High investment management fees could set back a comfortable retirement by up to four years, says Mercer Canada's Retirement Readiness Barometer, released on February 24, 2022.
Mercer calculated that a person who pays the median level of fees of 1.9 per cent in the individual investor market will be retirement ready by around age 70. By comparison, the analysis finds that a member who pays the median level of fees of 0.6 per cent in a workplace group plan will be ready to retire by age 66.
In addition, investors who pay a median fee of 1.9 per cent and retire at age 65 will deplete their savings five years earlier than if they had paid a median group fee of 0.6 per cent.
The Barometer defines retirement readiness as the age at which an individual can receive 70 per cent of their annual pre-retirement income each year for the rest of their lives. The probability of them not depleting all their savings is 75 per cent. The analysis takes into account government plans’ contribution to retirement income.
The power of pooling
According to Mercer Canada, the difference illustrates the power of pooling available to employees who contribute to a group retirement plan. Group workplace plans could achieve economies of scale, reducing costs for investors and delivering a higher net rate of return over time, Mercer adds.
“Individuals can make all the right investment decisions, but a workplace DC and savings plan could provide a level of scale unavailable to an individual going it alone,” Jillian Kennedy, Partner and Leader of Defined Contribution and Financial Wellness at Mercer Canada, explains in the release.
Mercer assumes that individuals have invested in a “balanced” target date portfolio. The total contribution rate is 12 percent, split equally between the employee and employer share. The analysis also looks at different contribution levels and investment approaches.
Inertia not an issue
In its announcement of the results, Mercer emphasizes that fees are only one variable in retirement planning. “Achieving retirement at 65 requires a holistic look at retirement income. This might mean higher contribution levels, a smart investment strategy, and having a comprehensive approach, including personal savings and being wise with money after retirement.”
Individual investors usually receive advice that prompts them to take action. In contrast, plan members may be left to their own devices. Many might not act, leaving their savings in a poorly performing default fund. Not anymore, says Jean-Philippe Côté Investment Consultant Associate at Mercer Canada told Insurance Portal.
It is no longer true that the default fund for a defined contribution plan, group RRSP or TFSA is a low-return fund, Côté points out. “In the past, the default fund for a group plan tended to be a guaranteed fund or a money market fund, but today, the vast majority of plans are choosing a target date fund as their default fund, which means well-diversified funds,” he explains.
“The farther the target date, the more the fund will be invested in equities to maximize returns. The closer the target date, the more the fund will be invested in bonds in order to preserve capital. This exercise is done automatically for investors,” he points out.
In addition, people who invest in a target date fund by default will have the target year of their fund automatically set at age 65, which is the normal retirement age, Côté continues. “In this case, we assume the employee is invested in an appropriate fund for retirement savings,” he says.
Jean-Philippe Côté mentioned certain situations in which employees may not reap the advantages of pooling. One example is when employees do not contribute to their group retirement plan. Often, participation in the group plan is not mandatory for the employee, he points out, especially when it is a group RRSP or TFSA.
The timing of retirement may also be skewed if an investor does not provide investment guidance and the employer does not select an appropriate default fund.
Employer participation in the plan also plays an important role, Côté continues. “When the employer does not contribute an employer match, we see a low participation rate in the plan. We assume that the employee does not see any benefits to investing in the plan,” he adds.
Steadily declining fees in group plans?
Jean-Philippe Côté points out that group pension plan sponsors have a fiduciary responsibility to ensure that management fees are competitive. “They must regularly compare their fees to the market,” he says.
Assets also play a role in plan expense competitiveness. “The plan sponsor can encourage members to consolidate their assets or make voluntary contributions to increase the assets under management in the plan. As the assets within the plan increase, the bargaining power becomes more attractive,” Côté adds.
The analysis of retirement readiness is based on retail investor fee data in the September 2019 report Morningstar Global Investor Experience Study: Fees and Expenses. The group plan fee analysis is based on Mercer's Defined Contribution Canadian fee database.