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Tony Keller: why the obvious fix for the country’s collective pension problem is being ignored

Work Till You DieLast fall, the Royal Bank of Canada—with $27 billion in annual revenue, $752 billion in assets and 74,000 employees, the biggest and most prudent bank in the world’s safest banking system—announced that new employees would no longer be eligible to receive what is probably the company’s most important workplace benefit: the comprehensive retirement insurance plan. It insures the Royal’s Canadian employees, or at least those hired before January 1, 2012, against all sorts of risks. The risk of reaching retirement age at a time when stock markets are down, or interest rates are low. The risk of outliving one’s retirement savings. Inflation risk. Risks you’ve probably never even heard of, like reinvestment risk and liquidity risk. Even the risk of earning below market returns.

This generous program wasn’t unique to the Royal. Many employers, particularly big companies, once offered similar plans. Some still do, though their numbers are dwindling. You may be wondering, “Why have I never heard of retirement insurance?” You have. It’s called a pension.

We’re heading for a pension crisis. The federal government says so. The opposition says so. Most provinces say so. The library shelves of the land groan beneath the weight of studies. The first class of baby boomers hit 65 this year, and we’re still not ready. The economist Michael Wolfson, formerly the assistant chief statistician of Canada and now at the University of Ottawa, estimates that half of all Canadians born between 1945 and 1970 who have average career earnings between $35,000 and $80,000 are facing a drop of at least 25 per cent in their post-retirement standard of living. Which is perhaps not surprising given that most of us don’t have a pension plan.

The logical fix would be to expand our modest national pension plan: CPP. The Ontario finance minister, Dwight Duncan, spent several years pushing the idea. Workers and employers would contribute more so that, come retirement, they’d receive more. Pension crisis solved. For a while it looked like Duncan’s federal counterpart, Jim Flaherty, was onside—and then ideology got in the way. (It can’t have helped that the NDP and the union movement both favour an expanded CPP.)

Flaherty opted instead for a private-sector solution. Don’t expect results. The Tory government’s big fix is the Pooled Registered Pension Plan (PRPP), expected to come into effect sometime next year. It has major defects—including the fact that neither employers nor employees are under any obligation to join. Canadians are already sitting on more than $600 billion in unused RRSP room, and in 2009, only 31 per cent of those eligible to contribute to an RRSP did so. Nevertheless, a country that isn’t saving enough for retirement through voluntary savings programs is going to try to fix the problem with yet another voluntary savings program. But the biggest problem with the PRPP is its dishonesty. It’s not a
pension plan.

There are two major types of pension plans. The first—the kind that RBC offered its employees until this year—is called a defined benefit pension, or DB plan. Thanks to the pooling of funds among contributors and beneficiaries of different ages and retirement dates, members are insured against retirement savings risks, and then some. Long before they retire, members know what kind of monthly payments they’re going to receive. The employer guarantees it.

Someone enrolled in a typical DB plan and earning $100,000 a year knows that he will be owed an annual pension of two per cent of his salary, or $2,000, for each year of employment. A 30-year employee at that salary would be eligible for roughly $60,000 a year until death. That pension is made possible by a forced savings plan, with the employer required to regularly set aside and invest some combination of employer and employee contributions. The math is complicated, but the pension and RRSP systems are based on the assumption that, if you were that $100,000 earner saving by yourself, you’d have to put aside $18,000, year after year after year, to achieve the same result.

New hires at RBC, along with increasing numbers of private sector employees, receive a different type of pension plan. It’s called a defined contribution pension, or DC plan. The employer may put money in, sometimes quite a lot of money, but as for what comes out at the other end, that’s unknown, and unknowable. The health of the plan is not the employer’s responsibility. Which is why, according to Moshe Milevsky, a finance professor at the Schulich School of Business, DC plans are not pensions. In a recent paper, he describes them as nothing more than “tax-sheltered investment plans with zero guarantees.” A DC plan is really just another RRSP. The individual bears all the risks. And returns, instead of being guaranteed, are guaranteed to fluctuate—wildly.

The shift from pensions to not-quite pensions—or no pensions at all—is happening all across corporate Canada. Only 39 per cent of employees have a workplace pension plan, according to Statistics Canada. And that figure, dismal as it is, paints too rosy a picture. It includes DC pensions. It includes government workers, most of whom have a pension, and a DB one at that. In the private sector, only one in seven workers has a DB pension plan. One worker in nine is in a DC or other plan. The remaining 75 per cent of us? No pension coverage at all.

  • jp laporte

    There is a better alternative to expanding the CPP: it is creating a Supplemental CPP. It would allow people to direct. All of their RRSP contributions to a separate CPP account to purchase additional pension benefits.

    Employers could participate as well as employees and even the self-employed or those with no employment. Those that care for our children deserve a pension too.

    The monies would be administered by the CPP Investment Board at a fraction of what PRPPs or RRSPs cost. Small business that can’t afford to contribute wouldn’t be faced with a payroll tax. And it would force the private sector to be truly competitive. A true middle of the road – balanced and Canadian solution.

  • pensions_man

    The solution that JP describes would be a very good first step. Studies, however, repeatedly show that the best way to increase retirement plan coverage is through compulsory arrangements (unclear if JP’s proposal would or would not be mandatory). A voluntary supplemental CPP account could certainly leverage the CPP’s institutional efficiencies (i.e., offer contributors better returns for lower fees), but it would not address the 20- (and 30-) somethings whom Mr. Keller writes about. These folks would sooner exchange $5 extra in 30 years for $1 extra today. They simply would not contribute to a voluntary CPP account (assuming they had the extra income to do so, but that’s another issue). A mandatory expanded CPP (as supported by the current Ontario government) would, in my view, be the best solution. There should also be an increase in the maximum income on which CPP contributions will be assessed. Currently, annual contributions stop after your income reaches $50,100. There are a lot of middle-class workers making more than this with inadequate retirement savings.

  • JP Laporte

    While Pensions_Man makes some good observations, it should be noted that forcing someone into the same mould may not make any economic sense. For example, someone with 28% interest rate credit card debt who has an extra dollar of disposible income would be a fool not to pay down the credit card debt. The CPP or Supplemental CPP may return, in a good year 8%. That individual would be worse off trying to save, while having huge debt liabilities eat away at his net worth. Same analysis when faced with rental versus mortgage calculations, or savings vs paying for children’s education etc.

    At some point, we have to trust that people are not idiots and can make good economic decisions. Hence the voluntary nature of the S/CPP. Of course, if an employer wishes to make participation in the S/CPP mandatory (i.e. as a term of the employment relationship), nothing would prevent that employer from doing so. So, to answer Pensions_man’s question, the S/CPP could be both voluntary or mandatory to a certain extent, depending on the employer’s rules in the workplace.

    Employers should be happy with a S/CPP: 1) no imposition of a payroll tax 2) no fiduciary oversight 3) no administration responsibilities 4) perfect transferrability etc..

  • JP Laporte

    One last detail: many people do not realize that the CPP also offers disability benefits. This means that someone who qualifies may collect a full pension for decades, without contributing. This serves a useful societal goal of helping those who are truly disabled with income support. BUT: someone has to pay for it. All contributors to the CPP pay the “insurance premium” component. This means that of the 1$ contributed, less than 1$ is applied to provide a pension since someone has to bear the risk of having some unfortunate Canadians end up on disability pension. This is not the case with the S/CPP. There, 100% of the contributions go to create a supplemental pension for the contributor. On that ground alone, a straight extension of the CPP (as advocated by labour groups and the NDP) is again not the most efficient use of resources.

  • R

    If only all the taxpayer dollars lost to government waste and corruption could be put into a fund to support seniors.

  • Rob

    What isn’t mentioned is that more and more of the corporations that have defined benefits plans are cutting benefits to retirees – so is a defined benefits pension really any better?

  • Bruce

    Isn’t the big question really: how can a bank that has 752 BILLION dollars in assets and 27 BILLION dollars in annual revenue NOT count its employees among the assets?

  • Socialists dont get it

    The author is in well read and knowledge but sure does not get the fundamental –citizens should be responsible for themselves, the government creates the structure and infrastructure for citizens to achieve that. Government is for the people, but not to guarantee luxurious retirement with good pension. (Although socialists strongly believe it is their right to be taken care of and retire early, get OAS at age 65. See what happens to Greece, the birth place of democracy that turns socialism).

    Decades ago the world was a different place. It was very hard to get information, financial or otherwise. Lots of workers had lower education, so to do good, companies takes on the task of “managing workers’ money for them” with DB plan.

    Today, with internet and easy access to data and progress, everyone, including those DB workers, are speulating and gambling in the stock market, which mess up the fundamental capital market model. The world has changed, and guranteeing an income 50 years from now is no longer viable.

    Government did the right thing. It only assist citizens to achieve income up to 25%, the rest has to be done by the citizens themselves, hence PRPP.

 

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