When the federal and provincial finance ministers meet on June 20-21, they will have to decide whether or not to enhance the Canada Pension Plan (CPP) as promised by the Liberals in the last federal election. This will require the support of at least seven provinces with a combined two-thirds of the population and, effectively, a broad public consensus.
In that context, it is encouraging that the leading business organizations of all provinces but Alberta endorsed a modest expansion of the CPP in a letter sent to finance ministers on June 1.
Expansion of the CPP to provide higher benefits in the future has been widely supported by pension experts. The evidence shows that, left to their own devices, many Canadians are just not saving enough to secure a decent retirement, and certainly not enough to make up for the sharp decline of compulsory saving though traditional employer sponsored pension plans. As well, the seniors poverty rate, defined as the proportion with below one half of median incomes has been rising since the mid 1990s and now stands at 11.1%.
It should be recalled that the CPP was deliberately set up in 1966 as a very modest pension plan in the expectation that employers would continue to provide and indeed expand company pension arrangements. But just one in eight private sector workers (mainly union members and senior managers) currently contribute to a traditional defined benefit plan, and almost no new plans are being established.
Former Assistant Chief Statistician Michael Wolfson has shown that the majority of middle income earners now aged over forty have not saved enough to avoid a significant decline in their living standards in old age. A recent study for the Broadbent Institute by Richard Shillington showed that one half of all Canadians age 55 to 64 with no employer pension plan have only very modest retirement savings, a median nest egg of just $21,000 for those with incomes between $50,000 and $100,000.
The CPP in combination with Old Age Security is the major source of retirement income for most Canadians. It is fully portable between jobs and provides a secure and predictable pension for life, fully indexed to inflation. The only significant problem is that the maximum CPP benefit is very modest, just $1092.80 per month, and the average benefit is less than one half of that amount due to years of earnings below the maximum amount and years spent outside of the paid workforce.
From an employee perspective, CPP is an extremely efficient way to save for retirement since longevity risks are pooled across the whole population. While contributions (like contributions to traditional employer pension plans) are compulsory, they are matched by employers and provide a decent implicit rate of return. The large CPP Investment Fund operates with low overhead costs and has earned very respectable returns.
While employers would be required to pay one half of the cost of the modest premium increase required to finance an enhanced CPP, companies which sponsor defined benefit pension plans would not face additional costs since the great majority of these plans are fully integrated, meaning that they would pay out less as CPP benefits were increased. The financial risk of sponsoring such plans would be diminished.
Increased premiums would also have little net impact on the many responsible employers who provide some support for employee retirement through a defined contribution plan or a matching contribution to group or individual RRSPs. The need for these relatively costly and non portable arrangements would fall if CPP benefits were to be expanded.
Opposition from the financial sector has been vociferous until now, mainly reflecting the fact that high cost mutual funds boost the incomes of financial advisers and the profits of financial institutions. This just underlines the fact that the CPP provides better average returns at much lower costs than individuals can achieve by saving though RRSPs.
Employers now seem to recognize that it will not be beneficial to business if tomorrow's seniors face major reductions in their purchasing power. This will not only lower demand in the economy, but will also likely result in higher taxes to pay for higher spending on the income-tested Guaranteed Income Supplement to Old Age Security, which is already paid to more than one in three seniors.
However, the employer letter seems to envisage confining an expanded CPP to middle income workers, leaving those with higher incomes (a term which is not defined) Canadians out of any new plan. This would be unfortunate since earnings can vary a lot over a lifetime, and because such a plan would leave far too large a role for high cost RRSPs which provide a very uncertain future retirement income.
It is good that employers have jumped on the train of CPP reform, but they should not steer it in the wrong direction.
Photo: Dave Dugdale. Used under a Creative Commons license.