The Oct. 19 Globe and Mail editorial supporting expansion of the Canada Pension Plan (CPP) got it exactly right. The CPP is “one of the country’s great public policy successes” and “the best [savings plan] we’ve got.”
Notwithstanding evidence that many middle-income earners will face a sharp decline in living standards in retirement as a result of the erosion of employer pension plans and very low rates of private savings, the Harper government has refused to endorse the emerging provincial government consensus in favour of CPP expansion. The main argument against seems to be that the required increase in contributions (about 3 per cent of earnings) would amount to a damaging tax increase.
Not so. Increased premiums would directly finance increased benefits down the road. For the great majority of individual workers, the CPP is the best pension deal on offer. And there are clear benefits for most employers as well. As The Globe and Mail editorial argues, the CPP has major positives for employees compared with the alternative of contributing to Registered Retirement Savings Plans (RRSPs) and Pooled Registered Pension Plans (PRPPs). In a rapidly changing job market, the CPP provides coverage for all jobs held over a working lifetime, and provides flexible retirement options.
The CPP retirement benefit amounts to a rock-solid, lifetime annuity that is fully indexed to inflation. Such a product is all but unavailable for individuals to purchase from the Canadian financial sector, and would be extremely expensive. Few Canadians appreciate that the present-day value of today’s maximum CPP benefit at retirement (about $12,000 per year) is in the order of $250,000 or even more, given today’s ultra-low interest rates. By contrast, an RRSP provides a highly uncertain amount of future income, with no guarantee at all against erosion by inflation, and no protection against the longevity risk of running out of savings.
The CPP is also an incredibly cost-effective way for individual workers to save for retirement compared with the alternatives.
Not only are employee contributions fully matched by employers, but the CPP Investment Fund also has extremely low investment management costs of under 0.2 per cent – compared with management expense ratios of 2 to 3 per cent for most equity mutual funds. Every percentage point of additional management fees results in about a 20-per-cent loss in the total value of savings over a 40-year fund.
The CPP Investment Fund is a very large, highly diversified and very low-cost fund that can invest in assets that are simply not available to individual investors. The 10-year annualized rate of return has been 5.5 per cent on top of inflation, well above the 4-per-cent return needed to backstop existing benefits.
From an employer perspective, there are also significant positives to CPP expansion.
While premiums will rise modestly over time, this will have little or no impact on the significant number of medium-sized and large employers who still sponsor an employee pension plan. The great majority of such plans (including most public sector pension plans) are fully integrated with the CPP, meaning that required employer contributions to the plan will fall as CPP premiums rise. If the provincial proposal were to be adopted, some place would remain for employer pension plans for those with high earnings. But many such plans would be essentially phased out as the CPP expanded.
Most employers would welcome shifting the responsibility for securing a decent retirement for their workers to a well-run government plan.
There would also be only a small or no cost impact for the many responsible employers who do not sponsor a workplace defined benefit plan, but do already make contributions to a defined contribution plan, or match employee contributions to an RRSP. As the CPP expanded, contributions to these vehicles would shrink. True, employer and employee premiums would have to rise modestly to finance a more generous CPP. But there is no evidence that past CPP premium increases that were gradually phased-in had a significant impact on employment.
The fundamental problem with the current CPP is that it is just too small – providing a maximum benefit of just $1,012.50 per month, and an average benefit of just $602.86 per month.
The Harper government and employers should carefully consider the long-term consequences of a rising population of seniors with very limited incomes to supplement their bare-bones public pensions. How, for example, will this affect consumer spending, or the ability of governments to finance care for the very elderly?
Canadian employees and employers have much to benefit from an expanded CPP to ensure that middle-income Canadians have decent retirement incomes in the future.
This piece originally appeared in the Globe and Mail's Economy Lab.