Longevity Planning with Alexandra Macqueen | E069
Making sure you don't outlive your nest egg.
In today’s episode, Jason is going to talk to Alexandra MacQueen. She is a well-known financial author and co-conspirator of many different projects. Today Jason and Alexandra are going to zero in on a core issue of retirement for any generation.
Episode Highlights:
1.19: For the last few years, Alexandra has focused on providing quality content; this is the new word that people use now.
1.30: Jason says, basically, the retirement income question or making sure that you do not run out of money when you are retired. This sounds like a simple premise, but frankly it has been called by Bill Sharp, Nobel Prize winner, that is the dirtiest problem in finance.
1.40: We are dealing with a problem that is nothing but variables except for one constant, and that constant is that you need wealth to consume, says Jason.
1.46: The variables are how long you live? what returns look like? what are you going to spend? and how does that expenditure vary? and then on top of that, what is the inflation? do we have to plan for it?
2.28: In the list of variables tax always think about planning for retirement and specifically longevity. The other issue with longevity is that it is what we call multiple; it multiplies all the other risks, says Alexandra.
3.31: Retirement is still a relatively new concept in western society. In the past most people worked until they were decrepit and died. And just to let further proof that, the first state-sponsored pension modern society was the Germans under Otto Von Bismarck, who basically set up pension date of 65 and was later move the 67. The pension was designed to basically pay you money when you were old so that there was no possible way that you could continue to contribute to society and continue to earn income.
4.20: Alexandra explains that when we talk about longevity, we actually lose a billion different number of billions? She says there are several different ways to measure it; there is life expectancy at birth. So, if somebody is born in 2021, they are expected to live well.
5.03 Alexandra says, “One of the things that you need to understand longevity is at what point are you measuring it?” She explains, If I look at life expectancy at age 65, you will notice it is five or six years longer.
7.03 Alexandra says we talk about life expectancy that is 50% probability but let us talk about how we are encouraged to use life expectancy?
08.17: Jason says we look at the impact of the decision if we are wrong. Do you want to die on your deathbed with more money in your account than you spent, or do you want to literally be worried about it prior to burning out on money?
11.35 Jason predicts, if you were not a smoker, your gains and mortality are minuscule. However, if you were a smoker, a large percentage of the population than yours were increased.
12.54: Alexandra says that the numbers in tables are actually quite different from what we call population life tables, which is the life expectancy for the entire population. This includes people in poor health. So, as a rule, people who seek out retirement planning advice are people anticipate living long lives and who are positioned to live long lives they have money they have asked for seeking out advice.
14.09: Jason talks about the various ways we can protect ourselves in longevity. So purely planning for that and preparing for that is important, but there are various tools we have to use for the planning.
14.25: Jason says that the downside to all these longevity gains has been that the timeline that we keep on planning keeps on getting longer and longer which basically means that - You need more and more capital to take care of it.
16.01 Alexandra suggests, “Your working career might only be 30 years. So just as a very basic math problem analysis - How am I saving and meeting my goals during my working life? How am I saving sufficiently to fund another 30 years? Doing nothing is actually fairly cheap compared to what we expect to do.
17.48: There are the old standbys of income annuity when you are transferring the risk to the insurance company in exchange for your one-way lump sum; they promised to repay you for as long as you’re alive.
21.24: The generic advice is delay because it is the cheap guaranteed lifetime source of income. It’s waiting for you when you turn it on, and that is amazing. It is just that it may not apply to the individual well.
24.54: The annuity is actually a solution through a better version. Because what we are talking about for the person align – “I should have taken CPP earlier, I would have had more to spend so they would have had more certainty of income.” That is what actually annuity provides.
27.15: Mortality credits is very simple; you put money in the pool. Alexandra says we can talk about it with PPP for example or any kind of longevity product that doesn’t provide a large debt. She says, If “I die even before taking a single payment. What happens to my money? Well, I only get $2500 out, and the remainder is left, and the sponsors or supporters then withdraw the money by other means through what is called mortality credits.”
30.45 Jason recollects about a product called Guaranteed Minimum Drop Benefit Fund. Those guarantees were so rich they caused some problems for insurance companies. And to this day, I still have clients who have a bunch of those are paying out very high guarantee rates.
32.22 Jason says from a business owner standpoint, and this is very convoluted by the fact that we start throwing in holding companies and other structures into place. Then the tax implications of these products or the number of different ways we can hold these things increase substantially, so there’s a lot of different options there.
34.34: As per Jason, longevity planning is problematic. There are a lot of variables. There is a ton of decisions.
3 Key Points:
If your returns are substandard, but your life is short, then there is a chance that inflation is high. But if you only live a few years in retirement, inflation doesn’t have the chance to eat away at your retirement income or your savings.
During the COVID pandemic, we have seen many newspaper articles about how average life expectancy has decreased. The layman understands what is meant when we say average life expectancy decreases because COVID is called period life expectancy. If the conditions that prevail now in this period continue, then life expectancy will be impacted.
Now Canada Pension Plan (CPP) doesn’t actually formally use mortality credits. That is a kind of insurance. But the underline concept is contributions go in, and not everybody will make it to average longevity, so those who die early their premiums are then spread among the remaining people in the pool, which is what we call mortality process.
Tweetable Quotes:
“Retirement is still a relatively new concept in Western Society.”- Jason
“Life expectancy increases as you age.” - Alexandra
“To say that the changes to mortality are going to stay our state permanent presumes that nothing changes now.” - Jason
“The average information is absolutely useful in informing our decisions, but we all still look at the distribution and where you fall on that on the spectrum of various factors that affect you.” - Jason
“Now the stakes are so much higher when the numbers that big, which is why a lot of people may make the wrong choice when it comes to pension commutations.” - Jason
Resources Mentioned
Facebook – Jason Pereira’s Facebook
LinkedIn – Jason Pereira’s LinkedIn
Woodgate.com – Sponsor
LinkedIn – Jason Pereira’s LinkedIn
Transcript:
Producer: Welcome to the Financial Planning for Canadian Business Owners podcast. You will hear about industry insights with award-winning financial planner and entrepreneur, Jason Pereira. Through the interviews with different experts, with their stories and advice, you will learn how you can navigate the challenges of being an entrepreneur, plan for success and make the most of your business and life.
Producer: And now, your host, Jason Pereira.
Jason Pereira: Hello and welcome. Today on the show, I brought back Alexandra Macqueen. Alexandra is a well-known financial author and a co-conspirator of mine on many different projects. She was on the podcast previously with David Field talking about their book, The Boomers Retire. But specifically, I brought her on the show to zero in on a core issue of retirement for any generation and that's specifically the challenge of longevity. That is a little bit more unique to business owners because of the number of different options we have for how we basically build wealth. But I want to really focus in first and foremost on what is the challenge and why is this so difficult? With that, here's my interview with Alexandra.
Jason Pereira: Alexandra, thanks for taking the time.
Alexandra Macqueen: Thank you.
Jason Pereira: I gave you a brief introduction, but if you'd like to introduce yourself and tell people a little bit more about yourself, that'd be great.
Alexandra Macqueen: Co-conspirator.
Jason Pereira: Co-conspirator.
Alexandra Macqueen: Yeah. The last few years, I've really focused on providing content. I mean, that's this new word that people use now. I [inaudible 00:01:25] writing a lot about financial stuff.
Alexandra Macqueen: There. Your intro was better.
Jason Pereira: There we go. Basically, the retirement income question of making sure that you do not run out of money when you're retired. It sounds like a simple premise, but frankly, it has actually been called by Bill Sharpe, Nobel Prize winner, Bill Sharpe, that is, "the dirtiest problem in all of finance." I like to basically, when people say, "Well, why is this that big of an issue other than the anxiety it causes within me?" I say, "Well, here's the situation. We're dealing with a problem that is nothing but variables, except for one constant. And that constant is that you need wealth to consume, period. But the variables are how long are you going to live? What do returns look like? What are you actually going to spend? And how does that expenditure vary? And then on top of that, what is the inflation that we have to plan for if we can't plan for it at all?"
Jason Pereira: So, it's just a bag full of variables and an inability or an unforgiving environment if you don't get it right, because I always say the most tragic thing in the world to me is someone in their 90s running out of money. That's my framing of the problem. But from your standpoint, how do you view it?
Alexandra Macqueen: Well, don't forget in that list of variables, tax. [crosstalk 00:02:32].
Alexandra Macqueen: I always think about planning for retirement and specifically longevity as is if you're planning to take a trip and you think, "Okay, [inaudible 00:02:39] the car," but you don't know how long the trip is, so how much gas do you need? And the other issue with longevity is that it is what we call multiplicative, which means it multiplies all the other risks. So you listed a bunch of risks, things like inflation, return. All of those things are multiplied. They're made larger in the presence of longevity. So if your returns are substandard, but your life is short, then it doesn't matter. If inflation is high, but you only live a few years in retirement, inflation doesn't have the chance to eat away at your retirement income or your savings. But [inaudible 00:03:14] a long time. And all those other risks are made larger by the fact that you are living a long time. And as you just said, it's a bag of uncertainty.
Jason Pereira: Yep. So, let's talk about how this problem has evolved over time, right? So, we can think back to what retirement meant... And actually, let me just take a step back on this. Retirement is still a relatively new concept in Western society, in that most people worked until they were decrepit and died, quite honestly, back in the day. And just to lend further proof to that, the very first state sponsored pension in modern society was the Germans under Otto von Bismarck, who basically set a pension date of 65 and was later moved to 67, moved around, around 65, 67. But back then, life expectancy was 35 to 38. And the pension was designed to basically pay you money when you were so old that there was no possible way that you could continue to contribute to society and continue to earn income. So, that's a fast forward to today where it's all about freedom at early ages and this concept of enjoying your golden years, which our industry has sold to everybody.
Jason Pereira: Talk to me about the key factors that have changed between Otto's days to now. Alexandra Macqueen: There's so much to say. I mean, you talked about life expectancy under von Bismarck. It was around that 35, 45 year age. So that's life expectancy at birth. So, when we talk about longevity, what do we actually mean?There's several different ways to measure it. So there's life expectancy at birth. So if somebody is born in 2021, they're expected to live. Well, they haven't lived any of those years yet, so it's obviously a projection, but life expectancy increases as you age. So even under an 1880s Germany, if people lived to age 45, it's not as though everybody died at 45. Some people lived beyond that. If they did, then they have lived into a very advanced old age. And it was at that very advanced old age that von Bismarck said they would be eligible for a pension.
Alexandra Macqueen: So one of the things that you need to understand about longevity is at what point are you measuring it? Because if I look at life expectancy at birth today, it's around that 84, 85 year mark [inaudible 00:05:14] but if I look at... It's lower, it's around 81. That's the whole point. If I look at life expectancy at age 65, you'll notice it's five or six years longer. So, what happened? How did I grow five or six extra years? It's because the population on which that's being measured, all the people that died early are now out of the pool, and it's just like survivor bias in our mutual [inaudible 00:05:37]
Jason Pereira: Exactly. It's funny because... I like to basically say it's kind of like... Life expectancy is a 50% probability, right? So odds are half the population will die before that, odds are half will die after that, even though someone wants to pay to be on this, which I thought was hilarious, but it's a measure of your current age, like what you're expecting. And I always liken it to the mechanical rabbit at the dog track in that you don't really ever catch life expectancy. Because if you manage to be like, okay, great. My life expectancy was 81 at birth. I'm at 81. It ain't like you're dropping dead there. Your life expectancy is now 87. So short of you being on your deathbed and you're about to die, where your probability of life expectancy drops to literally zero minutes, that's always a number in the distance, not in front of you.
Alexandra Macqueen: Well, here's another analogy that may resonate for some of your audience. It certainly did for me. I have two kids. And of course when you're pregnant, you have a due date, but that due date is just the same thing. It's a median expectation of how long the pregnancy will last. So, there's actually a huge variability around due dates for humans and how you know that is that once upon a time, Sears... That's another whole conversation, but once upon a time, [inaudible 00:06:41] set up a baby registry at Sears, and if you actually had the baby on the day it was due, everything on your registry was free. And why did they do that? Chance of actually having the baby on the duty was very low. So I know that median life expectancy for me is whatever age, but the chance that I'm going to die at that age is low. There's a huge dispersion or a very wide dispersion around that median.
Alexandra Macqueen: So we talk about life expectancy as that 50% probability, but let's talk about how [inaudible 00:07:08] to use life expectancy. So, you and I are both certified financial planners, and if you look at the projection of guidelines that FP Canada publishes, together with their sister organization in Quebec at the Institut québécois de planification financière.
Jason Pereira: You have better odds are getting it than I did, so you go ahead.
Alexandra Macqueen: They released projection assumption guidelines that certified financial planner [inaudible 00:07:30] are encouraged, directed to you. And one of those guidelines is about how long should you plan for your clients to live? So you look at that and you are encouraged to plan for not that 50th percentile because it's too risky. You're encouraged to plan for the 25th or even for a conservative client, the 10th percentile.
Alexandra Macqueen: Average longevity might be 81, but if I start looking at the 10% probability from the age of 65, now I'm well into the 90s. So I'm planning for 10, 15, maybe more years of income. And that's a very material difference when I'm planning how much I can take out of this.
Jason Pereira: Yep. I mean, I once had a client debate me on why is it I was going that far because life expectancy was X? And the end of the day, it's again, when you look at the impact of the decision of [inaudible 00:08:19] wrong, right? So do you want to die on your death bed with more money in your account than you spent? Or do you want to literally be worried about it prior to? Oh, you're running out of money prior to. And as I said before, and someone wants debated me and I thought this was hilarious, no one ever said to themselves, "Oh, my God. I haven't spent it all. Quick, hand me my laptop so I can order a bunch of crap on Amazon." Right? No one has ever done that. Has ever said, just out of spite, "I'll spend it all." Right? So, when people tell me they want to bounce their last check, my old joke is it better be the thing that killed you, because otherwise I can't possibly guarantee that.
Alexandra Macqueen: No, [inaudible 00:08:53] knowing that you're not going to run out of money. It's not about actually running out or bouncing the last check. It's being able to live out your retirement years knowing, or with some level of certainty that you are not going to run out of money and you're not going to be forced to reduce your standard of living. So we treat this like a math problem, but it's really a behavioral psychological problem as much as it is anything else.
Jason Pereira: [crosstalk 00:09:14] It's interesting you mention that, because there's a number of issues we're going to touch upon that are behavioral and psychological that have to do with regret aversion and any number of things that lead us to the wrong conclusions, unfortunately.
Alexandra Macqueen: So you said that... a client might say to you, "Why are you using 95?" Or, "Why are [inaudible 00:09:28] number as the life expectancy to give me? That's not what life expectancy is." So, it goes back to what I said about what are you looking at when you're saying this is life expectancy?
Alexandra Macqueen: So, during the COVID pandemic, we have seen newspaper articles or media articles about how average life expectancy has decreased. So it's important... And I don't know that people would understand, like a lay person, which I am... but a lay person understand what is meant when we say average life expectancy has decreased because of COVID? That is what's called a period life expectancy, which is if the conditions that prevail now in this period continue, then life expectancy will be impacted, but we are not in fact expecting COVID to continue killing people at the rate... That sounds so morbid, probably appropriate for this podcast. But we are expecting that the deaths from COVID will trend down. We have a vaccine. So we are not expecting that the tremendous mortality increases because of the pandemic will continue. But I don't know that you would understand that by seeing a headline or glancing at... So people come into these conversations with very different ideas and they're supported or not supported by all the different things they're reading.
Jason Pereira: Well, that's the thing, right? So just to say that the changes to mortality are going to stay permanent presumes that nothing changes now.
Alexandra Macqueen: Another one that people look at is the opioid crisis. It does decrease life expectancy, absolutely, as a population, but it does not affect my longevity. So if I'm not an opioid user, I am not actually impacted personally, for my own personal life. So even though life expectancy might be declining around me, that's kind of an economic problem. Obviously, it's a social problem, but it doesn't mean that I can suddenly, "Oh, look, average life expectancy decreased by 15 months because of the opioid crisis or because of COVID, I can knock 15 months of income off my income plan."
Jason Pereira: Well, I mean, consider the gains in mortality from the decline in smoking over the last 20 years, right? If you were a non-smoker, your gains in mortality were minuscule. However, if you were a smoker, which was a large percentage of the population, then yours were increased. And if you were born in that period, where smoking was less socially acceptable and therefore, you were likely to remain a non smoker your entire life, those gains... Let's say you were 50/50 odds that you were going to smoke or not. Those gains now become static. It becomes a gain, for sure.
Jason Pereira: Again, this is all statistics, right? So, it's the old... I hate to quote Twain on this one, "There's lies, damned lies, and statistics," but the reality is no one's an average. And I keep saying this all the time. No one's an average. Now, the average information is absolutely useful in informing our decisions, but we all still look at the distribution and where you fall on the spectrum of various factors that affect you.
Jason Pereira: I mean, for example, as planners, if we have someone who's got a family history of advanced cancer killing them all off by a certain age, and this person's already had three forms of it and barely survived, I'm not going to plan for 110. The odds of that happening are pretty weak.
Alexandra Macqueen: Well, let's go back to that idea of who are we looking at when we're talking about longevity? So I mentioned those projection assumption guidelines. Those are actually for what we think of as healthy retirees, so if you look at the population life tables, those are the tables of data that are used to make the projection... If you look at the tables that are used by FP Canada and the IQPF, it is for pensioner. So those are people who have already lived to retirement and they are presumably healthy because they're continuing to be alive. And so what that means is that the numbers in those tables are actually quite different from what we call population life tables, which is the life expectancy for the entire population, which includes people in poor health.
Alexandra Macqueen: So, as a rule, people who seek out retirement planning advice are people who anticipate living long lives and who are positioned to live long lives. They have money, they have assets, they're seeking out advice. So, the [inaudible 00:13:18] cohort of people is actually substantially different.
Alexandra Macqueen: Already, I've talked about a couple of different things, the difference between period and cohort of life expectancy, the [inaudible 00:13:28] population life expectancy, and the healthy retiree group. So I'm one individual and I'm looking at this data that's from Canadian school or a subset of Canadian [inaudible 00:13:38], how do I locate... We haven't even talked about the differences in gender, as well.
Jason Pereira: Yeah. There's the old phenomenon that women live longer than men. However, the flip side is men are less likely to claim disability as an issue. However, I like to say that I can explain that entire phenomenon anecdotally in that men are just too stubborn to get something treated and it'll kill them. Whereas women are more likely to actually go get treated when they have a problem. No doctor's ever refuted that assumption.
Jason Pereira: Okay. So, we've identified the problem. We can go into depth about the problem, but let's talk about how things have changed. The various ways we can protect ourselves in longevity, right? So, purely planning for that and preparing for that is important, but there's various tools we have. And the first one... Now, I'm just going to go back quickly to my previous comment on Otto von Bismarck. The downside to all of these longevity gains has been that the timeline that we keep on planning for keeps on getting longer and longer and longer and longer, which basically means that you need more and more capital to take care of it.
Jason Pereira: And actually, I'm going to take a sidetrack here. Part of the problem is the fact that we have as a society anchored on 65 as a retirement age. And somehow, if you go beyond that, maybe you're a failure, right? Or if you do it earlier, you're a success. When in actuality, 65 was picked because of decrepity back in the day. And frankly, if you had adjusted the retirement age in Germany for longevity gains, retirement age would now be 95 in Germany. So, that's the level of decrepity we're talking about in ability to work. The reality is, is that, again, this newer concept of retirement is one that's actually costing us a lot. It's costing us a lot because if you do look at the world as 65 is when I'm done, potentially 30 plus years is a long time to do nothing and is a long time to have to fund your lifestyle.
Jason Pereira: So, let's talk about the different methodologies for how... We got the government pensions, which are a great cornerstone to a good retirement, because that becomes the kind of basic level of income that's indexed to inflation and pretty much guaranteed by whatever government, depending on how dependable the government. The reality is, is that those are cornerstone, but where are you seeing a move around the world to change the retirement age from 65 to later? The US has moved the normal retirement age back to 67. Canada, we tried to do that with [inaudible 00:15:47], but then there was an election. And then that got reversed, even though it was bad policy, in my opinion. But I think if anything, I think in the future, we can count on those government pensions to start to see those numbers start to push a little bit older, which puts more of an onus on us.
Alexandra Macqueen: Well, back to what you said before, 30 [inaudible 00:16:03] retirement. I mean, your working career might only be 30 years. So, as a very basic math problem, how am I saving and meeting my goals during my working life? How am I saving sufficiently to fund another 30 years? I think it's also key that you said we're not designed to do 30 years of nothing. Is retirement nothing? ...Doing nothing is actually fairly cheap compared to what we expect to do. Maybe not so much [crosstalk 00:16:26], but whatever it is that people are doing in retirement, life doesn't stop even though you've withdrawn from the workforce.
Alexandra Macqueen: But your question was about how do we solve? Government pensions are guaranteed lifetime income, and we are essentially required to participate in those, whether it's CPP... or if we get OAS by virtue of the fact that we've lived in Canada and contributed to the economy and to society. But if I want guaranteed lifetime income from any other source, I have to pay for it because guarantees are expensive. So I'm transferring the risk away from me.
Alexandra Macqueen: It's just people in general have a challenging time understanding two things. First is why is it so expensive? And the second thing is comparing the income from... what it takes to produce lifetime retirement income, like the amount of money. So, with pension commutations that we've talked about, somebody says, "Oh, look at that. My pension is worth a million dollars, but it only pays me 2000 bucks a month or $2,500 a month. How can that be?" Because one figure looks so small compared to that lump sum value. The amount of money that it takes to generate secure retirement income over an expected retirement of 30 or 35 years is a big number. [crosstalk 00:17:41] Either you fund that yourself or you can share the risks with others.
Alexandra Macqueen: So, as you know, there's innovative products coming out in the marketplace. I mean, there's the old standby of income annuity, where you're transferring the risk to the insurance company in exchange for your one way lump sum. They promise to repay you for as long as you're alive. All you have to do to receive the money is breathe.
Jason Pereira: So here we come up to what's known as the annuity puzzle, which is everybody loves pensions, but annuity sales are pathetic, quite honestly. There's definitely incentives around the industry not pushing them because you can manage assets at 1% or you can get 3% for one sale, right? There's that, but the bigger issue comes down to consumers just actually have a really hard time pulling the trigger.
Jason Pereira: Think of that million dollar example you had with the pension. That is the biggest purchasing decision outside of a house in GTA. I'm making fun of properties. But for most people, that pension decision may be the single biggest financial decision they've ever made in their lives with some of the biggest repercussions they've ever had. And the reality is... That's the pension saying, "stay and we give you income, or take this." Now flip that around. "You've saved a million dollars and we can give you X amount per month." I have never encountered anything but resistance to that recommendation. But it's hilarious, if you ask people: if I could get you to join the teacher's pension plan, the Ontario teacher's pension plan tomorrow, would you do it?" They're like, "Oh, God, I'd love to." And it's like, but kind of giving you that opportunity now, you just don't want to take it.
Alexandra Macqueen: But you can see the framing around [inaudible 00:19:08], it's very different. So the pension, I've purchased it over a long period of time. It was contingent with my workforce participation. My employer kicked in and planned. I didn't participate at all. The employer paid it all and then I get this benefit when I retire. Versus I saved all by myself, nobody helped me and now I have to give it all away. So I just feel like even though structurally, the income coming into my account is very similar, it's very, very different. You make it wrong decision- [crosstalk 00:19:37]
Jason Pereira: Well, we'll call it regretter version, right? At the end of the day, you're changing one large purchase decision for a lifetime of tiny purchase decisions, so that it's far more easy to live with than it is basically, because now the stakes are so much higher when the number is not big, which is why a lot of people may make the wrong choice when it comes to pension commutations.
Alexandra Macqueen: But if we just look at, what is the goal? So if I say, okay, I've got my CPP, I've got my OAS, and I'd like a little more. And I'd like it to be guaranteed so that I have a certain amount [inaudible 00:20:10] and I don't have to worry about spending. So I could buy a moderate annuity. So now I don't feel like that kind of moderate choice gets impressed, but it's kind of discussed as an all- [crosstalk 00:20:22].
Jason Pereira: Or none.
Alexandra Macqueen: ...and all at once decision because you could just... You could dollar cost average [inaudible 00:20:28] investments. You could dollar cost average into annuities over time, and I'm probably the first person to say that, but annuity versus take your chances in the stock market is really always framed as an either/or decision as opposed to a mix. It could be both.
Jason Pereira: Absolutely. It absolutely could be. It reduces that regret aversion.
Jason Pereira: I think part of the big scary problem is that unless you're looking at a refund annuity, which changes the rates, so you're paying for that refund privilege, you could have buyer's remorse there in that, oh, I just gave this up and it's irreversible. That's part of the entire issue is I think people are just really averse to... They're afraid of regret aversion, essentially. And actually, that leads to another kind of regret aversion. We discussed this beforehand. It also leads people to make the wrong decision around their candidate pension plan deferral, or sometimes their Old Age Security deferral. Care to speak to how we see people basically make the wrong choice there?
Alexandra Macqueen: Well, certainly the ice has been tipping toward defer as long as you can. But personally, I think it's important to recognize that that is generic advice suitable for a population. It may not be suitable for you. There's many circumstances, actually, especially for business owners, where you may want to take it early or on schedule or sometime before 70, the maximum possible deferral, because it has to do with the mix of the other sources of income. So you minimize taxable income as opposed to taking it all at 70, I guess my main comment is that the generic... I don't mean generic as any kind of [inaudible 00:21:58], it's just meant to describe the whole population. The generic advice is delay because it's a cheap, guaranteed lifetime source of income. You don't have to buy. It's waiting for you when you turn it on. And that's amazing, good advice. It's just that it may not apply to individuals.
Jason Pereira: Well, I'll go back to the entire: no one's an average. Averages came out of, believe it or not, US military studies on size. And I was just listening to a podcast where they talked about how early in World War 2, the number of crashes were through the roof. And then when they did a study on how many people actually fit the average cockpit size, because the average was designed for the average, not a single pilot in the military was the average. And therefore, the cockpit was designed for no one. So once they redesigned the cockpit to be flexible and to adapt to whoever was in the seat, suddenly the crash statistics just felt like a rock, right?
Jason Pereira: And that's the same principle around, hey, on average, maybe you should think of deferring. However, that highly depends on every other factor going into your financial plan. I had a client the other day where the previous recommendation was to do it earlier, and then we pushed it back. It said recommendation 10 years later and the reaction was, well, why? Well, here's a bunch of the variables that changed that resulted in a different answer. And I think they were a little annoyed because they were looking for a universal, but it's like, there's no universal. It's what fits you best.
Alexandra Macqueen: But really, with longevity, that is the crux of the issue that we're taking a universal idea, "How long do people live?" And trying to take that generalization to get some sort of individual answer. How long will I live? I don't know. There's my genetics, my gender, my habits. I don't know, my attitude. All that stuff plays into how long I individually will live, and I have to plan for myself as an individual and be guided both as [crosstalk 00:23:42] and find out that point.
Jason Pereira: Anecdotally, in my experience, I always feel like I typically find people... Unless they have family members who have lived into their nineties, no one seems to think that they're going to be the person that lives into their nineties. Right? For whatever reason, that seems to be what I've seen in my experience. However, as they get older, they start to think it's more possible. But it's funny, because that leads to, like we said, regret aversion issues like deciding whether to take CPP or Old Age Security. It's like, well, okay, that's nice, but what happens if I die before 70, right? I'm going to get nothing.
Alexandra Macqueen: Yeah. I know. But you will actually be dead and you won't care.
Jason Pereira: Exactly. This is the thing is that, "Oh, no, I'd be really, really angry." No, you wouldn't. On your death bed, you would not be thinking about the fact that you did not take Canada pension plan early and profit from it. That's not how it's going to work. Quite honestly, a lot of these products that have returner premiums embedded in them, they're designed to minimize your regret aversion. However, they come at a cost and largely, they're irrelevant. I'll pick on critical illness ROP. In most cases, it's like, "Oh, you didn't get critically ill and you're 80 years old and you die. And oh no, you just paid for something that you got nothing out of." Yeah, well, if your house doesn't catch fire, be happy about that. It was cheaper to have insurance that didn't refund your premium.
Alexandra Macqueen: Paradoxically, though, the annuity is actually a solution to regret aversion, because what we're talking about for [inaudible 00:24:59], "I should have taken CPP earlier. I would've had more to spend." So they would have had more certainty of income. That's what actually an annuity provides, you know how much you can spend. I said this on Twitter the other day, but we always decry the gig economy. People have this uncertainty of income and I think... that uncertainty of income becomes acceptable in retirement. Who wants a gig economy retirement?
Jason Pereira: Exactly. That's unfortunately what we're dealing with.
Jason Pereira: Now, you mentioned earlier some innovative products that are coming onto the market. And of course, for anyone listening in Canada, you're probably are seeing most of our comments on social media. We're talking about the tontine. Care to explain that concept?
Alexandra Macqueen: Well, yes, tontine. It's funny because until it started re-emerging in the financial world, people will have heard about it from [inaudible 00:25:40] and old films. Tontine is just
Jason Pereira: Or The Simpsons. There was a Simpsons episode where Grandpa Simpson was in a tontine to... The last man surviving got all the Nazi stolen art. It's kind of an extreme tontine, but...
Alexandra Macqueen: But that is the essence of the tontine, is the group. The reward, the money is being shared in a group and it is shared among survivors. So, as people are removed from the group through other means, depending on the tontine, then the proceeds are shared among a smaller and smaller group. So in the modern [inaudible 00:26:15], a tontine is a way to provide guaranteed lifetime income without the intermediary of an insurance company. So, insurance companies provide the back, the only companies in Canada that can do this, that can provide a lifetime guarantee, that's the insurance component. But the tontine is able to do that because they're not providing insurance, they're just... The way that the product is structured, there are participants in the pool and they either are in the pool and surviving or out of the pool, so you don't have to give any money to them.
Jason Pereira: Yeah. So, it's basically like an annuity where essentially, you give money to an insurance company and they give you a guaranteed income stream for life, but they take all the risks. In this consideration, the people in the pool are the insurance company. There's no guarantees. They share the risk themselves. So there's no guarantees on the income, the income is going to be income divided by whoever's left over, but one of the things that this does, and a term people are not familiar with, is the concept of mortality credits. Can you explain that concept?
Alexandra Macqueen: Okay. So, mortality credits is very simply, "put money in the pool." So we can talk about it with CPP, for example, or any kind of longevity product that doesn't provide a large debt on death. CPP is a classic example: I pay in during my lifetime, I die. Maybe I die even before taking a single payment. What happens to my money? Well, I only get $2,500 out of my survivor's do as a death benefit and the remainder is left in the plan and it actually sponsors or supports the withdrawals by other, through what is called mortality credits.
Alexandra Macqueen: Now, CPP, doesn't actually formally use mortality credits. That's kind of an insurance, but the underlying concept is: contributions go in and then if people die early, and that's the essence of... I've said "essence" [inaudible 00:27:58] times in this podcast so far, but that is the crux of longevity. Not everybody will make it to average longevity. So, those people who do die early, their premiums or their [inaudible 00:28:07] are then spread among the remaining people in the pool. And that's what we call mortality credits.
Jason Pereira: And this leads many to say, "Well, that's not fair. I'm losing my return," or whatever else it is. And you know what? I say, again, would you like to be a member of a pension plan? Because if you'd like to be a member of a defined benefit pension plan, that's exactly how defined benefit pension plans work. Right? It's the old cop show or movie where the guy's like, "Oh, I'm about to retire. Can't get shot because I must protect my pension." Right? The reality is, yeah, unfortunately... The probability of a cop dying the day after he basically starts his pension is pretty slim, but it does happen. And in that case, it's the mortality credit to everybody else.
Jason Pereira: At the end of the day, no one likes to lose that bet. But really you're not entering in that bet because you're so afraid of losing it. You're entering that bet because the cost of winning that bet if you're not in... Of basically having the event where the bet would pay off is so enormous that you're going to benefit from it. It's like life insurance, right? You don't want to lose the bet on life insurance. But the reality is that, especially from a protection standpoint with your family, if you don't have it, the repercussions for your family are pretty substantial, right? So, it's like any other form of insurance, but in this case, without insurance.
Alexandra Macqueen: And you can tell what the benefit of mortality credits is if you simply look at what a GIC pay. So GIC has a [inaudible 00:29:27] to an income annuity in terms of the guarantee for the income, but it pays just a tiny fraction of what an annuity purchase, particularly as you age, [inaudible 00:29:35] of course, increase as you age. So buying an annuity at age 80 will pay more than at age 70. And if ... I want guaranteed income, okay, I'm going to put it in a GIC. Have you looked at GIC rates lately? Compare that to an annuity, right? It might pay four or five... And why can it do that? It's because mortality credits.
Jason Pereira: I mean, the other issue there with the GIC concept is several people or many people treating the principles of if it sacred. They want to live off the income because... And all they're really saying is that I'm trying to create a sense of security around the entire thing. When an actuality, frankly, if you really want to leave something behind, you buy life insurance. It's cheaper. But the reality is that, especially at current rates, you're going to eat into your principle. Unless your net worth is so substantial that a 1% annual yield on your GICs is more than sufficient enough to pay all your after tax expenses, then guess what? You're eating into your principle.
Alexandra Macqueen: No, but you've made the point. The GIC is for [inaudible 00:30:32]. If you want income, and you weren't guaranteed, now you have a limited selection of products to choose from and the annuity should be in that group that you're looking at.
Jason Pereira: Absolutely.
Alexandra Macqueen: I mean, what else is there that has a guarantee?
Jason Pereira: Well, I mean, we used to have a product called the Guaranteed Minimum Withdrawal Benefit, which we both wrote about extensively back in the day, but those guarantees were so rich, they caused some problems for insurance companies. And to this day, I still have clients who have a bunch of those that are paying out very high guarantee rates.
Jason Pereira: So, really what we're talking about is it's kind of a spectrum. On one end of the spectrum, you have just normal investing, which comes with no guarantees on how long it's going to last as you consume it, because at end of other day, you're going to be drawing down on it. So no guarantees, a hundred percent market risk. On the other end of the spectrum, you have the annuity, which basically is a zero risk essential... Potentially zero risk. We'll talk about insurer risk if we need to, but we have basically, okay, I've created certainty around income stream now and someone else is taking that risk on for me. Of course, they are charging. I can get into that later, but point is: there it is.
Jason Pereira: And then you have this middle one now, which is the tontine, which says, "Hey, you can take on the risk the insurance company was taking on, but still benefit from mortality credits," and it gives you basically not a guaranteed income stream, but an income stream where you do benefit from the mortality credit that an insurance company was going to give you by way of the annuity. So, when you factor in the fact that insurance companies got their profit margins, that's now stripped out of it.
Jason Pereira: And the other piece is... I remember... I'm not sure if you were there, it was [inaudible 00:31:57] conference, believe it was Don Ezra who talked about a study of the US that showed that the average expected rate of return on an annuity was about 97 cents on the dollar for the average person, right? And again, the insurance company is... taking a price for essentially guaranteeing you and immunizing you against any running out of money. Whereas now, that risk and that profitability is all back in the pool.
Alexandra Macqueen: Well, let's talk about when you say that the tontine is not guaranteed, I want to just dig in a bit. So when we buy an annuity, when you buy an annuity, the amount is guaranteed. So, you can buy all kinds of different writers, cost of living writers, guarantees and so on, but I buy the annuity. Whatever the agreement is, that money is coming into my account every month, as long as I'm alive and breathing and then potentially as long as the survivors. With a tontine, we say that it's not guaranteed, but that doesn't mean that no income is coming out. It just means that the amount is uncertain
Jason Pereira: Right, yeah, because at the end of the day, [crosstalk 00:32:50] it's percentage of the pool.
Alexandra Macqueen: Correct. So it's not as though there's nothing coming out. It's just that the amount is unknown because there is no guarantee. It doesn't operate in the same way.
Jason Pereira: But every year, it pays out to a smaller and smaller proportion of people because of mortality.
Alexandra Macqueen: So you look at that and say, "Ah, it works." That's different from an insurance company paying the guarantee no matter what, but it doesn't mean that there's... It's riskier, right? It's not the same as an annuity, but... from an income point of view, it doesn't mean that it's an unsuitable product.
Jason Pereira: And going back to the premise of the podcast, from a business owner's standpoint, this is very convoluted by the fact that when we start throwing in holding companies and other structures into place, then the tax implications of these products or the number of different ways we can hold these things increases substantially. So, there's a lot of different options there.
Jason Pereira: I mean, the reality is, and we've talked about this now too, the tontine's so new, we don't have a framework for it, but ideally, someone's going to solve this with a math equation as to what is the combination of the three types of products? And given the current levels of return and the specifics of the clients that basically give us the highest probability of never running out of money. And that's going to be an interesting
Alexandra Macqueen: [crosstalk 00:34:03] An efficient tontine frontier?
Jason Pereira: An efficient tontine frontier or similar to [inaudible 00:34:09] previous work on the RSQ score.
Jason Pereira: Let me plug in the variables in a calculator or financial planning software, and I want the Monte Carlo score to now be 99, 95%, whatever it is, what combination of these three types of guarantee or longevity products is going to basically result in me having that score? That's what I need to know. So, it's still early.
Jason Pereira: Overall, I think if I'm going to sum up the message of this, is that longevity planning is problematic. There's a lot of variables. There's a ton of decisions. Everything from pension start dates to the mix of products you have, nevermind... We didn't even talk about asset allocation as well. And we didn't really cover the... Actually, before we do, let's cover this: retirement risk zone. Let's talk about what that is, because that is a very important concept.
Alexandra Macqueen: Right. Well, again, in a nutshell... You think okay, I need to do my retirement income starting at the age of 65 or 67 or whatever the data is that I've chosen. So what do you need to do before that? You may think, "Oh, my investments [inaudible 00:35:08] of how they are," if you are heavily invested in equities and we go through a 2008, then you may have a material difference in your sustainable retirement plan over the longterm because you're starting to withdraw when markets are down. So if you experience a big loss, 30%, 40%, and you start [inaudible 00:35:25] IE you retire, then the sustainability of those withdrawal is diminished. So what you need to do is start to think about yourself as preparing for retirement, but when you're in that retirement risk zone, which is probably five years before retirement starts... Five years before and five years after. A 10 year window.
Jason Pereira: Yeah, I've seen a 10 year to 20 year frame done as to when this is. And the reason why those years are so much more sensitive is because, well, I mean, you're in the last five to 10 years before you actually make the decision to turn off the income tab from working. And in that first five to 10 years of retirement, that is your longest period... That is the front end of the wedge in terms of how much time you have to do it, right? So 10 years down the road, 10 years in retirement, your timeline has now shrunk. Your timeline has now shrunk. So therefore, the nest egg only has to provide income for a shorter period of time. And therefore, is not as, believe it or not, sensitive to market shocks where a big market shock early on, simple principle, you're down 30%, need to draw out four or 5% to sustain yourself. Now you're down 34, 35%, which makes the recovery even harder.
Jason Pereira: So, there's any number of tactics for how to deal with that beyond the scope of this conversation. But the point is, and the reason I bring that up is, this is a topic that anyone who is in that five to 10 year zone of before they're thinking about retiring or anyone who was in that 10 years after retirement needs to be very aware of and needs to be very concerned with. And I think the never-ending bull market we've had in the last 10 plus years as lulled a lot of people as to the risk of that. But it could vary... If you were tired with just enough last week, based on where all the inflated values are around... This is a very dangerous place to be, quite honestly.
Alexandra Macqueen: Well, I think that what you said earlier is that eventually, we'll have a math problem. You'll bring out your financial calculator and press a button and it'll say, "Okay, this is the optimal allocation between all these different products to give you the optimal retirement for your service." So there's the math problem side of it, but then there's the psychology and behavior part of it. So even if I had the perfect math answer today, I don't know that that would solve half the problem, because the other half is having people be satisfied with the number that comes out of the calculator. And that's a planning function. That's the function of financial planning, which is all about you as an individual.
Jason Pereira: Absolutely Perfect. So, before we wrap up, where can people find you, Alexandra?
Alexandra Macqueen: Oh, the place I hang out the most probably is Twitter.
Jason Pereira: You and I both.
Alexandra Macqueen: Yeah. I've been on Twitter for a long time. I don't know. Maybe Twitter names are harder to get, but I am moneygal on Twitter. That is the place to find me.
Jason Pereira: Excellent. Alexandra, thank you so much for engaging this conversation.
Alexandra Macqueen: Thank you, Jason.
Jason Pereira: So that was my interview with Alexandra Macqueen on the concept of longevity planning. As you can hear, there's no real definitive answer around this because frankly, every situation is unique. And as I said earlier, when you're a business owner, all the different things we talked about just kind of compound and become even more difficult because the number of possible positives to draw from and the implications of each of those increases as well. So, bottom line is get help. As we always say on this podcast, is that don't take this lightly. Nothing breaks my heart more than talking to families whose seniors in their eighties and nineties are running out of money. So, don't let yourself be one of those.
Jason Pereira: As always, if you enjoyed this podcast, please review on Apple podcast, Stitcher, Spotify, or wherever's at your podcasts. And until next time, take care.
Producer: This podcast was brought to you by Woodgate Financial, an award-winning financial planning firm, catering to high net worth individuals, business owners, and their families. To learn more, go to woodgate.com. You can subscribe to this podcast on Apple podcasts, Stitcher, Google Play, and Spotify, or find more episodes @jasonperreira.ca. You can even ask Siri, Alexa or Google Home to subscribe for you.