How to help CAP members now and in the future
In this time of pandemic, a lot has been shared about the woes of defined benefit pension plans, but members of capital accumulation plans are also feeling the impact, even though few have even noticed.
Once again, inertia has been CAP members’ best friend — by preventing them from impulsively moving out of equities at a time when equity values are low. In mid-April, Sun Life Financial told Benefits Canada it saw just 1.8 per cent of CAP members asking to make changes to their investments during the month of March. Going further, a minority of if its CAP members moved to a more conservative strategy, a situation seemingly in line with other providers’ informal conclusions.
In the U.S., 401(k) statistics are similar, with Fidelity Investments Inc. indicating less than 0.5 per cent of TDF holders had made investment changes in March, while Vanguard Group reported just 2.5 per cent of its 401(k)-only participants had made changes in the month leading up to March 20.
This is all good news, since a vast majority of new CAP contributions in Canada are going to TDFs, as well as a fast-growing portion of assets. As a result, members nearing retirement will benefit from these funds’ investment de-risking design, and younger plan members will stay on track thanks to their proactive asset rebalancing.
Obviously, not all TDFs have delivered in the same fashion, either due to the construction of the de-risking glide path or by the performance of portfolio managers selected for each asset class. In addition, there’s been a large disparity in returns during the first quarter of 2020.
Generally, TDFs have done a good job of protecting the capital of CAP members who are nearing retirement, with a market value loss of roughly six per cent not seeming too catastrophic.
This has also been the acid test for some of the TDFs that were ordinary or poor performers in the past years, on the basis that their approach was favouring capital preservation. Sadly, many of those weren’t able to deliver on their promise and ended up at, or below, median.
Most CAP members can also create their own customized portfolio with à la carte funds. Almost every investor behaviour study I’ve performed for plan sponsor clients over the years has shown a majority of these members have a higher allocation to equities at mid- to late-career stages than most TDF glide paths would suggest. Though equities have done well over the last decade, this market crisis has no doubt hit these individuals more severely than necessary, jeopardizing their retirement plans.
In a recent webcast, Fidelity said the à la carte investors in its 401(k) record-keeping business were generally eight-times more likely to trade than TDF holders. This implies that some may have been more prone to change their asset allocation, badly timing the markets and locking-in their losses.
In between the two situations above, members are using older generation, ready-made investment options such as target-risk and balanced funds. These have set risk levels and — to keep things short — a majority of TRF users and almost every balanced fund user ends up with about 60 per cent allocated to equity.
Unlike TDFs, these investors must proactively review their risk profile and adjust their investments if they want to reduce risk as they approach retirement, which — you guessed it — most never do. Since these funds were prevalent more than 10 to 15 years ago, a large portion of people in this situation have probably just continued to invest in this way (again, this is what I’ve seen in many plan sponsor studies). Failing to reduce their risk level has left them more vulnerable to market downturns, such as the current one. The median return of BFL universe’s TRFs with a 60 per cent equity allocation was negative 10.6 per cent for the first quarter of 2020.
So what are CAP sponsors to do? There are a number of actions they can take to ensure their plan is effective in supporting employees from an investment point of view.
First, CAP sponsors should review the structure of their investment options, including number and types of funds. If they don’t offer a TDF solution, plan members are missing out on a sophisticated yet simple solution. If a plan sponsor decides to switch from TRFs to TDFs, the transition should be planned strategically in the short term due to the current market volatility.
If a plan sponsor is already using TDFs, the next step is to check if they’ve performed according to expectations and to review their construction to make sure they’re well-designed. The last few years have been important improvements in these products. Plan sponsors would be advised to see what other options are available and consider if a change would be beneficial.
As well, whether they offer TDFs or not, plan sponsors should review their plan members’ behaviour and actual personal rates of return to identify targeted communication and education opportunities to help them better manage their savings. This review should include checking to see if members are investing properly in TDFs.
And finally, plan sponsors should coordinate with their CAP record keeper to offer education and individual support to help plan members reassess their retirement planning and determine how they can get back on track.
During the current financial difficulties, pension regulars are introducing breaks for defined benefit plan sponsors, but what about CAP sponsors and members? Falling markets and lower interest rates have the same kind of impacts on their retirement planning.
In the short term, pension regulators have allowed administrative flexibility, such as extended filing delays, for DB plan sponsors, but little or nothing for plan members. The Canada Revenue Agency, on the other hand, was very quick to reduce the minimum registered retirement income fund withdrawals by 25 per cent for 2020 to limit how Canadians would have to crystalize market losses. It’s also considering providing access to registered savings in a way similar to the home buyers’ plan.
There are many other measures that could help CAP members in the short term. First, multiple studies have shown that many Canadians have very limited savings, living paycheque to paycheque. Pension regulators should automatically allow them to unlock a portion of pension savings in line with the anticipated CRA rules for an emergency program to access liquidities. These savings could be reimbursed in any registered savings plan, whether it’s a DC plan or a regular registered retirement savings plan, in line with the CRA program that’s being discussed.
As well, the CRA and pension regulators should allow deferred profit-sharing plan and DC pension members to suspend their contributions, with no impact on sponsor contributions, without the need to amend their trust agreement or pension plan text. However, amendments should still be required for plan sponsors that want to reduce their contributions.
In addition, I’d urge the regulators to implement some of the suggested changes put forth both recently and over the years to better support CAP members over the long term:
- Increase contribution room for retirement savings. Even though DB plan members are technically limited in the value of the pension they’re receiving due to DB pension adjustments, these have become unrepresentative of the real value of pension accruals because they haven’t been reviewed since their implementation 30 years ago, creating two very different worlds for DB plan and CAP members.
- DB plan sponsors are required to pay seemingly unlimited contributions to make up for funding deficits, with no impact on members’ pension adjustments. However, CAP members aren’t able to make additional contributions when running behind on their targeted retirement income, whether due to poor returns or lower interest rates. To level the playing field, the CRA should implement a mechanism that would allow for additional catch-up contributions for Canadians not participating in a DB plan.
- Finally, the federal government should implement the advanced life deferred annuity, as it announced in its March 2019 budget. This will be a true game changer for the financial security of Canadians who aren’t in a DB plan.
The gradual disappearance of DB plans has shifted risks to CAP members, and it’s time the regulators recognize that Canadians also need a regulatory and tax environment that will help and support them achieve their retirement goals. Now is the time to act.