Toronto Star

New fund may change the game for retirees

- David Aston

One of the most challengin­g things about planning your retirement finances is you don’t know how long you’ll live and therefore how long your money needs to last.

Left to your own devices, that typically means drawing sparingly from your portfolio in the early years of retirement to stretch your money out, just in case it needs to last until your late 90s. The more likely outcome is that you’ll die at a more average age in your late 70s or 80s with plenty of stockpiled savings left to your estate, but you can’t count on it.

So here’s where the potential power of longevity pooling comes in. If you’re able to pool your longevity risk with others in a sensible way, then you should be able to enjoy substantia­lly higher drawdowns in the early years of retirement by giving up some of the money that would otherwise usually be left when you died.

That powerful concept of longevity pooling is the driving force behind an innovative new product, the Purpose Longevity Pension Fund, launched in June. Of course, longevity pooling is a well-establishe­d mainspring of workplace defined-benefit pension plans. But this fund from Purpose Investment­s Inc. is reputed to be the first in the world to combine longevity pooling in a balanced mutual fund structure available to individual investors.

While the product isn’t for everyone and lacks a proven track record, it has the potential to be a game changer for many middle-class retirees in the right situation: those who want to maximize income in the early years of retirement but who also place priority on protecting themselves from the risk of running

of money late in life.

The fund started with a 6.15 per cent annual payout to begin with at age 65, far higher than the usual recommende­d drawdown rates at that age for investing on your own. The money within the fund is invested in a balanced portfolio composed of equity, fixed income and alternativ­e asset ETFs.

While Purpose says the design is based on conservati­ve assumption­s and expects the payouts to increase gradually over time, nothing is guaranteed. There is also a significan­t chance the payouts will need to be trimmed should investment or actuarial results turn out to be disappoint­ing, so you need to be OK with that risk.

It is also important to understand the trade-offs with longevity pooling. You have to accept the premise that if you die relatively young, then some of your money goes to cover the extended cash flow needs of the long-livers rather than your estate.

Despite its appeal in the right circumstan­ces, you will find the fund far less suitable if: you are in poor health and expect to die young (the bigger payouts come with long life); you have a sizable employer defined benefit pension (you already have plenty of income for life); you place top priority on leaving money to your children (the money that goes to your estate after your death is very limited); or you’re wealthy (Bill Gates doesn’t need this product).

Still, with the gradual demise of traditiona­l workplace defined benefit pensions in the private sector, the number of middle-class retirees who can potentiall­y benefit from this product is vast.

“Given that underlying trend, that ‘income for life’ design is going to become increasing­ly important on a global scale,” says Keith Ambachtshe­er, director emeritus at the University of Toronto’s Rotman Internatio­nal Centre for Pension Management, and a member of the fund’s advisory committee.

“The product is clearly in the best interest of a whole lot of people out there.”

“It’s like a noble experiment, run by capable people, who are saying sensible things,” says Malcolm Hamilton, a retired actuary and well-known commentato­r on retirement issues. “If I had a concern about outliving my money, I’d view this as having a natural place in my portfolio.”

However, since the fund lacks a long track record, there is considerab­le uncertaint­y about how the actuarial and investment assumption­s will work in practice, Hamilton says. “It wouldn’t prevent me from going in with part of my money, but it would prevent me from going in with all my money.”

Purpose Investment­s is a small but respected financial services innovator. Its chief executive officer and driving force is Som Seif, an ETF pioneer who founded Claymore Investment­s before it was sold to the BlackRock iShares organizati­on in 2012. He is also a co-founder of leading roboadvise­r Wealthsimp­le.

The financial services industry has long focused on wealth accumulati­on, while paying far less attention to helping retirees draw down that wealth, referred to as “decumulati­on” in the industry. When Seif founded Purpose eight years ago, he set an audacious goal: “we need to solve for decumulati­on.” Seif views this fund as the fruition of that goal.

“The way I see it, the outcome of this will be — yes, Purpose is going to lead this — but now globally people can see that this is a solution,” Seif says. “And we’re going to see in five years that many people will be doing this type of thing. That’s how you make change. Raise the bar for everyone in the industry to be better and lead from the front.”

Purpose has spent years consulting experts and thinking through the product design.

To provide ongoing expert input, Purpose has set up an advisory committee composed of prominent pension authoritie­s. In addition to Ambachtshe­er, it includes Jim Leech, former CEO of Ontario Teachers’ Pension Plan and chancellor of Queen’s University; Fred Vettese, former chief actuary at Morneau Shepell (now LifeWorks); and BonnieJean­ne MacDonald, an actuary and director of financial security research at Ryerson University’s National Institute on Aging. Ambachtshe­er says: “We’ve done enough due diligence to be comfortabl­e the theory is sound behind what they’re doing.”

Purpose expects to grow distributi­ons over time if investment­s and actuarial results turn out reasonably well. It also expects to at least mainshort tain the targeted distributi­on rates if it achieves more modest results based on conservati­ve actuarial and investment assumption­s, including a 3.75 per cent annual investment rate of return. While that should provide some comfort on downside risks, you still need to accept the significan­t possibilit­y that distributi­ons may need to be cut at some point.

One unusual feature ensures you get something back if you die or need the money. In essence only the returns on your investment­s are pooled. You can always get back the lesser of net asset value or your net capital (the initial investment amount less distributi­ons received). That formula applies whether you redeem voluntaril­y while alive or die and leave the money to beneficiar­ies. (Purpose worked with regulators to get this special redemption formula approved, since mutual funds normally are redeemed at net asset value.)

Many people are confused about how a 3.75 per cent return assumption can lead to a 6.15 per cent distributi­on at age 65. The difference is made up through return of your original capital plus money from the longevity pool made available when others die or leave the plan.

The age 65 distributi­on amount serves as a kind of benchmark, but in fact different payout rates apply to different ages. The youngest decumulati­on cohort (born 1954 to 1956 or roughly age 65 to 67) started with the 6.15 per cent annual payout. The oldest decumulati­on cohort (born 1945 to 1947 or roughly age 74 to 76) started with a 7.40 per cent annual distributi­on. You can also invest prior to age 65 in pure accumulati­on mode with distributi­ons to start after you turn 65.

Fees are relatively low compared to what mutual funds typically charge. The fund’s Management Expense Ratio (MER) should end up around 0.73 per cent for the D-series fund (for do-it-yourself investors) and for the F-series fund (for advisers who charge their advisory fees separately). Meanwhile, the A-series MER should be higher at around 1.25 per cent (since it incorporat­es a trailing commission for advisers who do not charge separate fees). That contrasts with typical MERs for convention­al balanced A-series mutual fund portfolios at around two per cent.

The 6.15 per cent target payout at age 65 is net of fees for the D-series and F-series fund versions. But in the case of A-series funds, the payout is reduced to cover the adviser’s trailing commission (so the effective net payout should be in the mid-five-per-cent range).

Do-it-yourself investors can buy the D-series fund at certain online discount brokers, including Questrade, and National Bank Direct Brokerage. While National Bank is the only major bank discount broker to allow access so far, Seif expects others to follow. Still, “we’ve been a little bit frustrated by the slow pickup at the banks.”

While initially the product is being offered to individual investors, it also makes sense as an option with defined contributi­on pension plans, employer group RRSPs, and roboadvise­rs. Seif says Purpose is in talks with other financial providers and expects announceme­nts to follow shortly.

If you are looking for a lowfee fund designed for steady decumulati­on, but longevity pooling doesn’t appeal, then one alternativ­e worth considerin­g is the Vanguard Retirement Income ETF Portfolio (ticker: VRIF).

It comes with a conservati­ve target distributi­on of four per cent annualized and a low MER of 0.32 per cent. It can also generally be redeemed any time you want at close to net asset value.

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 ?? ?? With the demise of defined benefit pensions in the private sector, the number of retirees who can potentiall­y benefit from a product that provides income for life is vast, David Aston writes.
With the demise of defined benefit pensions in the private sector, the number of retirees who can potentiall­y benefit from a product that provides income for life is vast, David Aston writes.

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