Adding a pure longevity insurance payout option to the CPP would go a long way to ease the pain of private sector employees with disappearing pensions. This blog adds some meat to the proposal I mentioned in last week’s PRPP or expanded CPP? Consider adding a pure longevity insurance payout option to the CPP.
The PRPP doesn’t meet the four basic requirements to real pension reform, as it doesn’t: (1) require/encourage adequate savings for retirement, (2) provide low-cost accumulation and decumulation vehicles with life-cycle appropriate investment and withdrawal defaults, (3) provide low-cost pure longevity insurance products and (4) modify BIA/CCAA legislation to raise the priority of private sector DB pension plan deficits in case the employer/sponsor goes into bankruptcy protection.
Canadians already have the flexibility to choose the start of CPP anywhere between age 60 and 70 with appropriate incentives for starting payouts later rather than sooner, as permitted by the individual’s circumstances. Recent OAS announcement suggested similar incentives are on the way to defer OAS past 65. These are significant improvements since the CPP and OAS are relatively secure life-time inflation indexed income sources, and it’s a powerful way to boost them.
Since we don’t seem to be making any progress on pension reform, how about something very simple. Why not add a pure longevity insurance payout option to the CPP that would go a long way to helping those who do not have the benefit of a public sector pension plan?
How would this work? Allow each CPP recipient to irreversibly forgo a small portion of their annual CPP pension, in exchange for life-contingent lifetime income stream starting at age 85 (i.e. those dying prior to age 85 will effectively not benefit from their forgone portion of their CPP). Using a recent New York Life pure longevity insurance quote, each single $1 premium at age 65 results in a life-contingent un-indexed life-time income stream of $0.64 starting at age 85. Then some back of the envelope calculation would suggest that the inflation indexed CPP payouts have actuarial present value of about $25,000 (i.e. if you could buy an inflation indexed annuity it would pay about to 4%/year) for each $1,000/year forgone payout starting at age 65. Therefore each $1,000/year of inflation indexed lifetime income forgone between ages 65-84, could translate (conservatively) to $16,000/year un-indexed lifetime income starting at age 85.
While such a pure longevity insurance payout option might not be useful to all CPP recipients, many average income Canadians with modest accumulated retirement savings might find this option interesting. Typical and maximum annual CPP payouts at age 65 are about $7,000 and $12,000 respectively. So for example, if a CPP recipient entitled to $7,000 per year also has assets of $200,000 at retirement, then forgoing $800/year of CPP at age 65 (i.e. would receive $6,200 instead of $7,000/yr) would translate to and un-indexed lifetime income of close to $12,800. Then assuming 2% inflation, (a very conservative approach of) 1% real investment return and an annual draw of 1/20 in year 1, 1/19 in year 2, 1/18 in year 3 until retirement savings are spent in year 20, the following graph shows the lifetime real income stream with and without longevity insurance option in age 65 dollars. This graph shows all dollars adjusted for inflation since age 65 (for simplicity CPP is assumed to track inflation), so the $12,800 un-indexed income at age 85 start off at $8,445 with the assumed 2%/yr inflation since 65. Note the -$800/yr negative “longevity insurance” cash flows between age 65-85, turning positive at age 85.
There are clearly other decumulation strategies possible, but this was chosen purely to illustrate the impact of a longevity insurance payout option in CPP.
You may not be able to control your returns, but can you get a pretty good kicker from the mortality credits that accrue from age 65 to 85 (since half the people won’t be there to collect). This boost has nothing to do with “cross-generational transfers”, the incremental income is purely a result of investment returns boosted by ”intra-generational transfers” from those who die before 85 to those still alive at 85. In fact this vehicle could be made even more valuable and more widely applicable if there was an opportunity to include a survivor benefit option, for a somewhat reduced income stream. As to concerns about the timing (delay) of the governments’ tax flow, it is unlikely to be material given that typically only a small proportion of the CPP would be forgone each year and not all CPP eligibles would partake in such an option.
Therefore, forgoing relatively small portion of the CPP each year starting at age 65, you can build significant income stream starting at age 85, should you be one of about half the 65 year olds still expected to be alive.
For those who have no retirement assets, this proposed option is of little value. However those who have retirement assets that they plan to draw down during a retirement of uncertain duration, the CPP longevity insurance payout option would provide some combination of these benefits:
- allow a retirement plan of known duration
- reduce the fear of running out of money
- reducing the risk of becoming dependent on family and government handouts if assets are exhausted
- allow more aggressive withdrawal (and possibly more aggressive investment), yielding overall a higher total retirement income
- allow a long-term care income stream starting at 85
- potentially increase residual estate as compared to case of no longevity insurance option