LIF- What is it and why   important for Nortel pensioners

In a nutshell

Ontario government announced that as part of the Nortel pension plan windup procedures the pensioners in this case will not be compelled to convert the (reduced) commuted value of their pension to an annuity, but will also have an option to choose a LIF. (e.g. see “Nortel pensioners get greater choice for their pensions“)

Most Canadians have heard of RRSPs and RRIFs, but what are LIFs? Commuted value of a pension would typically go into a LIRA which is an RRSP-like account except the funds are locked-in until pensionable. When RRSPs are ready or required to be converted to retirement income, the funds are transferred to a RRIF; similarly LIRAs are converted to LIFs (or similar accounts). RRIFs and LIFs both have similar minimum annual withdrawal requirements; however LIFs also have annual caps on maximum permitted withdrawal. Those opting for LIFs, instead of annuities, when the pension plan is wound up will have additional decisions to make, such as: exercise the right to unlock up to 50% of the LIF during the first 60 days of creating the LIF, how to invest the assets and withdraw annual income, and evaluate a GLIF (which probably stands for a ‘group’ LIF) option which I believe is still being worked by the NRPC.

So if you are a Nortel pensioner who is considering other than available default annuity option, it’s probably time to read up on the subject and consider taking independent (no axe to grind) professional advice.

As an aside this blog also discusses some of the advocacy work under way by those who argue for 100% unlocking of LIFs.

Why a LIF blog now

With the upcoming decision for Nortel pensioners and plan beneficiaries, resulting from the forced pension plan windup, I’ve been thinking about doing a blog on the subject of LIF. In the past week I’ve received two reminders to execute on this task as a result of a blog on LIFs in the latest issue of Canadian MoneySaver and then a couple of days later an email from a member of the Ontario Coalition of Independent LIF Holderswhich advocates for removal of all lock-in restrictions associated with LIFs, especially since much of the moneys which end up in these accounts are from DC pension plans. Not being an expert on LIFs in general, and the province-by-province and federal restrictions sufficient to discourage even some of the most determined DIYs, I decided to read up on LIFs and share my understanding of the situation. (Please let me know if you violently disagree with any of my observations.)

In the BMO Nesbit Burns “Locked-in retirement plans” pamphlet you can read about the complexity of Canadians’ options upon retirement;  an alphabet soup of names representing very similar but different constructs available for vested pension benefits upon leaving an employer and/or starting retirement. Depending on the province that one worked in and whether one’s plan was governed by federal or provincial legislation, different acronyms describe similar or slightly different constructs. (RBC also has a pamphlet on “Retirement income accounts”)

Upon leaving an employer the vested pension rights can be left in the plan to obtain a deferred pension; alternately, the commuted values of the DB plans or actual accumulated assets in case of a DC plan, become available to transfer to a locked-in account (Locked-in RRSP or Locked in Retirement Account-LIRA) to insure that funds are ultimately available for a lifetime retirement income. Upon retirement, but no later than age 71, for these locked-in accounts (locked-in RRSP or LIRAs) the accumulated locked-in assets must be used for an annuity or a LIF, LRIF or P-RIF, depending on province.

Funds in an RRSP are available for withdrawal (though hopefully this right is not exercised) at anytime with withdrawals being subject to taxation as income in the year that funds were withdrawn. More commonly the RRSP is transferred to a RRIF by age 71, which then is subject to annual minimum withdrawals which are specified as some percentage (increasing with age) of assets in the RRIF.  The difference between the RRIF and a LIF (and other similar locked in products) is that while they both have similar required minimum withdrawal requirements, the LIF also has annual maximum withdrawal specifications. Each province may have its own twists and turns on the amount and timing of (minimum and) maximum withdrawals. P-RRIFs (Saskatchewan and Manitoba) do not have limits on annual maximum withdrawals. Some provinces require you to purchase an annuity at age 80 while others do not. The BMO “Locked-in retirement plans”pamphlet also includes a table of access options to locked-in funds for each province.

Nortel (Ontario) pensioners

Until recently, Ontario pensioners whose plan were being wound up, were required to annuitize the then commuted value of their pensions. Under the newly announced rules, in addition to annuitization, the pensioners will have the option to transfer commuted value to a LIF. Furthermore, in the Canadian MoneySaver’s “Making “locked-in” funds work for you” Burns and Johnston write that “Ontarians can also unlock up to 50% of their LIF. They must do so within 60 days of transferring their monies into a LIF. You may unlock less than 50%, but keep in mind that this is a one-time opportunity… The benefit is the unlocked funds can be used when you want them without being limited to the maximum withdrawal restrictions… Typically, the unlocked funds are transferred to an RRSP with no immediate tax consequences.” “If you currently are in an old LIF or LRIF in Ontario (opened prior to January 1, 2010), you have until April 30, 2012 to take advantage of this one-time 50% withdrawal/transfer option.” (The latter is a good reminder to the approaching deadline and the former may be useful to Nortel Ontarian pension plan beneficiaries, as they’ll only have 60 days after the funds will be transferred to a LIF to exercise unlocking). Burns and Johnson in the article also describe three states to your retirement/pension funds: present/future DB pension (“commuted value of the pension”), locked-in retirement account (”monies not permitted to be withdrawn”) and locked-in income account (“moneys permitted to be withdrawn, dollar and age restrictions apply”). At the FSCO website you can read a summary of all the 2009 “Changes to the rules for Ontario locked-in accounts”.

So what this means, for Ontario Nortel pensioners, is that decisions will be required at some upcoming forks in the road:

-First choose whether to annuitize or to transfer commuted value of their (reduced) pensions to a LIF. For some annuities will be the right answer, especially if they have low risk tolerance, have no desire to leave an estate or have no interest/capability to worry about managing their retirement assets. Even if annuitization is preferred, one may want to choose a LIF first and then annuitize with a different insurance company (should a better deal be offered (more income or much higher rated insurance company) or annuitize in stages to minimize interest rate risk- i.e. instead of purchasing an annuity with all available funds in what might turn out to have been in retrospect a historically low interest rate environment, some might choose to annuitize partially and/or in 2 or 3 stages over 5 or 10 year interval.

-Second, if they chose the LIF option, then decide whether to exercise the right to unlock up to 50% of the assets in the LIF by moving them to an RRSP/RRIF (or even taking out funds in cash and of course paying tax on the withdrawal). It appears that typically there would be no downside to the unlocking decision (so long as proceeds are not taken out in cash) since the unlocking effectively removes a constraint on the maximum annual withdrawals (should you ever need to do that) without any penalties.

-Third, for those having chosen the LIF and/or an RRSP/RRIF there will be a requirement to make an investment decision and a withdrawal rate decision (or better put a spend rate decision since not all withdrawn funds need to or should be spent, as high required minimum withdrawal/spend rates might lead to depletion of one’s asset before death.

The fight to unlock 100% of Ontario’s locked-in plans (-an aside)

There is an advocacy angle/battle as well to LIFs; this is the fight to unlock 100% of the funds in an Ontario LIF. In this context, I received an email from a member of the Ontario Coalition of Independent LIF Holders discussing politicians/parties positions in preparation for the upcoming Ontario provincial election. For background on unlocking of LIFs, you could read a 2007 view entitled “CARP’s campaign to unlock locked-in funds in Ontario” . No doubt, that the efforts of members of the Ontario Coalition of Independent LIF Holders and others resulted in 2009 “Changes to the rules for Ontario locked-in accounts”and the permission to unlock 50% of the Ontario LIFs during the first 60 days of their creation.

The more one reads about Canada’s pension system the more one realizes its systemic failure: the differences among provinces and federal jurisdiction, the total lack of protection of the assets, the constraints on tax-sheltered saving based on presumed pension contributions by your employer, the high MER abuse that Canadians who are diligently saving for their retirements are subjected to…all the way to constraints on what you should or should not be allowed to do with is ultimately “your money” upon retirement. (This is not the place to discuss DB pension plan administrators’ and hired professional guns’ (actuaries’, investment managers’, custodians’, etc) conflicts of interest and the resulting disastrous impact on pensions as in the recent Nortel bankruptcy, or for that matter the ineffectiveness of existing pension regulations/regulators). But since we are on the subject of LIFs, it is worth spilling a little ink on the pros/cons of what some would consider arbitrary lock-in of funds in LIFs or, for that matter, minimum/maximum annual withdrawal requirements from LIFs (and even RRIFs).

Ideological issues aside (or perhaps it’s impossible to separate this from ideological considerations), there must downsides and perhaps honest differences of opinion between reasonable people; those who advocate for and against the requirement for gradual withdrawal of accumulated tax deferred retirement assets in order to try to preserve a lifetime income stream on one side, and those who oppose any government (‘big brother’) interference with the timing and level of withdrawals from such tax-deferred accounts.

Some of these arguments on the pros/cons might be similar to the arguments used in support of the level of compulsion to be used in accumulation of assets for retirement (i.e. forced (e.g. CPP) as opposed to voluntary retirement savings (RRSP) contributions).

No doubt these arguments range (or rage) from “it is my money, so give it to me” all the way to “if you allow, financially irresponsible/unsophisticated people or people who have no other assets to fall back on in their retirement, access to their accumulated pension/LIF assets, you run the risk that they’ll spend it all very quickly and end up living on government programs paid by all taxpayers”. I suspect that I (or any of you) would readily be able to take on either side of this debate and generate a long list of pros/cons to either proposition.

Without trying to start an political or ideological battle (as I work hard at making the opinions expressed in the blog apolitical), and even though I generally am a believer in as little compulsion as necessary to achieve necessary public policy objectives and minimizing government involvement in what many would consider natural rights and freedoms of an individual to act and live with the consequences of those actions. I could even convince myself of the wisdom of some form of a government run low-cost annuity (or pure longevity insurance) option, given the lack of competition in the Canadian financial services industry. Even an increase in the current level of CPP to say 50% of median Canadian income (as advocated by some and viciously opposed by others) with compulsory employee contribution for incomes above some level) but without compulsory employer contribution (in order to access a low-cost large-scale investment/annuity-like pool necessary to secure a lifetime income requiring minimal investment skill/interest/time at a reasonable cost).

Perhaps one of the more potent arguments for lock-in is to protect retirees from spending their LIF assets too quickly (thus running out of funds during their lifetime, and perhaps ending up on government assistance); perhaps the most potent argument for complete freedom to unlock is the perspective that “it is my money and my life, and let me live it as I want, and live with the consequences”. However some would say that it is somewhat contradictory to simultaneously argue for a freedom to unlock LIFs yet argue for compulsory increase in CPP contributions or vice versa, refusing to support/introduce an expanded compulsory enhanced CPP (requiring compulsory employee contribution) but insisting in keeping existing LIF funds locked-in?

Bottom line

All those impacted by the upcoming Nortel pension plan windup better start reading up on the upcoming choices and perhaps even explore independent advice.