What is the Longevity Pension Fund and should you own it?

There has been a lot of buzz about the Purpose Investments Longevity Pension Fund and for good reason – it solves a number of big problems that retirees face. The top questions to be answered for most retirees are the following:

1. How long will my money last?
2. How will I generate sufficient income for my retirement?
3. Did I even save enough for retirement?

These are seemingly short, simple questions but they do not have simple, easy answers…

Is the latest solution to retirement income planning (the Longevity Pension Fund from Purpose Investments) the answer?

What is the Longevity Pension Fund, how does it work and should you own it?

Read on to find out our take at Cashflows & Portfolios.

Why the Longevity Pension Fund is getting some press

Over the past few decades, the savvy Canadian investor has realized that defined benefit (DB) pension plans have been on the way out – meaning – companies are simply not offering them any longer.

This trend is significant for two big reasons:

1. The liability to fund retirement has shifted from the company directly to the employee, or you, the investor, and
2. Canadians will need to rely on increasingly, themselves, to improve their financial literacy to ensure they are owning financial assets that meet their needs, for the right reasons. Ideally, all financial plans come way before jumping into financial products. More on this important point later in our post!

The launch of the Longevity Pension Fund by Purpose Investments is essentially trying to pick up the slack where traditional, defined benefit pension plans used to play a role for many Canadians: offering up some pension-like cash for life.

How does the Longevity Pension Fund work?

At a high level, the longevity pension fund is a cross between a balanced index mutual fund (47% equities/38% fixed income/15% alternatives), an annuity, and a defined benefit pension.  While wealth accumulation for investors is relatively straightforward, decumulation of wealth to fund retirement can be complex. That’s where the Longevity Pension Fund comes in – the main features include:

1. Income for life, but without the guarantees. As mentioned, the Longevity Purpose Fund is a mutual fund that any investor will be able to buy. Once purchased, and the investor is 65 or older, the fund will pay a distribution for life (at least that is the plan).  Purpose Investments has stated that the 6.15% yield may sound high, but to maintain that yield they would only need to achieve an annual return of 3.5% net which is well below historical returns for a 60/40ish portfolio.  Combined with mortality credits (investors who die sooner than expected), Purpose Investments has stated that 6.15% is conservative and can possibly go higher in the future. On the flip side, the distributions are not guaranteed and if there is a severe bear market, the yield could potentially be reduced (or even eliminated).
2. You can get some of your investment back. With annuities and defined benefit pensions, you don’t typically get your contributions back. With this Longevity Fund, if you sell the fund you will get your initial investment minus any income payments. For example, if you have invested $100k into the fund, and have been paid out $10k, then you get back $90k if you sell.  At a yield of 6.15%, essentially you can get some capital back up to 16 years of being invested in the fund. After that point, consider yourself invested for life.
3. The taxation of the distributions will be tax efficient. The Longevity Fund will pay out about 50% return of capital and the remaining will be a mix of capital gains, dividends and interest. This means that in a taxable investment account, the distributions will be tax-efficient (much more so than a defined benefit pension payment).
4. The Fund does not pass onto heirs. As mentioned above, the mortality credits are how this fund will sustain its yield into the future, which also means that the fund and its payout do not pass onto your spouse/heirs.  For investors with a spouse/heirs, this is one of the largest drawbacks of the Longevity Fund.

Of course, the devil is in the details. Instead of repeating much of the content found on various sites related to this subject, we’ll just reference our colleagues in the financial community that have already written about this fund.

We’ve provided some excerpts from each recent article below.

With thanks to Jon Chevreau and the team at MoneySense:

Consider the Longevity Pension Fund (LPF) as follows: “Retired actuary and retirement expert Malcolm Hamilton describes the LPF as “quite an ambitious undertaking. I’d say it’s partly variable annuity, part tontine and part mutual fund.” Canada’s financial industry has been much better at creating wealth-accumulation products than decumulation vehicles, Hamilton says, adding he’s “quite pleased they’re doing this and will watch with fascination as the experiment proceeds.” 

Based on Dale Robert’s post from Cut the Crap Investing:

Given many retirees don’t want to manage their own investments, and may want to enjoy life “without financial worry” – “The Purpose Longevity Pension Fund will allow Canadians to top up their Canada Pension Plan and Old Age Security payments. Retirees may have other private pensions and other assets within the mix. The fund will allow a retiree to pensionize a large percentage of their liquid assets. The approach would remove much of the stock and bond market (volatility) risk.”

Rob Carrick from The Globe and Mail also wrote about the dynamics/drivers behind the fund (subscribers only):

“The Longevity fund was created to supplement income from the Canada Pension Plan and Old Age Security and help pay fixed living costs, said Som Seif, CEO of Purpose Investments Inc. “It’s designed for someone who doesn’t know how long they’re going to live and doesn’t want to run out of money,” he said. “It’s all about longevity risk.””

As per Rob’s post, you might want to consider this fund if:

1. 1. You’re looking for a “turn-key solution for generating retirement income.”
   2. “You are prepared to commit long-term to the fund and don’t see yourself swapping it out for something else down the line.”
   3. “You want some assurance you won’t outlive your savings.”

Million Dollar Journey also had some interesting things to say about this fund:

“Essentially when you put money into the Purpose Longevity Pension Fund they’re going to keep track of two separate parts.

A) The original money you invested.

B) The investment returns that your money has gained.

The stream of money into your bank account each year (that is very likely to be 6.15% of your original invested amount even though it’s not guaranteed) is going to include some of “A” and some of “B”.

The key here is that when you pass away your estate will get back all of “A” that has not already been “paid back to you” over the course of your retirement.  

HOWEVER – all of “B” that remains, will be left in the fund.  In this way, there is a sort of annuity/tontine aspect to spreading the risk of longevity around all of the investors.”

How much will you earn from the Longevity Pension Fund?

While there are two main classes of the fund, see more from Purpose Investments here, essentially if you’re near or approaching age 65, the fund targets to deliver close to 6% or more to investors depending on the asset decumulation cohort they fall into:

With thanks from Dale’s site for reference.

From Purpose:

“The fund has two classes: an Accumulation Class (for individuals who are saving for retirement or not yet retired) and a Decumulation Class (for individuals 65 and over). By investing in the Accumulation Class, your assets can continue to grow, and the month after you turn 65 your investment will be automatically switched into the Decumulation Class, and will start receiving income based on your investment in the fund. The best part? There is no taxable event upon this switch.”

Of note, be mindful of the money management fee range. Depending upon the class of the mutual fund purchased, the money management fee will differ.

(Recall F-series class units of mutual funds tend to be available only through a financial representative, often through a fee-based account where you pay a single annual fee for services. A-series class units tend to be the most costly option because money management fees tend to include trailing commissions paid to advisors. We don’t like those here on this site!)

We believe, for the most part, investors should at least consider the D-series class. We read that Purpose will provide an option for this class – which is great. D-series class funds are designed for do-it-yourself investors, and as such, usually have lower money management fees because of their no-advice structure. Something to think about…

Why the Longevity Pension Fund works

A key feature of this Longevity Pension Fund is a script from the annuity playbook – mortality credits. Similar to an annuity, you are participating in a pool of credits – those that die. When you die, your estate gets your initial contribution minus the total amount of income payments. The investment gains generated by your investments over the years stay in the fund and are used to top up monthly payments for everyone else.

Unlike an annuity though, you can get out of the fund – it’s not a one-way binding contract.

From Purpose:

“Unlike many traditional annuities or other lifetime income products, the Longevity Pension Fund is not meant to feel like a binding contract. You can change your mind and access the lesser of your unpaid capital** (i.e., your invested capital less the distributions you’ve received) or current NAV. Your beneficiaries are entitled to the same amount if you pass away. Once your cumulative distributions surpass your invested capital, there will no longer be any redeemable value left. Please speak to your advisor or see the prospectus for further details.”

The fund is also designed similar to many pension plan funds or funds of funds – a balanced mix of stocks, bonds and other investments that should* meet their income obligations to unitholders.

*The financial future is always very cloudy!

What the pros and cons in owning the Longevity Pension Fund?

While the fund is available for all kinds of accounts (including tax-free savings accounts (TFSAs) and registered retirement income funds (RRIFs), potentially the best home for this fund could be in a taxable account. That is because monthly income distributions in the first year are expected to be roughly half a return of capital (RoC) with the remainder from capital gains, dividends and interest. That’s tax-efficient.

Second, we should highlight beyond the name of this fund, this fund is designed to be a long-term investment. If you like to dive in-and-out of financial products, this fund is not for you.

Third, monthly payments seem juicy right now but the Longevity Pension Fund is not like an annuity whereby income is guaranteed for life – the 6% or more income target is just that – a target. So, distribution income cuts from this mutual fund, could happen. Should investments held by the fund underperform or if the number of investors live a ripe old age, well, the fund may be underfunded just like a pension plan. More money going out than coming in…

We’ll be even blunter about some of the feedback shared about this fund to date, from various readers, all is not overly positive before we give you our take!

From Dale’s site:

• “If all goes according to plan and one has an extended life span, the reward is a higher payout than an annuity would have provided in your later years. Interestingly, the biggest benefit over an annuity appears to be if you expire early !!”
• “I can earn over 6% with Enbridge and have a pretty safe dividend plus dividend increase s. Also, I was lucky to buy the banks at their lows like Bmo Bns and Cm also averaging 6%. I had excellent growth and I do know the risks of market corrections etc. But I like the fact of annual dividend increases. I will let the kids worry about how much principal is left in my estate. BLUE-CHIP DIVIDEND STOCKS IS THE WAY TO GO FOR ME.”
• “If it sounds too good to be true, it probably is”
  Most assuredly, I don’t need to pay Som Seif 0.6% to 1.1% of my stash, to do something I can do via TDDI with a couple of clicks of the mouse, for under 0.2% plus a couple of $9.95 commissions a year. The difference looks better in my jeans than it does in his.”

Some other comments take it up a notch – good and not-so-good from The Globe and Mail:

• “Quite sad to read all these negative replies from those who clearly do not understand what they are talking about. This product is a ‘tontine’ – a type of pooled investment strategy that has been around for literally hundreds of years. I have no idea why Rob would not have mentioned this in the article. Google it to learn more. Good for Purpose bringing this to market. There are pros and cons to the strategy, like anything else, but it is a perfectly legitimate and reasonable option for many investors and to my knowledge, nothing like this currently exists in the Canadian investment landscape.” 
• “This is exactly what a Ponzi Scheme does. Any time you see the term “Return of Capital” as part of the description be very wary. This is not a 6% return if your capital when returned is reduced by the amount you paid yourself. It’s a less than 0% return! This product is illegal in my opinion and should not be allowed to proceed. What a mess!”
• “Assuming start date age 65, terminal date age 81, the implied return is zero!
  If the person lives until 85, the return is 2%. How amazingly attractive!”

Should you own the Longevity Pension Fund?

The readers are not wrong. Someone who started with this fund at age 65 and received say 6.15% would be paid back their initial investment by age 81.

Look at it this way:

$100,000 invested. Get 6.15% back per year. That’s about 16 years.

While monthly payments may be increased in time (we read about 3% annually) at age 83 or 84 as some investors in the fund die prematurely, that’s some risk right there.

So, what’s our take? Would we invest in this fund?

The answer is “no”.

The reasons are as follows:

1. At Cashflows & Portfolios, we are both in our 40s. We have another 20-25 years before we even consider such an income product. Even then, we might not invest in one.
2. Monthly payments are not guaranteed. If you are looking for income security in retirement, a target payment is not the same as a guarantee. Also, don’t confuse the distribution with returns. We read from Jon Chevreau’s article: “The targeted return is approximately 3.5% net of fees. Consequently, approximately 50% of the distribution is expected to be return of capital. People should not imagine that they are earning 6.15%; a 3.5% net return is quite attractive in this environment. Of course, there is no guarantee that you will earn the 3.5%.”
3. We really like the fact this is not a long-term, one-way annuity contract but we don’t like the fact that essentially you can create your own income stream, pay no fee, pay yourself 6.15% from your own $100,000 (just an example) and obtain the same returns on your own. Your break-even date is age 81. You better live that long to realize the benefits of this fund. So, the best “death value” is at least age 81 or 82.
4. While Purpose is using a mutual fund structure for this fund, the underlying investments are Purpose ETFs. So, there is a bias to marketing this fund. More assets under management.
5. We believe the asset mix is good but retirees should consider learning to live with more stocks as they get older – an equity glide path if you will. (The fund has about 47% stocks, 38% fixed income and 15% alternative investments at the time of this post.)
6. There is no inflation protection. With other assets, such as a higher % of stocks vs. bonds, you may be able to generate similar or higher returns than the fund may deliver over time. How? You may wish to consider owning some dividend ETFs or dividend-paying stocks as part of your portfolio as you get older. The latter, dividend-paying stocks can increase their dividends over time to help you with your inflation-fighting power in your senior years. Of course, this is not a must, just a consideration.
7. As part of any financial plan, we believe plans come before products. So, best to do your own homework and math to see if you need this fund at all as part of your retirement income toolkit. Your plan might have a home for this fund, it might not as well. Meaning, you may not need any income security beyond government benefits like CPP and OAS, depending upon your own mix of assets, pensions, part-time work, other income streams. Personal finance and investing are always personal!

Final Thoughts

Overall, a very creative product but sometimes creativity and convenience can come at a cost. The Longevity Pension Fund might be well suited for some investors/retirees that want to keep some of their assets in a turn-key solution. That’s good. Just be mindful of who is the key master with any financial product.

Further Reading:

What is the Canada Pension Plan (CPP) and how does it work?

What is Old Age Security (OAS) and how can you avoid the OAS clawback?

Curious about dividends? How to automatically reinvest dividends for wealth-building here.

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