David Dodge: Heed the wisdom of Sandy McIntyre

Canadians need to save more: Dodge

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Income trusts level the playing field
It’s time to level the investment playing field, and give the average retail investor the same tools as the public service pension plans, by restoring income trusts.

by J.A. McIntyre
The Hill Times
March 1, 2010


TORONTO—In 2005, Statistics Canada found that 85 per cent of public sector workers and only 26 per cent of private sector workers have employer-sponsored pension plans. It is therefore remarkable that the discussion of “pension reform” seems to be preoccupied with the concerns of this relatively small group of Canadians as opposed to the concerns of the vast majority of Canadians.

In this piece, I explain why the major decline in investment returns makes it imperative to preserve the income trusts as an investment vehicle for RRSP investors in order to preserve a level playing field between those workers with pensions
and those without.

The pension problem is exacerbated by declining investment returns. From January 1956 to December 2009 the S&P/TSX Composite Index generated an average annual return of approximately seven per cent plus dividends for a total annual return of 10 per cent. To put this into the proper risk context, equity investors experience annual volatility in excess of 20 per cent to achieve returns of half that level.This type of risk/return is poorly suited to paying a recurring monthly income benefit. As portfolio returns declined following the last serious government review of RRSPs and RRIFs in 1992, the amount of capital required to generate $45,000 in annual income from a balanced portfolio (50 per cent equity, 50 percent fixed income) has increased from approximately $700,000 in mid 1992 to more than $1,300,000 as of December 2009. Declining yields have exposed the under-capitalized funding of both pension and individual investors’ retirement plans.

The individual investor accumulates capital to take care of their retirement in a Registered Retirement Savings Plan (RRSP) and when they need to begin harvesting their savings the capital is transferred into a Registered Retirement Income Fund (RRIF). In a RRIF mandatory withdrawals start at four per cent at age 65 and rapidly rise to 7.38 per cent at age 71. It is very clear that an investment return in a RRIF below four per cent is inadequate as one’s income and capital will decline in absolute terms from age 65 onward. Indeed, the mathematics of an RRIF require a compound annual return of eight per cent to deliver a long term income stream that keeps pace with two per cent inflation; the targeted inflation goal of the Bank of Canada’s monetary policies. This return could be achieved using Government of Canada bonds when the withdrawal rates were set in 1992, but today this return of eight per cent cannot be generated using low risk, fixed income investments.

With the market decline in returns, RRIF holders are forced to expose themselves to equity-like returns and risks. In response, RRIF investors moved some of their money to income trusts because they met a very direct need, and when properly executed, delivered predictable eight per cent or better returns with lower volatility (risk) than the stock market.

Like private equity funds employed by pension funds, income trusts gave individual investors a degree of control over the business’s capital allocation and direction of management that were unavailable in traditional equity investment.

The crux of the issue is clear: if public income trusts are not appropriate then why are private income trusts acceptable to the government? The Finance minister did not object to the taking private of many public income trusts like Teranet and GolfTown by the Ontario Municipal Employees Pension System. OMERS, a pension fund, are benefiting from unfair tax legislation that exempts them from the 31.5 per cent trust tax whereas individual investors’ RRSPs and RRIFs are exposed to this tax

Both groups of investors, pension plans and RRSP/RRIF holders need the returns provided by the income trust structure. Why is it acceptable to Canadian taxpayers that public service pension plans, like OMERS, whose benefits are guaranteed by the tax revenues of either the federal or a provincial government, are allowed to use tax structuring that is denied taxpayers themselves? The “tax leakage” argument so much emphasized by Finance Minister Jim Flaherty was quickly shown to be incorrect by HLB Decision Economics and others like BMO Capital Markets.

Bottom line: Level the investment playing field, and give the average retail investor the same tools as the public service pension plans, by restoring income trusts.

J.A. (Sandy) McIntyre is senior vice-president and chief investment office, Sentry Select, Toronto. The company has managed income trust portfolios since 1997.

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