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

If your entire knowledge of economics and finance theory is “free markets good, big government bad,” the above might rank as progress. Savings are being liberated from the dead hand of bureaucracy! But it turns out that a free market in retirement savings is nothing like a free market in, say, groceries. Most people aren’t going to forget to eat lunch. But what about planning for an event, like retirement, that may happen 20, 30 or 50 years hence? A growing literature in behavioural economics shows how the rational person is anything but when it comes to planning for a distant, uncertain future. Which may explain why Canadians on the edge of retirement, aged 55 to 64, have an average of just $55,000 in their RRSP. That’s enough to pay out maybe $300 a month. Pre-tax.

My own experience sadly confirms the short-termism of Homo Canadensis. Way back when, starting my first job, I had the option of taking part in my new employer’s defined benefit pension plan. I didn’t. Why not? Because like most 20-somethings, I wasn’t too concerned about saving for retirement. After two years, my collective agreement forced me to join—subjecting me to forced biweekly deductions, about which I constantly complained. A few years later, I moved to a job with no pension plan. No more deductions! I felt richer. But I was really just spending in the present by borrowing from my future.

And even if you have the discipline to save regularly and sufficiently on your own, you’ll run into another problem: Bay Street is not a safe space for individual investors. It’s sort of like that movie Dinner for Schmucks: if you can’t figure out who the schmuck is, it’s probably you. This country’s mutual fund fees are among the world’s highest, with the average equity fund carrying a management expense ratio of 2.3
per cent.

Given that long-term market returns aren’t likely to exceed six or seven per cent, you could wind up losing a third of your portfolio growth to fees.

Don’t blame Bay Street for overcharging you. The market charges what the market will bear. Don’t even blame corporations for getting rid of their defined benefit pension plans. Offering a DB plan means taking on risk and volatility, which will from time to time negatively shock the company’s earnings statement and balance sheet. Transferring those risks back to employees may be bad for society, but a CEO’s job is to do right by shareholders. He or she isn’t responsible for the well-being of society. Our elected
representatives are.

Ottawa and Queen’s Park are where the solution to our pension crisis lies. CPP is a defined benefit pension plan. Back in the mid-’90s, in an act of political cooperation that needs to be repeated, the provinces and the feds came together to save the Canada Pension Plan from insolvency. They prepared it for the baby boomers. Premiums were nearly doubled, bringing them into line with benefits. The plan is now solvent as far as the actuarial eye can see. CPP’s only remaining defect is its modesty: it was designed two generations ago, at a time when employers were expected to do much of the heavy lifting. As a result, CPP aims to provide a pension worth just one quarter of the average industrial wage. The maximum CPP pension at age 65 is currently less than $1,000 a month, and the average pension is just $512.64. It’s peanuts.

The Conservative government has been beating the drum, repeatedly and loudly, on the need for Canadians to save more for retirement. But there appears to be fundamental ideological discomfort with doing so through an expanded CPP, even though it’s obviously the cheapest and most efficient way to make sure we have more savings now, and more income later. A bigger CPP would even help the Tories accomplish their goal of lowering Old Age Security costs. The more we ramp up CPP, the more we can eventually scale back on taxpayer-funded OAS. A dollar saved today for retirement adds up to dollars worth of taxes that won’t have to be raised tomorrow to support indigent retirees. Stephen Harper even touted CPP’s virtues this year in Davos as an example of where Canada gets it right. But he never suggested that we needed more of this good thing to solve our retirement problem. Instead, he fell back on the usual mantras about less government.

More retirement savings through CPP looks, to those who aren’t looking carefully, like more government. Bad, bad, bad. And what about Joe Lunchpail, scratching together a few cents to take a flyer on one of Bay Street’s speculative, high-fee mutual funds? Why, that looks like freedom.

  • 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.