Retirees who rely heavily on savings for their income security will always want the most retirement income they can get for a given level of risk. If those savings are in a workplace defined contribution (DC) pension plan, however, they face a formidable hurdle in achieving this goal. That hurdle is government pension regulations.
Consider Kyle who is about to retire with $600,000 in his DC pension plan. He has no other financial assets. His DC plan money goes into a Life Income Fund (LIF) which is like a RRIF for RRSP monies except limits are imposed on how much money he can take out each year.
The limits are particularly strict for DC plans under federal jurisdiction where the maximum withdrawal is about 5 per cent of assets a year at age 61, about 6 per cent at 70 and about 12 per cent at 80. For DC plans under provincial jurisdiction, the withdrawal limits are modestly higher, but still a problem.
Consider two scenarios, if Kyle retires at 61. In Scenario 1, we apply all the limits on withdrawals. If Kyle’s LIF achieves a return of 4 per cent each year (less 0.6 per cent in fees), the maximum income he can draw in his first year of retirement is just under $40,000, including CPP. This amount jumps by nearly $10,000 at 65 when he starts to receive OAS pension as well.
In Scenario 2, we assume there are no withdrawal limits and we push back the starting age for both CPP and OAS pensions to age 70. As the chart shows, the amount of income he can now receive in year one of retirement is nearly $10,000 higher and it continues to be higher than under Scenario 1 for the rest of his life. By age 90, Kyle would have drawn about $140,000 more income under Scenario 2. And here is the really startling news: That higher income is safer than what would be payable under Scenario 1.
The government bodies who enforce the regulations would say they are protecting retirees like Kyle since he might otherwise draw down his LIF balance too quickly. As the example shows, however, they are preventing retirees from maximizing their retirement income.
The withdrawal limits should be increased but there is nothing to suggest this will happen. It is not clear to me why there should be any limits to withdrawals given that the money was put into the DC plan voluntarily in the first place.
Incidentally, the civil servants who could change the regulations are not affected themselves since they are covered by defined benefit pension plans.
Frederick Vettese is former Chief Actuary of Morneau Shepell and author of the PERC retirement calculator (perc-pro.ca)
