Reimagining Retirement Savings: Transitioning from…

When they get to retirement, many seniors still think in terms of risk and return when they should be thinking in terms of income. That could lead them to favor other assets and strategies.

“Workers have long been encouraged to take an accumulation mindset as they focus on growing their account balances in preparation for retirement, making it difficult to switch mental gears to the decumulation mindset when transitioning into retirement,” states a recent study by the National Institute on Aging.

The pension fund “industry” encourages this mindset with the emblematic Three Pillars framework for retirement savings. Pillar 1 is composed of government-sponsored programs: OAS (old age security), GIS (guaranteed income supplement), CPP/QPP (Canada pension plan/Québec pension plan). Pillar 2 is the “workplace-sponsored” part of employer pension plans and group savings plans. Finally, individually sponsored savings plans like RRSPs (registered retirement savings plans), RRIFs (registered retirement income funds), TFSAs (tax-free savings accounts), annuities, and home equity make up Pillar 3.

The NIA insists that this framework adopts the point of view of the providers of funds, not the consumers. For example, from the government’s perspective, each pillar shows how the Canadian system is financed as a fiscal expense. OAS/GIS is financed on a pay-as-you-go basis from general revenue, while CPP/QPP is partially funded outside the public accounts. The Three Pillars “emphasize how funds are accumulated from a provider’s funding perspective, rather than how they are decumulated,” notes the NIA.

The Reason to Save

This framework pushed retirees to focus on short-term risk and return rather than lifelong consumption, viewing their savings as investments rather than a source of income to sustain retirement. This leads them “to undervalue financial strategies that protect their financial wellbeing long after they retire – including choosing an optimal balance between their lifelong monthly income flows (to finance ongoing routine expenses) and accumulated savings (to finance any non routine expenses that arise).”

Spencer Look, director at the Morningstar Center for Retirement and Policy Studies, says, “I agree that putting the focus on a monthly income amount is a good thing. Most of the time, emphasis is on savings and balance, but it’s good to shift it to how much income it can generate against spending. This is something we’re talking a lot about in the United States. Savings is not the key, but the amount of income.”

The NIA’s study proposes to “reframe” the whole edifice of retirement away from the temple-like Three Pillars architecture to a more prosaic two-story-bungalow-like structure of foundation and living space. The foundation is built from different income streams of government programs, pension funds, and annuities that take charge of fixed and recurrent expenses like rent, heating, telecom, insurance, and health. The living space is divided into “spending areas,” such as RRSPs, TFSAs, home equity, and other savings that pay for non-routine expenditures like travel, gifts, and renovations. “After ongoing spending needs have been addressed, there is more flexibility to focus on non-routine spending such as expensive repairs and luxuries,” notes the NIA.

Benefits to Reframing

“Reframing” retirement is not just an intellectual exercise; it leads to tangible consequences. For example, an earlier study showed that moving from an investment to a consumption mental frame caused the share of participants who preferred lifelong pension income (like annuities) to increase from 20% to 70%, versus holding money in a savings account.

The NIA’s two-tiered structure allows retirees to consider new options they probably would have previously rejected offhand. Indeed, in a consumption frame, a vast majority of individuals prefer an annuity over alternative products like GICs. They also show greater receptivity to many other avenues that were previously underrated, like considering one’s home equity as a potential income stream. Another avenue is to delay CPP/QPP benefits, with the expectation of increasing future income.

Also, investors can layer their portfolio quite differently according to the “bungalow” model. On the first foundational layer, they should invest in very conservative assets that ensure a steady and secure revenue stream. On the top layer, Look suggests that because their recurring expenses are covered, they can venture into more risky assets that deliver stronger returns, like growth stocks, commodities, and even liquid alternative funds.

A fixation on investment risks and rewards can also prompt other questionable decisions, like electing to receive a lump sum instead of a steady lifetime revenue from a defined benefit pension plan. Unexpectedly, it can also lead to unfortunate choices. Look points to people “without a good retirement plan and who haven’t thought out their budget, who end up going to extremes, either spending too much of their savings too early in retirement, or saving too much … and dying a millionaire.”

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