In this post I will review a Member’s role in the Ideal Canadian Pension Plan.
As set out in the previous post, we want to reframe the discussion with the Members of the ICPP and have the Members concentrate on their retirement lifestyle choices – their personal benefit targets – and not on the investment process that supports these targets. This is a paradigm shift from traditional defined contribution pension plan approaches that require Members to focus on individual investment decision making.
Remember the ICPP is a cooperative and collective defined contribution pension plan. The collective part allows us to manage investments together and streamline administration thereby reducing expenses. The cooperative part allows us to introduce optimal payout strategies that otherwise would not be available.
Remember also that the ICPP is one pension plan that must provide solutions to many different Members. The ICPP is therefore designed with several targeted benefit payout options to meet all of our Members’ potential needs. The CPP Double-Up Benefit, the Lifestyle Maintenance Bridge Benefit, the Lifetime Lifestyle Benefit, the Additional Lifetime Income Benefit, the Extra Cash Early Benefit and, take a breath, the Minimum Taxable Benefit payout options are all designed to meet specific needs of the Members. There is a lot to digest with so many payout options, but for many Member’s, if not most, the ICPP will be very simple from a practical point of view. To illustrate this, we will review an example.
Example 1 – Employee of a Typical Participating Employer
A Participating Employer agrees to adopt the ICPP on behalf of his employees. The Participating Employer establishes a 3% Employer Contribution and a 3% Optional Member Contribution. The Participating Employer sets the minimum CPP Double-Up Benefit target at 100%. Most of the employees who work for this Participating Employer have total annual incomes that range from $30,000 to $80,000.
On enrolment each employee of this Participating Employer must make a few simple decisions:
- When do I want to retire? (Expected Retirement Date).
- What are my expected retirement needs? (Basic, Lifestyle Maintenance and Discretionary).
- Should I target more to meet my basic needs? (Increase the CPP Double-Up Benefit to 200%).
- Will I contribute more than the required 3% of Earnings now to meet those needs? (Discretionary Contributions).
- Should I transfer any existing registered savings into the ICPP?
Many of these employees will select expected retirement at age 65, to make no Discretionary Contributions, to stick with a 100% CPP Double-Up Benefit target and to make no transfer-in of existing retirement savings at enrolment. In fact, these selections are the defaults.
These employees will likely not prioritise any other target benefit under the ICPP on enrolment. Some may set a 200% CPP Double-Up Benefit target (especially those at the high end of the salary range in this example).
A career everyone of this Participating Employer will generally receive the CPP Double-Up Benefit that is funded on their behalf at retirement and any remaining assets held on their behalf will be paid out as a Minimum Taxable Benefit from the ICPP Accumulation Fund.
Employer and Member Optional Contributions are automatically deposited into the ICPP Accumulation Fund, funds are then automatically transferred (at the right time) to the ICPP Payout Fund and ultimately paid out to the Member as a monthly pension in the form of the CPP Double-Up Benefit. Any excess amounts are paid directly to the Member as a Minimum Taxable Benefit from the ICPP Accumulation Fund. A flow chart for this process is included below.
The Lifestyle Maintenance Bridge Benefit, the Lifetime Lifestyle Maintenance Benefit, the Additional Lifetime Income Benefit and the Additional Cash Early Benefit will not apply to these Members.
Members will be provided support, typically paid for by the Participating Employer, during the enrolment process through group meetings and through one-on-one follow-up meetings for those Members who request them.
After enrolment, each Member will be able to monitor the Member’s progress towards retirement and will receive regular updates through a dedicated ICPP website or by mail if the Member requests.
At retirement, a Member will receive all of the regular options that any Member of a registered defined contribution pension plan would expect. The Member will be given the option to transfer all of the Member’s account balances to another prescribed registered retirement account, may elect optional forms of payout under the ICPP (i.e. optional forms of the CPP Double-Up Benefit) and may elect to receive other ICPP target benefits if there is additional amounts left in the Member’s accounts after providing the CPP Double-Up Benefit.
At termination prior to retirement, a Member may elect to leave the Member’s accounts in the ICPP or to transfer the Member’s accounts to another prescribed registered retirement savings arrangement.
Most Members who retire from the ICPP in this example will receive a CPP Double-Up Benefit that should provide enough to meet the Member’s basic needs in retirement (when added to the OAS benefit and the regular CPP benefit). The CPP Double-Up Benefit is designed to provide an expected payout during the member’s lifetime that increases with inflation over the long term. It also provides a spousal pension (60% of the Member’s pension) as a default.
The total 6% contribution in this example should be enough to look after each Member’s basic needs in retirement with a little left over. The contribution that is expected to provide the “little left over” amounts effectively provides a cushion and limits the Member’s exposure to the long-term risk of not obtaining the targeted CPP Double-Up Benefit and therefore meeting the Member’s basic needs in retirement.
From a Member’s point of view this Participating Employer is providing a pension plan that provides for the Member’s basic lifetime needs in retirement. For low-income and middle-income Canadians this is essential.
The ICPP can also be quite complex when it has to be. To illustrate this we have created another example.
Example 2 – Executive at the Same Typical Participating Employer
The same Participating Employer has established a 3% Employer Contribution and a 3% Optional Member Contribution and set the minimum CPP Double-Up Benefit target at 100%. The executive’s earnings are in excess of $200,000 per annum.
On enrolment this Executive must also must make a few simple decisions:
- The Executive’s Expected Retirement Date.
- The Executive’s Expected Retirement Needs.
- The Executive’s Discretionary Contributions, if any.
- The Executive’s CPP Double-Up Benefit personal target (i.e. 100% or 200%).
- The Executive’s transfer of existing registered savings into the ICPP, if any.
The Executive selects an expected retirement at age 60, elects to make the maximum Discretionary Contributions, elects a 200% CPP Double-Up Benefit target and elects to transfer-in existing retirement savings in his Locked-in Retirement Account that was established from a transfer from a prior employer’s registered pension plan.
The Executive also set’s target benefit priorities beyond the 200% CPP Double-Up Benefit to provide an Additional Lifetime Income Benefit of $30,000 per annum first, followed by the Lifestyle Maintenance Bridge combined with the Lifetime Lifestyle Maintenance Benefit . The Executive selected the Additional Lifetime Income Benefit after a retirement planning session where it was determined the Executive’s Family would need that support during retirement. Any additional amounts will be paid out as a Minimum Taxable Benefit to the Executive from the ICPP Accumulation Fund.
The Executive set the target benefit priorities after meeting, one-on-one, with an advisor provided by the Employer as part of the enrolment process.
The Executive has the same options on retirement or termination as any other Member.
The ICPP is an executive pension plan from this Executive’s point of view. The Executive’s combined lifetime income from the ICPP is expected to exceed $100,000 per annum. The ICPP offers this Executive more flexibility than typical current registered pension plans.
The CPP Double-Up Benefit – Controlling a Member’s Primary Risk in Retirement
The CPP Double-Up Benefit has been designed to meet Canadians’ basic needs, when combined with their OAS and CPP pensions, in retirement. A pensioner’s primary risk in retirement is a failure to meet the pensioner’s basic needs. There is also a risk that a pensioner will not be able to maintain the pensioner’s lifestyle in retirement but that risk is at a whole different level – the “big risk” is not even meeting the pensioner’s basic needs during retirement.
Some would argue that the government will provide for a pensioner’s basic needs in Canada. We argue that relying on government to provide for basic needs is risky, and it is much better, from a risk management point of view, for a pensioner to take control by personally providing for the pensioner’s own basic needs, as a minimum.
The CPP Double-Up Benefit must:
- Provide enough to meet the Member’s expected basic needs at retirement.
- Provide payments during the Member’s entire lifetime.
- Provide payments that maintain purchasing power for the Member’s entire lifetime.
The CPP Double-Up Benefit was designed to match, on an approximate basis, the benefit a pensioner would expect to receive under the CPP. When the CPP Double-Up Benefit is added to the actual CPP benefit and to the OAS payment, the total payout would be approximately $2,700 per month for anyone receiving the maximum under the CPP. If the Member doubles the CPP Double-Up Benefit, then the total payout would be about $3,800 per month. These amounts should be enough to meet most the pensioner’s basic needs.
For pensioners who earned less than the maximum CPP benefit the targeted pension benefit would be less. For example, a Member who earned $2,500 per month could expect a total payout of $1,800 if 100% if the CPP Double-Up benefit is achieved or just over $2,400 per month if 200% of the CPP Double-Up is achieved.
Based on the above the CPP Double-Up Benefit should allow Members of the ICPP an appropriate target benefit to meet their expected basic needs at retirement. Members with no other resources (e.g. unmarried) will tend to target 200% of the CPP Double-Up. Others may decide to target 100% of the CPP Double-Up Benefit. All Members will receive support in making this decision.
Establishing and saving towards an appropriate target benefit to meet minimum needs at retirement is not enough. A pensioner then needs to receive that target benefit, including spousal benefits, during the pensioner’s lifetime. Further, the monthly income that begins at retirement must grow with inflation during the pensioner’s lifetime if it is to continue to provide for the pensioner’s basic needs. The cost of the basic necessities of life can be expected to generally increase with inflation each year.
In the ICPP, the CPP Double-Up Benefit is paid out through an uninsured variable annuity administered by the ICPP Administrator. The uninsured variable annuity provides lifetime benefits to all pensioners with regular increases that are expected to provide for inflation over the long-term.
Through this process, the pensioners’ investment risk, longevity risk, sequencing risk, expense risk and inflation risk are all managed on a shared basis.
This cooperative solution allows individual members to receive benefit payouts that approach the security received by pensioners who are members of a defined benefit pension plan. The risks still exist but they are professionally managed and minimized through sharing.
A pensioner receiving the CPP Double-Up Benefit under the ICPP has security through the collective that the pensioner will not outlive the pensioner’s savings. Given a large enough pool of pensioners, and the techniques adopted for the uninsured variable annuity, the probability of anyone outliving their savings will almost vanish.
A pensioner will receive benefit increases based on the uninsured variable annuity’s aggregate experience, the increases may be lower than actual inflation or they may be higher. The variable annuity is designed and priced so that the increases are expected to be approximately equal to inflation over the long term.
This collective sharing technique will allow pensioners receiving the CPP Double-Up Benefit through this uninsured variable annuity to receive higher payments than they would be able to receive, with the same risk, if they managed their payments on their own (including buying an insured annuity).
Members of the ICPP will have a stable CPP Double-Up Benefit target, a stable amount necessary to purchase the uninsured variable annuity at retirement and lifetime benefits that generally increase with inflation over time. The ICPP has effectively managed the pensioner’s “big risk” in retirement.
The Lifetime Maintenance Benefits – Controlling a Member’s Lifestyle Risk in Retirement
The Lifetime Maintenance Benefits have been designed to provide most Canadians’ with sufficient pensions to support their lifestyle during retirement. Most pensioner’s want to maintain their lifestyle in retirement. The risk that a pensioner will not be able to maintain the pensioner’s lifestyle in retirement – the lifestyle risk – is a secondary but very important risk.
The Lifestyle Maintenance Benefits must:
- Provide enough to meet the Member’s expected lifestyle needs at retirement.
- Provide payments during the Member’s active
- Provide payments that meet the Member’s lifestyle needs during the Member’s active lifetime.
The Lifestyle Maintenance Bridge was designed to provide an income of up to approximately $3,000 per month. In fact, the maximum amount under this benefit, when added to the maximum CPP Double-Up Benefit, the maximum CPP pension and the OAS payment will provide a total income that is just below the current OAS Claw back amount under the Income Tax Act.
Based on the above the Lifestyle Maintenance Bridge Benefit should allow most Members of the ICPP an appropriate target benefit to meet their expected lifestyle needs at retirement when added to the CPP Double-Up Benefit.
Establishing and saving towards an appropriate target benefit to meet lifestyle needs at retirement is not enough. A pensioner then needs to receive that target benefit during the pensioner’s active lifetime. We set the target as the Member’s active lifetime because we believe lifestyle naturally evolves as a Member ages. We define active lifetime to end at age 85. The Lifestyle Maintenance Bridge Benefit therefore ends at age 85.
If a Member believes that the Member’s active lifetime will extend into the Member’s 90s, the Member may also elect the Lifetime Lifestyle Maintenance Benefit, a target benefit that will continue the lifestyle payments beyond 85 through the purchase of an insured annuity. The insured annuity will be purchased at age 85 and if the Member dies prior to age 85, the assets set aside to support this benefit will form a death benefit.
The lifestyle monthly income that begins at retirement does not need to grow with inflation because lifestyle needs will not tend to grow – Member’s will slow down, even during an active retirement.
Members of the ICPP will have stable Lifestyle Maintenance Benefits that are insured (if selected by the Member) later in retirement. The ICPP has effectively managed the pensioner’s “lifestyle risk” in retirement.
Other ICPP Benefit Options – Personal Control of a Member’s Risk in Retirement
The ICPP also provides two other Benefit Options, the Additional Lifetime Income Benefit and the Extra Cash Early Benefit.
The Additional Lifetime Income Benefit allows a member, typically a high income Member, to target additional funds to pay for an insured annuity in an amount that is completely discretionary. The ICPP will then invest any available contributions to support this benefit and purchase an insured annuity on the Member’s behalf at retirement. The Member will be able to use this tool to complete the Member’s lifetime retirement planning. The Extra Cash Early Benefit allows a Member to designate additional payments early in the Member’s retirement. Perhaps to pay additional income before the OAS payments begin, or perhaps to meet special travel or other need at retirement. This benefit allows a Member to personalise a retirement plan at relatively little additional cost.
Any amounts saved on the Member’s behalf not needed to support other selected benefits are used to provide the Minimum Taxable Benefit. This Benefit is administered like a Life Income Fund (or RRIF) but within the ICPP. The CPP Double-Up Benefit is mandatory, no other Benefit must be targeted.
All of these additional Benefits are intended to allow a Member to take personal control of the Member’s other risks or needs during retirement. The ICPP has the flexibility to meet each individual Member’s unique needs.