Ensuring Relevance in the Payout Phase and Developing Holistic Value Proposition

Running Out of Money

A common predicament for retirees in Canada and beyond is whether they have saved enough to maintain their existing lifestyle retirement—or outlive their savings.

While retirees face challenges on multiple fronts, the combination of uncertainty around market returns and longevity lie in a category of their own. Concerns of retirees about how and how much to save, what to invest in, how to balance spending and inheritance plans all amount to reportedly significant anxiety about financial wellness in retirement.

The good news is that Canadians are living longer. However, living longer means that retirees need to accumulate more to fund their desired retirement lifestyle. According to a recent Edward Jones survey, a mere 31% of Canadians believe they can afford a retirement of 20 years or more, and just 61% believe they can afford a 10-year retirement.¹ With retirement periods now stretching for more than two decades, the risk of running out of money has come to the fore for many Canadians.

A Retiree’s Dilemma = A Potential Advisor Opportunity

After focusing for many years on saving for retirement, pivoting to spending their accumulated assets does not come easily to most retirees. This shift from the accumulation to the decumulation phase is an opportunity for advisors to optimize clients’ sources of income, realize tax efficiencies and create a balanced and sustainable cash flow in accordance with their personalized lifestyle choices. With the right retirement modelling tools, products and skills, advisors can not only reduce the risk of a potential customer flight at retirement, but can also build scale as clients consolidate their holdings to ensure orderly decumulation. On a firm-wide basis, this can result in increased market share and revenue gains.

A Family Approach To Holistic Offering

As explained in the previous paper, “expanded value advice proposition,” advisors need to provide holistic advice and earn their clients’ trust. Areas in which Canadian clients require a holistic approach are retirement planning and reimagining retirement income in a new light. Today’s clients, then, want advisors to address an ever-widening array of needs, from pre- and in-retirement planning; estate and insurance services; healthcare planning; inter-generational wealth transfer; philanthropy and legacy planning; income, debt, and tax management.

The opportunity for financial service providers, be they product managers or advice-givers, is to approach the retiree (and pre-retiree) population with a potential bridge for funding the retirement savings gap in order to maintain their standard of living after retirement. Some experts call for a pivot from an asset allocation focus to a holistic cash flow-based approach. In any event, advisors must continually learn and evolve to ensure relevance in the payout phase. Paradoxically, advisors must set aside at least some of what has proven to be the recipe for their success in the accumulation phase and dedicate themselves to polishing and adding new competencies.

Compounding the retirement savings gap, intergenerational wealth transfers present a vast opportunity for financial advisers, but also a significant risk for those who fail to capitalize on this trend. As per Investor Economics’ (IE’s) estimates, just over $1.2 trillion (one-fifth of household financial wealth), will change hands from one generation to the next over the coming decade. The business retention challenge associated with the intergenerational transfers of wealth has been flagged a long time ago by most financial service providers, but the problem is complex and requires a holistic “family approach.”

While presenting some retention challenges to incumbent advisors, the retirement opportunity looms large. Investor Economics estimates that by 2032, 44.6% of all financial household wealth (investible assets) will be controlled by households whose head is 65 years old or older. It will take several years for the growth opportunity to shift back to the younger generations—the millennials and Gen Z, which means that, at least for the time being, retaining and growing the business with retirees is critical for all financial providers.

The Retirement Opportunity By The Numbers

Canada will see the highest levels of households transitioning to retirement over the next decade as younger baby boomers reach retirement age; thus, the need to secure retirement income is at an all-time high.

Canada’s population is aging at accelerated rate; the share of Canada’s population aged 65 or older is expected to increase from 4.9 million (2021) to 6.6 million by 2030

Life expectancy in Canada has risen from 81.8 years in 1980 to 85.2 years in 2019, leading to longevity risk

Compounding the aging demographics and longevity risk, macroeconomic factors are contributing their fair share of uncertainty.

With a prolonged period of rising inflation, home prices and interest rates, Canadians of all ages are finding it harder to save for retirement. Inflation has been slowly cooling in recent months, but at 3.3 per cent in July 2023, it is still ahead of the central bank’s target rate of 2%. Inflation—or the loss of purchasing power—is particularly hurtful to households in retirement with limited ability to counteract their power to erode the value of their income. In short, higher than predicted inflation can throw off both the retirement income and longevity mitigation plans.

Compounding the uncertain macroeconomic backdrop is the volatile progress of global capital markets. From the dot-com bubble in the 1990s, to the Great Recession and financial crisis of 2008-09, and a global pandemic of 2020-22, markets have witnessed a number of significant swings over the past few decades. Increased volatility adds uncertainty to retirement plans, and the timing of market drawdowns can severely impact long-term cash flows. Market volatility increases the risk of running out of money, creating a dilemma of how much to drawdown upfront and save for later stages.

Delayed Retirement and the Savings Gap

As per research from Fidelity Investments Canada ULC, more than 60% of Canadians who have not yet retired say they are delaying their start date due to the effect of inflation.² Delayed retirement could fuel what some a so-called grey tsunami of baby boomers retiring at the same time.

The Retirement Savings Gap Is The By-product Of A Combination Of Multiple Factors Explained Above:

A retirement savings gap is the difference between the amount of money someone has saved and how
much they will need throughout their life. As per a World Economic Forum (WEF) report published in 2019, globally from the United States to Europe, Australia and Japan, retirement account balances have not been increasing fast enough to cover rising life expectancy and rising inflation. According to the WEF report, in absolute terms, by 2030 the retirement-to-savings gap for Canada will reach $8.1 trillion, up from $4 trillion in 2015. In terms of how many years a senior might outlive their money, this projected retirement gap is 10 years for men and 13 for women.

A BMO survey found that Canadians now believe they need $1.7 million in savings in order to retire, a 20% increase from 2020.³ The eye-popping figure is the largest sum since BMO first started surveying Canadians about their retirement expectations 13 years ago.

None of these challenges are new, however, as aging populations are a slow-moving target, and financial unpreparedness is not unique to retirees. The size of the retirement-savings gap is such that it requires action from policymakers, employers, and individuals. There is a thus need to reimagine retirement income in a new light from all the stakeholders.

We Are Living Longer—And So Should Our Money

How Did We Get Here?

Defined benefit (DB) plans appear to be an ideal option for retirees, but the reality is that access to DB plans has declined significantly over the last 20 years in Canada for employees of the private sector. Canadian employers continue to steadily transition away from the DB pension structures that offered comfortable, confident retirements to previous generations. Indeed, fewer than 9% of private sector workers today enjoy access to a DB pension—far from the peak in the late 1970s when approximately half of employees had access to such plans.⁴

The shift away from DB pensions toward defined contribution (DC) retirement plans (or no group pension at all), transfers the retirement preparedness risk to the individual. But while the move to DC plans arguably reduces the liabilities of business, it has, if anything, raised the likelihood of an increase in the retirement gap as baby boomers retire. As a large number of group retirement accounts in Canada have relatively low balances, retirement unpreparedness is rampant even among those with access to a DC savings plan.

Big Shift In Mindset—From Accumulation To Decumulation

When clients accumulate retirement savings; their focus is on growing their nest egg. How much have they already saved? How much can they add in a given year? What would be their rate of return? The goal is to grow their savings into as big a pot as possible so they can draw on it one day, together with employer and government pensions, to make their retirement worry-free.

As retirement nears, the focus naturally shifts to the actual mechanics of creating a stream of income from savings. Clients are now confronted by the thorny problem of decumulation. On one hand, clients want to make sure their pool of savings provides a stable income for what will probably be a long retirement. Conversely, clients also want to avoid limiting their spending to the point where they are unable to enjoy their hard-earned retirement.

While a traditional asset allocation approach works well during one’s working years, today’s volatile markets render that approach unfeasible in the retirement spending phase. At a certain point in a client’s life journey, portfolios must shift their focus from asset allocation-based accumulation to cash flow-based decumulation approach. One of the most significant questions surrounding retirement is how to generate sufficient retirement income. Focusing on cash flows allows for a broader perspective and enables retirees to reach their financial goals without taking on a higher level of risk.

Few Income-Generating Product Options To Explore

This trade-off has existed since the dawn of actuarial tables, but in an era of higher interest rates, at least for the time being, the increasing number of recent retirees are faced with a tempting payout yield on their accumulated assets compared to recent history.

The past decade has seen many retirees load up on equity allocation as traditional products from term deposits, to annuities, to income funds provided little in the way of cash distributions. This, however, has shifted, prompting advisors and investor alike to take another look at these payout options which dominate the retirement income landscape. From new ideas to traditional products, the yields on payout options have spiked from 2-4% just three years ago to the 4-7% today. On the funds side, popular equity dividend and balanced income mandates are yielding 4.2% and beyond, with the implied promise of upward capital appreciation in addition to the relatively high yields.

On the insurance side, annuities have also caught some attention after years of declining usage by advisors and retirees. Annuities are a product firmly on the side of decumulation, as nothing is left at the end of the annuitant’s payments apart from death benefit guarantees, with eye-popping yields of nearly 7% for life renders them once again appealing to retirees. Payout annuities are staging a major comeback in terms of new premiums booked—which comes as no surprise after many years of subdued demand.

Canadian financial services providers have devised innovative products to tackle the aforementioned concerns. The last several years have seen the launch of products ranging from options providing capital protection for a lower yield to higher yielding asset classes that include market risks.

In 2021, the Canadian Income tax act and regulations were amended to introduce two new retirement payout vehicles: variable payment life annuities (VPLAs) and advance life deferred annuities (ALDAs).

VLPAs provide variable payments on annuities for pension plan members over the age of 65, providing the first truly variable annuity to the Canadian market, a niche which was covered to some extent by segregated fund policies. VPLAs will initially be available to pension plans, not retail clients, but for those plans which are looking to provide a slightly higher payment to members with limited investment risk, this new product can help create that goal.

ALDAs are a simple annuity with a low ($150,000) limit, which allows for advanced deferral (up to 85 years old) before payments begin. This product is available to individual clients and can provide the broader retail market with a hedge against longer life expectancy. For those clients with family members who lived well into their 90s—or made it past the century barrier—this product can offer some peace of mind.

Canada’s annuity market has been highly regulated in terms of payout deferral and variability for decades, and these two new products bring the marketplace closer in line with other global market, albeit still significantly behind annuities-rich product landscapes such as the United States.

Longevity Fund Solutions A “Modern Tontine” For Retirement Planning

Canadians approaching retirement age have a new type of investment product available that mimics aspects of annuities and DB pension plans.

Tontines, which have existed for centuries as a “last-person-standing” investment pools in which surviving members inherit the holdings of members who die have been launched. Toronto-based Purpose Investments was the first to bring the concept to Canada in June 2021, with the launch of its Longevity Pension Fund and Guardian Capital LP introduced its own GuardPath Longevity Solutions, the GuardPath Managed Decumulation 2042 Fund and the GuardPath Modern Tontine 2042 Trust.

In a longevity pension fund, retirees receive lifetime monthly income payments after the age of 65 with incremental increases with each age cohort. The objective of the fund is to increase payments for all age groups, though the payments are not guaranteed and can vary. Retirees are pooled together as per their risk profile to provide the benefit of longevity pooling.

Longevity pension funds differ from VPLAs in the flexibility of the mutual fund structure that allows investors to redeem and access unpaid capital. Prior to retirement, investors contribute to the fund and build wealth like any normal fund; once the investors turn 65, they are moved into the tax-free and income-producing decumulation class. If investors redeem before moving into the decumulation class, they receive their net asset value. The fund allows managers to adopt a conservative approach with regard to the investment strategy—a big plus especially when the markets are volatile.

The decumulation fund is designed to last for 20 years and aims to provide a steady stream of monthly distributions with the express purpose of drawing down to zero at the end of its lifetime. The fund is intended to help Canadians overcome one of the biggest reasons why individuals do not live their retirement to the fullest.

Covered-Call ETFs

A covered-call ETF is an exchange-traded fund that uses a covered-call writing strategy to generate income for investors. Covered-call writing is a strategy in which the fund sells call options on a security it owns in exchange for a premium. The premium received from selling the call option provides additional income for the investor. Covered calls, it would seem, fit solely into the income-oriented type of investments, as the premium received from selling covered calls offers two benefits—increasing cash income and placing a limit on potential stock price gains because the sold stock limits how much a covered-call seller can profit from a stock’s appreciation.

As per IE’s ETF and Index Funds Report’s Q1 2023, covered-call ETFs amassed $17.6 billion in assets with a 10% three-month growth rate.

While covered-call ETFs could therefore be a good option for investors looking for a hedge against volatility and income generation, it is important to consider the risks associated with the strategy, such as market risk and counterparty risk.

Retirement preparedness is an issue that will continue to demand creative and targeted solutions from asset managers.

Advisors Need A “Family Approach” Holistic Proposition

The new mantra is: “It is about life, not just retirement.” With ever-increasing lifespans, today’s client is not exclusively a retirement client, but rather a longevity client. From Gen Z to the oldest boomer, individuals and families are tackling (sometimes with little guidance) how to navigate a century-long life. They are today’s longevity clients.

To ensure relevance in the payout phase, advisors should start viewing their client relationships as “advisor to family” instead of “advisor to client” and develop holistic advice that caters to the needs of the entire family across generations. Advisors need to develop holistic value proposition for each generation to deliver appropriate value to their clients. Advisors who are able to understand their clients’ milestones will be able to retain existing clients moving to retirement and onboard new heirs in the family. By actively seeking out new clients, advisors can stay relevant and ensure their services are meeting the needs of entire family while building trust.

Advisors Need To Build A Multi-Pronged Holistic Approach To Service Today’s Retirees And Pre-Retiree Customers:

Retain existing clients and onboard new customers

Build bridges to the next generation of wealth

Retain Existing Clients And Onboard New Customers

The mantra for advisors: Connecting with all generations in a single family.

As mentioned in the report, “Expanding Advice Value Proposition,” a loyal client is one of the advisor’s most valuable assets. The association of trust with client loyalty and retention illustrates why building a client’s trust should matter for financial advisors.

Generally high-performing advisors ensure that they know and connect with all members of a client’s family at the beginning of the relationship. By doing this, advisors set the stage for future growth by cultivating a pipeline of new clients. Connecting with the next generation of their clients is also conducive to retain business in the event of an inter-generational transfer of wealth.

Advisors can get a head start in helping clients analyze and prioritize their financial goals by understanding the common concerns of their clients’ age cohorts. As their clients’ needs evolve over life stages, advisors can continue to build trust and demonstrate their value through various product and service offerings.

The table below illustrates possible priorities and financial products of interest for specific age groups across both the phases (accumulation and decumulation).

This family approach helps advisors retain and onboard new heirs, especially when younger generations are ready to start seriously investing or in the process of receiving an inheritance; they do not go searching for their own advisor—they already have one. This approach also serves to drive increased client satisfaction because clients feel more secure knowing their entire family is on the same page when it comes to their finances.

Build Bridges To The Next Generation Of Wealth

The other reason that advisors to connect with all generations in the family is the transfer of inter-generational wealth, which also represents a shift in how households manage their finances.

One out of every five dollars in Canadian household wealth will change hands as a result of the intergenerational wealth transfer in the next decade. More than $1.2 trillion will be “in motion” between generations, impacting more than 1.2 million relationships.

This dramatic change of guard in who owns Canada’s household wealth represents both a threat and an opportunity for advisors.

Crafting a successful holistic strategy for reducing business risk and maximizing the competitive capture of this “money in motion” starts with understanding the underlying dynamics of intergenerational transfer. Nearly three-quarters of the assets to be transferred are accounted for by 8% of transferors. The inheritances of the affluent segment include significant financial, in addition to real, assets. This concentration of inherited wealth—and the considerable effort involved in a proper legacy planning exercise—suggests that advisors will be best served by addressing the needs of their most affluent clients. The need for a comprehensive approach involving legacy and estate planning, taxation, insurance, product reallocations, debt management and more suggest that the asset size of the relationship needs to be meaningful enough to pay back for the high-touch service required.

The good news is that advisors are not alone in their mission to deliver comprehensive estate and insurance planning solutions. Estate and insurance planning expertise is increasingly supported by expert resources at financial planning and brokerage firms, and research from ISS Market Intelligence suggests its usage is growing among advisors.

Advisors will have to adapt quickly to the new client preferences and recognize that in some cases, an intergenerational wealth transfer may have an initial negative impact on the size of their book of business. Yet, maintaining the relationship and supporting inheritors in their preferences to dispose of, or invest in, their newly acquired wealth should translate into growth opportunities in the long term.

The opportunity looms large. Advisors who offer a high-touch service, with the right amount of empathy, trustworthiness, and personalization, are far more likely to thrive in the multi-generational nature of Canadian wealth relationships than the advisor who beats their benchmark return by a few basis points.

Tools For Advisors To Curate Holistic Client View

An ongoing challenge for advisors and product manufacturers alike is to consolidate these various retirement income accounts, paint a reasonably accurate picture as to how much is available for retirement, and convert those dollars into the most appropriate product selection for that client. But what may look for an opportunity for some financial services providers looks more like a risk to others, depending on who is consolidating the client relationship. Innovative companies are disrupting the retirement market with new technology interventions and ways to reach the end participant; these innovators have caught the attention of private equity firms that are deploying capital into the space via direct funding or through their platforms.

The emergence of fintech startups has the potential to disrupt retirement planning by focusing on automated wealth management platforms that specifically target retirement savings accounts. There are few other companies assisting advisors in retirement decumulation planning / pension modelling.

Common Wealth launched a technology-enabled retirement savings and planning platform designed to give all Canadian employers access to an easy-to-use, portable, and cost-effective way to help their employees save for their future. The first deployment of the Common Wealth platform, a retirement plan for Ontario physicians in partnership with the Ontario Medical Association, won two awards for innovation from Pensions & Investments and the Canadian Investment Review. With this launch, Common Wealth is inviting Canadian employers of any size to support the financial wellness of their employees with a digital retirement plan designed for the modern workplace.

Income Discovery, an AI-powered Platform for retirement decumulation, value-added planning tool to help advisors provide better answers to difficult questions from clients either contemplating retirement or currently in retirement. Current financial planning tools require advisors to manually adjust levers to try to find the optimal solution, which is not a good use of their time. Advisors want an easy solution that will do the heavy lifting of analyzing thousands of strategies and make them feel confident about the optimal recommended strategy.

Income Planning 2.0 helps eliminate the guesswork for advisors so they can focus on building deeper relationships with their clients by providing a clear, actionable, optimal plan with a single click. It is designed to be easy for an advisor to use, yet sophisticated enough for a detailed advisor to dig into specifics if they so desire. Retirement decumulation can be complex, but Income Discovery has simplified this process with Income Planning 2.0.

Cascades is another retirement income planning tool and cloud-based solution, enabling advisors to develop the most tax-efficient retirement income strategies quickly and accurately for their clients. It summarizes competing decumulation strategies and reveals the income tax savings of each one. It also provides a clear breakdown of retirement income, key planning considerations, and long-term financial projections.

Cascades and Flinks formed a strategic partnership to provide financial services firms with a best-in-class retirement income planning experience. The collaboration will see the integration of Cascades’ decumulation planning engine with Flinks’ financial data aggregation and analytics platform. Together with Flinks, advisors can now simply ask clients for their permission to collect the relevant financial data, thus streamlining the experience and putting more retirement income plans into the hands of Canadians.