The economics of retirement

Extreme market volatility and declining portfolio values — trends that are most on the minds of financial advisors and their clients this year — point to the conclusion that 2008 has been a bad year for retirement economics.

If volatility and portfolio values were the only criteria consider, this conclusion would be a slam dunk — difficult markets and uncertainty have raised some serious issues for those already in retirement or those actively planning for it. I suggest, though, that some positives have also emerged.

After the year we’ve had, many readers might be asking if there could possibly be enough good news to offset the bad? Let me list some things that have happened in 2008 and let you be the judge:

1. It is possible to deal with the worst-case credit market/economic scenario.

It may be too early to reach this conclusion, since credit markets are not yet back to full and normal function. The first reports of economic slowdown and recession are only just coming in, and markets remain volatile.

That said, it does seem apparent that a combination of factors — alert and innovative central banks, massive national government responses and unprecedented international dialogue and co-operation — are slowly moving us away from an enormously serious financial and economic crisis, toward better, more normal times.

Some analysts have raised questions about whether we are facing a depression similar to the one North America faced in the 1930s, or a prolonged period of deflation such as Japan faced in the 1990s. I have learned through experience never to say “never,” but I can point to a number of differences that lead me to believe we won’t be facing either of those scenarios.

This time it appears that central banks have avoided the mistakes that were at the root of both these periods of severe economic difficulty. This time around, unprecedented co-operation and discussion, timely economic stimulus packages, policy co-ordination and pledges to avoid any protectionist measures (a root cause of the 1930s era depression), are all cause for optimism.

Understanding why problems happened and re-regulating the financial industries in many countries to prevent it from happening again, will be a major challenge. But to have dealt with what could be described as the most serious economic and financial crisis in an admittedly still young global economy is a serious accomplishment.

2. The unveiling of Tax-Free Savings Accounts (TFSAs)

Any time a government encourages our clients to avoid paying tax must be viewed positively. When a government rewards personal saving and investing by allowing savers and investors to carry on without paying tax on the investment earnings, that is even better. TSFAs are an enormously useful addition to the retirement savings toolkit. They will also be an important tool for younger investors.

Despite the current uncertainty about government and government policies in Ottawa, TSFAs are on the nation’s law books, waiting only for the start of 2009 to be activated. Government-sponsored opportunities to bring additional client assets into the fold are welcome any time.

3. A federal government commitment to pension policy reform

I am the first to admit that the federal government commitment to pension policy reform, contained in its Economic and Fiscal Update released on November 27, was spurred by the reality of a funding crisis caused by market turmoil. The broader issues around the reform of defined benefit (especially) and defined contribution plans — valuation methods, ownership of surpluses, plan sponsor contribution limits, to name a few — have been around for some time, though. If a funding crisis is what it takes to spur some serious public policy responses to some serious pension policy issues, let’s take the good with the bad and run with it.

4. New and revised thinking around pension policy

The federal government wasn’t the only contributor to fresh thinking about the role of pension funds in the economics of retirement. Keith Ambachtsheer brought interesting and useful ideas to play in his C.D. Howe Institute paper on supplementary pension plans. Whether you agree with his proposals or not, whether you think it would have a significant effect on your business or not, the proposals added significantly to the discussion of public pension policy — a discussion that may be stimulated by this year’s market volatility.

Late this year, the pension commissions in Ontario and Alberta-British Columbia presented their findings on pension reform. No one knows which, or how many of these proposals will become policy, but at least they are in the public domain, ready for reaction and discussion.

5. Life lessons about the economics of retirement

Books could (and will) be written about the credit crisis and its causes and effects. One effect, close to financial advisors and their clients, was a difficult dose of reality about the economics of retirement. We now have a different perspective of much of what we previously took for granted, such as assumptions about expected investment returns, and where and how much risk existed in client portfolios.

It would have been a more pleasant year if we hadn’t been forced to make such changes, but we were. Hopefully the industry and our clients now have a better grasp of the chilling reality that can exist in credit and investment markets. And hopefully these events have driven home the point that planning for retirement is an absolute necessity. Put another way, it is difficult to change course if you have no idea what course you’ve been on.

Finally, let me try putting the past year in context: Retirement and retirement planning will continue to exist long after this year’s crises are but a memory. Retirement is going to happen to some people each year, no matter what happens in financial markets and the world’s economies. However difficult the year has been, we still have a continued responsibility to our clients to provide the best retirement planning advice we can.

Peter Drake is vice-president, retirement & economic research, for Fidelity Investments Canada. With over 35 years of experience as an economist, he leads Fidelity’s research efforts in examining retirement in Canada today.