This week’s chart highlights how the seriously flawed regulations governing defined contribution (DC) pension plans can hamper one’s retirement planning.
A DC pension plan is much like an RRSP, except the assets go into a life income fund (LIF) on retirement instead of a registered retirement income fund (RRIF). An LIF is like a RRIF, but the money accumulates in a workplace pension plan.
Government regulations everywhere in Canada except Saskatchewan impose a cap on how much income can be drawn from a LIF in a given year. This income cap causes problems for retirees who are trying to implement a smart retirement strategy.
Consider two men, Rick and Larry. Both are 63 years old and have $600,000 in tax-sheltered retirement savings. Rick has all his money in a RRIF. Larry’s money is in a LIF. Let’s say Rick and Larry will both earn an investment return of 4 per cent a year, less 0.5 per cent in fees and both plan to have $80,000 remaining at age 92.
You might think they would have the same potential retirement income, but that is not the case. As the chart shows, Rick does much better with his RRIF than Larry does with his LIF.
In fact, Rick can enjoy at least $6,000 a year more from all sources than Larry and in some years, the gap is even greater. And here is the kicker: Rick is getting more income with less investment and longevity risk than Larry.
Why does Larry do so poorly? Because of the regulatory limits on how much income one can draw from a LIF. Because of these limits, Larry cannot do what Rick does, which is to start his CPP payments at age 70 and fill in the shortfall before then with more income from his RRIF.
In addition, Rick can start his OAS payments at age 68, which happens to be the optimal starting age for him. If Larry tried to do the same from his LIF, he would be able to draw a total income of just $30,000 a year in his first four years of retirement.
I should note that the result would be different if we assumed these two retirees lived only until age 85 and managed to earn a return of 6 per cent a year instead of 4 per cent, but neither assumption is sound.
It is obvious why governments impose caps on LIF withdrawals. Retirees who run out of money early make for the wrong kind of headlines. The end result, however, is that they are hurting retirees like Larry.
Frederick Vettese is former chief actuary of Morneau Shepell and author of the PERC retirement calculator (perc-pro.ca)
