The Pensions Squeeze and the Case for a Bigger CPP

There's no quicker way to get most of my friends' eyes to glaze over than by talking about pensions. The issues are complex and the fruits are decades away, so best to worry about other things. Like laundry.
But part of the Echo Blog’s mission is to get younger Canada thinking and talking about the big ticket items that'll affect our futures. Our ability to put money aside for our retirement definitely qualifies, especially at a time when volatile markets and low interest rates makes it hard to save.

It’s particularly critical that we speak up at moments like this, when our federal and provincial leaders are contemplating big changes to one of our flagship social safety net programs – the Canada Pension Plan (CPP).

So get out the eye drops and let’s talk pensions.

To begin with, there are really three major pillars in our retirement savings system. The first is the CPP. We pay into it off our paycheques, with 10% deducted on your first $50k of salary per year (so, all of it for most people). At retirement (usually age 65), it pays out a maximum of about $12k per year depending on how much you paid in.  This is because CPP was only intended to be a modest part of our retirement income.

The second pillar is Old Age Security (OAS), paid for through everyone’s taxes. It is a monthly pension cheque retirees start receiving at age 65 (or age 67 for most of us… find out why here). This is also relatively modest, topping out at less than $7k per year.

The third is the ‘do-it-yourself’ pillar. We’re on the hook for the rest of our retirement savings, whether through company pension plans or RRSPs that we manage ourselves.

The big problem governments are trying to tackle is that a growing number of Canadians aren’t saving enough through this third pillar to ensure a decent standard of living when they retire.

Unsurprisingly, it generally isn’t the wealthy. More surprisingly, poorer Canadians actually aren't the crux of it either. The retirement income challenge is really with middle and lower-middle income people. (This great presentation provides more details.)

Squeezed by lower incomes and higher household costs, many Canadians – under 45s especially, but also some Boomers – have struggled to save enough in their RRSPs. At the same time, the number of employers offering company pension plans has been falling dramatically, especially where they provided the guarantee of 'defined benefits'. This is an especially big issue for us in younger Canada, as we’re entering the job market just as employers are shifting away from providing pensions.

To fix the problem, some provincial governments (like Ontario and PEI), labour organizations and seniors’ groups have been pushing aggressively for the expansion of the CPP. It’d force us to save more, but we could expect higher incomes down the road. Short-term pain for long-term gain, they say.

The other benefit is that big pension funds like CPP, Ontario’s Teachers Pension Plan and Quebec’s Caisse de Depot have advantages over saving on our own. They tend to earn better returns than your mutual funds and charge you less in fees because managing a huge pot of money allows them to hire top notch fund managers and keep transaction costs low.

Still, others disagree with expanding the CPP. The reps for small businesses claim that forcing workers and employers to pay more into our pensions when the economy is weak will hurt growth and push some companies to cut jobs. Some federal officials have made this case too. But should avoiding the short-term pain be an excuse for inaction?

The more worrying risk for younger Canadians, raised by the CD Howe Institute, is that the ‘Bigger CPP’ proposal could create an intergenerational ponzi scheme.

With pensions, the million dollar question is, will your money still be there when you finally retire? To keep tabs on this, governments look at three things: how much is being paid in, how much has to be paid out, and how much investment income we can earn on that big pot of money in the meantime (like interest in our savings accounts).

CD Howe says the government is being too optimistic about the investment returns. And if the CPP fund earns less than predicted over the next 30 or 40 years, it’s the younger Canadians paying in today who won't get the benefits they're owed. Put another way, current and soon-to-be retirees would eat our lunch.

This is an issue for sure, but we shouldn’t throw the baby out with the bathwater. I think a modest expansion of the CPP is a good idea. We just have to get the details right.

If the problem is that the current CPP model places too much risk on younger contributors, part of the conversation governments should be having is how to better share that risk across generations. For instance, one new idea that is being explored is the 'target benefit' model. Rather than guaranteeing a 'defined' benefit amount to retirees regardless of how the investments perform, the plan sets a target benefit that can be adjusted over time depending on the rate of returns. This way, we all get our lunch; it just might be a little bigger or smaller than we expected.

The bottom line is, this retirement savings problem isn't going away on its own. Our governments have a golden opportunity to help younger Canadians sock away a little more for their golden years. They should take it, even if it requires a bit of tweaking of the Bigger CPP proposal.

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The Pensions Squeeze and the Case for a Bigger CPP
The Pensions Squeeze and the Case for a Bigger CPP
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