Unpacking "the nastiest, hardest problem in finance." (2024)

Saving is easy, decumulation is hard. Despite all the challenges a savings and investment plan presents, putting money aside and investing it for the future is a challenge that pales in comparison to what happens when that future arrives. When Canadians retire, they need to draw down on those assets. They do so with no firm idea of what the future holds. They don’t know what inflation rates will be, what unforeseen expenses they’ll incur, or how long they will live. All they know is they have a pool of assets and that pool has to last them the rest of their lives.

Eric Monteiro deals with decumulation problems every day. The SVP of group retirement services at Sun Life works on programs designed to address the core problems of decumulation. He explained why decumulation is becoming a bigger problem now than it was in previous generations. He outlined some of the risks around decumulation that Canadians don’t yet see, and he highlighted a few steps advisors can take to help address these challenges.

“It was Nobel Prize winning economist William F. Sharpe who said that decumulation is the nastiest, hardest problem in finance,” Monteiro says. “It’s a very complicated problem. You have to start by asking what your life is going to be like in retirement. You have to determine if you’re going to travel, how much you’re going to spend on healthcare, and if you’re going to need long term care at the end of your life. Budgeting for your retirement is very difficult because now you’re budgeting for 30 to 40 years.”

Increasing longevity is adding to the challenges of decumulation. Canadians are living longer than ever before, but their later years are increasingly spent in poor health requiring expensive long-term care. Inflation has returned as a major concern, with most economic forecasts treating the 2 per cent target as more of a floor than a ceiling for inflation in the next decade.

Pension access is playing a key role too. Monteiro notes that the current generation now retiring is one of the first to retire with such a limited amount of defined benefit (DB) pension plan coverage. Newer Canadian retirees are largely supported by their own savings alone or defined contribution (DC) pensions, which have far more limited supports to deal with inflation or longevity.

In addition to the complex questions around lifestyle, expenditures, and longevity, retirees also need to deal with tax decisions. Those include choices around when to take CPP, how to manage assets, when to turn RRSPs into RRIFs, and the myriad other choices that could have implications for decades.

“It’s very difficult to manage, and we know from behavioural economics that the average person does not deal well with complexity, people put if off or they feel embarrassed, so they don’t plan,” Monteiro says.

Just because this problem is so nasty, doesn’t mean that action can’t be taken to address it. Monteiro says that one of the biggest hurdles is in getting people to plan. Key to that is offering a seamless experience. Whether as an advisor or in a group retirement plan, platforms that can simplify and ease an otherwise complex experience are highly valuable. He says that tools like a digital nudge, short consultations, or quick reviews can also be extremely beneficial in getting the planning process started.

Those tools and platforms, Monteiro says, should come with explicit mention of decumulation. People should be able to easily visualize what happens when they withdraw their money at different rates. The goal should be eliminating the inherent complexity in these decisions as much as possible, so that Canadians begin to actively plan for decumulation. They should also introduce new ideas around investment risk and growth. Where in the past retirees may have moved to a low-risk fixed income portfolio, longevity risk dictates that even retirees need to keep some degree of investment risk in their portfolio, to generate the growth needed to last in the long-term. That idea needs to be introduced.

Whether through a group plan or a financial advisor, Monteiro believes that Canadians need coaches to go through this process. Those who serve as their advisors can act in that coaching role, supporting Canadians as they begin the work of planning and make crucial decumulation decisions along the way. In delivering that coaching, Monteiro says that technology may be key to success.

“We believe that the way to make things simple and to scale advice is digital,” Monteiro says. “Older people are more comfortable with their devices now, and you simply can’t afford to give every person live advice. But you can provide it digitally in a way that scales to everybody.”