’s market value is less than the capital base. The individual is able to draw down a percentage of the funds after he or she retires. These products also offer a payout of a portion of the balance if the individual dies.

But GMWB products are still relatively uncommon, and there are questions on their cost and the suitability of certain features. Also, given the lack of industry knowledge around GMWBs, it’s not surprising that very few Canadian plan sponsors are considering them (Hewitt’s survey indicates that only 14% are likely to introduce them in 2010).

Annuities: Adding a Twist
Currently, pension legislation permits the purchase of annuities after termination or on retirement. But one has to question if annuity purchases should be available before retirement.

In this scenario, individuals would have the ability to roll over a portion of the plan balance to an annuity on a regular basis. This approach would guard against purchasing a big lump sum on retirement with the exposure to interest rate risk at that time. Alternatively, perhaps the retirement plan could purchase annuities en masse and units could be sold to each individual member, thus making an annuity more cost-effective.

However, annuities are challenging, and member communication and plan administration would be more complex. Moreover, given the level of current interest rates, introducing an annuity option at this time is questionable.

No single approach to helping plan members preserve retirement savings is without drawbacks, although the solutions introduced over the last several years have taken steps in the right direction. As the baby boomers near retirement, more products will be developed to deal with the protection of capital throughout retirement. The economy in the last year has certainly identified the need.

Shawn Cohen is a senior investment consultant in Hewitt Associates’ Toronto office.
shawn.cohen@hewitt.com

> click here for a PDF version of this article

© Copyright 2010 Rogers Publishing Ltd. This article first appeared in the February 2010 edition of BENEFITS CANADA magazine.