By Randy McCord and Maria Lizak
Canadians are living longer and are in danger of outliving their retirement savings
Longevity risk, the risk that clients will outlive their money, is one of the most important concerns for advisors. The fact is, Canadians are living longer. According to Statistics Canada, individuals who were born between 2007 and 2009 are expected to live, on average, to age 81 (age 79 for men and age 83 for women). This number has increased consistently over the last century and is not expected to abate as medical advances prolong life. Funding retirement 50 years ago meant having a viable income for five to ten years; not such a daunting task for an Advisor. Today, the income may need to last fifteen to twenty-five years, or more, for retirees who take an early leave.
In addition, today’s low interest rate environment has more and more retirees wondering how to create sufficient lifestyle income for themselves. In a recent National Post article published in January 2015, Jonathan Chevreau points out that low interest rates create financial repression and may push advisors to place retiree’s investments at higher risk in order to achieve their target income.
The unprecedented low interest rate environment in today's economy has made the ‘safe haven’ of traditional income investments unattractive to investors, particularly retirees. It also creates a quandary for Advisors who are used to shifting investments to safer portfolios as their client approaches retirement. As Chevreau’s article outlines, the old rule of thumb was that the portfolio should have a proportion of income investments equal to the client's age. Today, that percentage simply will not provide a sustainable income in retirement. While balanced funds and pension funds have traditionally looked to a mix of 60% stocks and 40% bonds/cash advisors may be tempted to push the mix to 70%/30%.
So how can an Advisor produce sufficient income for their clients while protecting their capital?
Clients working with an Exempt Market Dealing Representative (EMDR) have access to a growing number of income producing investments that provide annual income in the range of 5 to 12%. This helps with the challenge of funding an extended retirement. However, since this is not a mainstream solution, there is debate over how much can be suitably allocated to these types of private market investments. Many EMDRs complain that they can only capture a portion of the client's portfolio with private equity as a result of compliance constraints and the rest of the portfolio must be abandoned to the banks or to advisors who are licensed to sell so called safe income investments like bonds and bond funds.
But even the ‘safe’ income investments, bonds and bond funds, can be affected by low interest rates. Longer term bonds are seen to have risk since increasing interest rates will affect their value adversely. This explains some advice to move to more short term bonds, unfortunately they provide no real return for the client. Some bond funds have moved to higher risk corporate bonds, so-called ‘junk bonds,’ to pad their portfolio yields. Yikes! It is a Catch-22 on the bond side. Many advisors suggest layering bonds of varying terms to cushion the adverse effect of the potential rising of interest rates.
How can EMDRs provide the safe haven to their client in the current regulatory environment without sacrificing income?
The only sector of the financial industry that is currently offering guaranteed income instruments for clients that outpace the current interest rate regime is - you guessed it - life insurance. Some of the life insurance providers have developed guaranteed income products that will easily outperform long term bonds and short term notes. The trade off is that even they cannot provide enough yield to produce sustainable income unless the client has enough capital. And even the segregated fund-based contracts have some risk if the client needs access to the capital. In many cases the guarantees are reduced with early redemption or withdrawals over a prescribed limit.
An alternative life insurance-based instrument that is the entirely overlooked as a retirement solution is the annuity contract. Many Advisors eschew this product since it also has a reduced return in low interest rate climates. In many cases however, they can fully replace the safe income portion of a portfolio. Furthermore, the income is 100% guaranteed for life so there is no way for the client to outlive their savings. Additional information on this strategy was published in the Financial Post by Fred Vitesse in 2012. It is a great explanation of the current value of annuities for retiree portfolios from an actuary, no less.
What does this mean to the Private Equity Specialist?
Once a base income is produced using the life insurance products, EMDRs can then use properly positioned private equity investments to top up the portfolio and achieve the desired income. It is the perfect mix of income guarantees and high yield risk adjusted income products.
How does a Private Equity Specialist provide the products without giving up a significant portion of the portfolio to a life advisor? There are two answers to this question:
1. Get life licensed! It is one of the easiest licenses to obtain and the regulators allow part-time licensees so there is no serious compliance concern from an outside business activity (OBA) perspective. It is also a relatively inexpensive license to obtain and maintain.
2. Find a suitable life licensed partner. In most jurisdictions, there is no problem for the life licensed representative to provide a marketing fee for referrals (check with your provincial regulator since the rules vary by province). Thus, you can refer your client to your life insurance partner and still get compensated.
Regulators look kindly on Advisors that show great concern for risk management when it comes to their clients. Life insurance is essentially risk management incarnate so having a life license or a partner who can provide this service can only help from a compliance standpoint.
The information in this article represents the opinions of the authors and does not necessarily reflect the views, opinions, or positions of Pinnacle Wealth Brokers and National Best Financial Network.
Maria Lizak, Ph.D., is co-founder and an Executive Business Director with National Best Financial Network. She is also a licensed Dealing Representative with Pinnacle Wealth Brokers, one of Canada’s largest Exempt Market Dealerships. Maria holds her doctorate in Clinical Psychology from the University of Saskatchewan, where she specialized in Sense of Community and Stages of Change. Connect with Maria on LinkedIn: https://ca.linkedin.com/pub/maria-lizak/22/5bb/9ab
Randy has been a lifelong investor (he bought a house with his first student loan while attending the University of Calgary) and decided 7 years ago to use his personal experience to assist others. He became licensed as an advisor in 2007 and gained his Exempt Market license in 2010. He teaches a course at Mount Royal University – Investing in Real Estate, and he holds regular workshops on financial planning. He is also an active guest speaker on risk management for business. He feels that a well-informed client helps create a long term relationship and that is the basis of his approach to customer service. As a private equity specialist, Randy is careful to appreciate the financial situation of his clients.