Canada's Huge Pension Crisis?
Canada is headed for a “huge economic crisis” if the provinces and federal government don’t take action now to improve retirement incomes, Ontario Premier Kathleen Wynne warned Tuesday.Kudos to Ontario Premier Kathleen Wynne. Unlike most Canadian politicians who are utterly clueless when it comes to meaningful pension reform, she gets it and is leading the fight in what I consider to be the second most important public policy issue of our time (the first is lack of good paying jobs so people can save).
“One of our fundamental priorities is retirement income security, especially for the middle class,” Wynne told a business audience in Toronto.
“People are not saving enough for retirement and if we let this go unchecked we’re going to face a huge economic crisis.”
Ontario’s Liberal government recently announced it would create a provincial retirement income plan if it can’t convince Ottawa and the other provinces to enhance the Canada Pension Plan.
“I believe that governments have to ensure a reliable and responsible retirement income system, one that evolves and responds to the practical realities of the times that we’re dealing with,” Wynne told the ACG Capital Connections conference.
“So we’re taking the lead in Ontario on that conversation across Canada, to make sure that we’re thinking ahead and making sure that everyone in this province is prepared for retirement.”
Wynne will raise the retirement income issue with the other provincial and territorial leaders when they meet Friday in Toronto.
“I will be meeting with my colleague premiers at the end of the week and will be talking about that as one aspect of our relationship,” she said.
Ontario is not the only province that has been pushing for action on the CPP for the past several years. Prince Edward Island wants to boost maximum CPP contributions to $4,681.20 a year from $2,356.20 starting in 2016, and also increase the maximum annual benefit to $23,400 from $12,150.
Quebec and Alberta have opposed CPP reform, which last week federal Finance Minister Jim Flaherty agreed was a good idea. However, Flaherty said it should only be considered when the economy is stronger.
“It’s a payroll tax on employers and employees,” warned Flaherty. “I don’t think the idea is a bad idea, I just think the economy has to be able to afford it at the appropriate time.”
Wynne said the slow economic recovery is not an excuse to avoid boosting CPP contributions and benefits.
“The way I frame it to my colleagues and to the people who say to me ’We can’t afford to do that (because) the economy is too fragile,’ my response is if we don’t find a way to do this now, we will pay later,” she said. “So we make a choice about whether we plan or whether we react.”
In December 2010, Ottawa and the provinces agreed to a half-way measure by creating so-called voluntary pooled registered plans, but Ontario says that’s not enough.
Several business lobby groups have opposed enhancing the CPP, instead advocating for Canadians to find alternate plans for retirement, including the pooled pension plans and other forms of savings without increasing the cost to businesses.
Wynne also intends to push the pension reform issue when the premiers meet with Prime Minister Stephen Harper next month.
Of course, critics will oppose any talk of enhancing the Canada Pension Plan because they too are utterly clueless as to how widespread pension poverty will endanger our economy. These critics like fearmongering on "big CPP", ignoring those who dispel public pension plan myths and they completely disregard studies which clearly demonstrate the benefits of defined-benefit pension plans.
Is Kathleen Wynne being too alarmist? I personally don't think so and neither do pension experts like Jim Leech, the president and CEO of the Ontario Teachers' Pension Plan, who told Matthew Pearson of the Ottawa citizen that pension reform is urgently needed:
The head of the Ontario Teachers’ Pension Plan says it’s time to enhance the Canada Pension Plan and to force workers without workplace pensions to save for their retirement by joining new, mandatory plans.I completely disagree with Bill Tufts and agree with Jim Leech, PRPPs are not going to work because they don't force people to save. Moreover, they are a dead giveaway to the financial services industry and Harper's government truly dropped the ball with this silly proposal.
Jim Leech says Canadians have failed miserably when it comes to voluntarily saving for retirement, so it’s time to reform the system or else future generations of taxpayers and workers will be saddled with skyrocketing pension bills they can ill afford.
His comments echo those of Premier Kathleen Wynne, whose government recently announced that it would create a “made in Ontario” retirement income plan if it can’t convince the federal government and the other provinces to enhance the CPP.
In a new book, The Third Rail: Confronting Our Pension Failures — co-written with Globe and Mail business reporter Jacquie McNish — Leech outlines a vexing demographic dilemma that pension designers never anticipated: The average retiree in Canada will soon spend more time collecting a pension than he or she did contributing to it.
Coupled with that phenomenon is the widespread failure to set aside the funds necessary to live comfortably in retirement, especially among the millions of Canadians without workplace pension plans.
“The concept of voluntary savings doesn’t work,” Leech said. “And it sounds kind of socialistic and big brother, but if you’re going to expect big brother to look after you if you haven’t saved, then we’re going to ask you to save.”
“It’s consume today or save and consume tomorrow.”
He points to a study former Bank of Canada governor David Dodge conducted for the C.D. Howe Institute that found a person would need to set aside between 10 and 21 per cent of their annual income for 35 years to have a retirement income equal to 70 per cent of what was previously earned.
But Canadians today are only saving at a rate of 5.5 per cent, which means many could be in for a harsh surprise the morning after their retirement party.
According to figures contained in Leech’s book, a person earning $50,000 a year today receives a maximum CPP pension of $12,150 annually if they retire at 65 after working 39 years. In addition, this worker is eligible for a $6,522 OAS supplement, meaning their annual income retirement would add up to $18,700, replacing only 37 per cent of their salary.
“That’s pretty scary,” he said.
Leech suggests three potential remedies, particularly among middle class workers who earn between $30,000 and $100,000 annually.
First, enhance CPP to take advantage of existing pension infrastructure. Enhancements would be financed through increased contributions so that employee earning $50,000 per year would see their annual increase jump to $2,930 from $2,300 (employers would match the contribution increase).
This would increase the CPP pension to $17,500, and, after adding in the OAS payments, would see almost half of the worker’s salary replaced.
An employee earning $100,000 would see CPP and OAS income jump to $37,000 per year.
He also recommends that defined benefit plans evolve so the risk is shared more equally between employer and employee and suggests the government create a series of large, pooled defined contribution plans that would be mandatory for people without workplace pension plans to join.
“We’ve proven through the Registered Retirement Savings Plan (RRSP) system that voluntary, even tax-incented savings doesn’t work. People are not saving to the extent they should or can in their RRSPs,” he said. “The people who use RRSPs are high-income people who are using it as a tax deferral as opposed to a savings vehicle.”
Although Leech and pension reform activist Bill Tufts seem to share a common goal — ensuring that every Canadian receives a sufficient income in retirement to afford an acceptable quality of life — they differ on how best to achieve it.
Tufts, who founded the non-profit group Fair Pensions for All, does not support enhancing CPP, claiming Wynne’s “hidden motive” is to hide the province’s public-sector pension plan’s $100-billion shortfall.
He also wants what he calls “gold-plated” public-sector defined benefit pension plans converted to defined contribution plans and supports the federal government’s new pooled retirement pension plans (PRPPs), which pool individual contributions in a larger fund.
“Canadians need to take responsibility for saving for themselves for their retirement, and the PRPP is a good solution to that,” Tufts said.
But PRPPs will have limited success because enrolment is voluntary, Leech said.
He wants people to be forced to save so future generations aren’t burdened by the high costs of caring for them in their old age because they didn’t save sufficiently.
At $36 billion this year, Old Age Security and Guaranteed Income Supplement payments are now the single largest line item in the federal budget, and it’s expected to triple in the next 16 years based on the government’s own projections, Leech said.
(Hopefully Harper et al. will manage to abolish the Senate to atone for their sins and spare us of unrelenting media coverage of the scandal. And if only Torontonians can get rid of their embarrassing mayor to spare the rest of us from the media circus, and allow the media's attention to shift to real important news, like the ABCP scandal at the Caisse).
I recently reviewed The Third Rail, the book Jim Leech co-authored with Jacquie McNish. Keith Ambachtsheer also wrote an excellent review of their book. If it were up to me, I would make this book compulsory reading in every high school economics class throughout Canada. I'm serious, it's important to educate our youngsters early on their financial future and what it takes to retire in dignity and security. They should be properly informed about all financial matters, including closet indexers gouging them on fees.
Unfortunately the debate in Canada isn't focusing on facts. Jacquie McNish wrote an excellent article in the Globe and Mail, The problem with pensions: symptoms and cures:
THE SYMPTOMSThat in a nutshell is the problem with pensions and what needs to be done to address our looming retirement crisis. You will read articles arguing against expanding the CPP but they're peddling myths and utter nonsense. I would love to debate these so-called experts in an open and public forum and crush every single argument they bring forth. They truly are clueless at best or pathetic financial industry hacks at worst.
Longevity: We are living too long. When Grand Trunk Railway introduced Canada’s first workplace pension in 1874, the retirement age was 70 and average life expectancy 55, meaning the average worker was dead for 15 years before they could collect a pension. Today the average Canadian worker is retiring at 63 and life expectancy is almost 80 years. As life expectancy rises, workers’ retirement years will soon exceed their career years, meaning they will be spending far more than anticipated.
Investment volatility: In an era of threadbare interest rates, pension funds have shifted most of their assets from bonds to stock market investments to generate returns needed to foot the pension bill. The strategy exposes funds to the increasingly volatile whims of the market. In the wake of the dot.com collapse in 1991 and financial crisis of 2008, the average Canadian pension plan in Canada is about 12 per cent short of assets needed to pay their pension bills.
Lax pension management: Bonds currently pay investors a real rate of about 1 per cent, but a large number of pension plans continue to project they will earn annual returns of 4 per cent. Many funds also rely on outdated mortality tables, which means they are assuming retirees will die sooner than expected. Added up, these practices mean funds have not saved enough for plan members.
Demographics: We are on the verge of the largest workplace exodus in history with more than seven million workers, 42 per cent of the Canadian work force, set to retire over the next 20 years. Many have not saved enough for retirement. For those who have pension plans, the exodus means there may be as many workers as there are retirees, a ratio that may leave younger workers with a much smaller pension pie than their predecessors.
Inflexible pension plans: When defined benefit pension plans gained popularity after the Second World War, they were sold as guarantees. Under these DB plans, workers and employers pay set amounts into a fund that promises a fixed pension cheque. As a result of rising longevity, investment uncertainty and demographic pressures, guarantees are increasingly unsustainable.
Pension inequity: Only 40 per cent of Canadian workers have pensions. The remaining majority must choose from a disappointing menu of registered retirement savings plans and other investment options to save for retirement. Canadians have such meagre savings that an estimated 30 per cent of modest- to high-income earners will experience a significant drop in their standard of living.
THE CURES
Shared-risk pensions: Introduced by the Dutch in the mid-2000s and adopted by New Brunswick and Rhode Island, shared-risk plans are based on a model of flexible benefits that can be paid or temporarily suspended depending on the health of the pension plan. If demographic and investment setbacks trigger pension fund short falls, plans suspend such perks as pension cost-of-living adjustments until a surplus is restored.
Later Retirements: Remember Freedom 55? It’s history. Federal laws and some provincial reforms are pushing the retirement age to 67. The longer people live, the greater the chance of further retirement delays to ensure enough is saved to keep retirees above the poverty line.
Stricter pension management: Reforms in New Brunswick, the Netherlands and other jurisdictions have made it much more difficult for pension fund managers to overexaggerate investment forecasts and underestimate mortality rates. Under the shared-risk model, funds are also subject to much stricter solvency rules that require plan sponsors to quickly restore funding shortfalls.
Greater pension equity: There is a large menu of reforms that have been proposed by leading experts and provincial task forces to address the needs of Canadian workers without pensions. One is to expand the Canada Pension Plan for the most vulnerable, workers without pensions who earn between $30,000 to $100,000. This group stands to suffer significant income drops in retirement. Other proposals include pooling the savings of defined contribution plans within organizations or under independent supervision to give plans more leverage to lower fees and shield members from longevity and investment risks. Quebec recently proposed a supplemental and mandatory pension plan that would not start paying benefits until the age of 75. The plan is designed to bridge the gap for retirees that are expected to outlive their savings.
Below, Finance Minister Jim Flaherty on his economic priorities, which include tackling debt. Mr. Flaherty, if you really want to tackle our long-term debt, join Kathleen Wynne, Jacquie McNish, Jim Leech and many others who argue the time has come to expand the Canada Pension Plan and enhance the retirement security of all Canadians.