The Fraser Institute has argued recently that the federal government has failed to make a convincing case for Canada Pension Plan (CPP) expansion. But their viewpoint depends heavily on trying to determine how much income Canadians need to retire with dignity.
Do we require a 50 percent replacement of final earnings; or is it 70 percent? Does spending go up or down when we retire? Can you sell your house and move to a less expensive region? Since none of these questions have solid, precise answers, the institute can claim the feds have not made the case for an expanded CPP.
Like many of you, I have wasted a few hours recently watching the U.S. Presidential candidates’ debates. I often find myself shaking my fist at my TV screen yelling: “You have not answered the question!” I feel the same way about the Fraser Institute analysis on CPP. While it is accurate, it does nothing to shed light on the matter at hand.
So, do we really need an expanded CPP?
Thankfully we have solid Canadian research available to let us know if future generations of Canadian workers can retire with dignity.
A 2015 McKinsey report uses survey results and concludes that 17 percent of the future elderly will suffer a decline in their standard of living in retirement. A 2009 study prepared for the Research Working Group on Retirement Income Adequacy used income tax data and concluded that 22 percent of future elderly will suffer a significant decline in their standard of living.
Two other studies used the Statistics Canada’s LifePaths microsimulation model to simulate future outcomes. The first, from the C.D. Howe Institute in 2010, suggests the future elderly will face declines of 44 percent, while a 2011 study from the Institute for Research on Public Policy shows a 50 percent decline in standard of living.
In other words, the best available Canadian data – even given that they vary substantially — all have the same bottom line: expect a significant decline in standard of living at retirement.
All four studies show that the risk of a declining standard of living in retirement is largely a middle-and upper-income earner problem, concentrated among the youngest age groups and those not participating in a workplace pension plan. For low-income workers, the combination of OAS and GIS will replace more than 100 percent of their final earnings.
Do these studies “prove” the need for expansion of the CPP? No — no more than the Fraser Institute study made the case against expansion.
What the studies do demonstrate, however, is that a significant proportion of future Canadian retirees are going to suffer measurable deterioration in their standards of living.
So what should be done as a result?
One answer is to “do” nothing. We’ve been doing just that for the last several decades and seen the steady erosion of retirement income security systems. Fewer workers today than a half-century ago have workplace pensions. Only 38 percent of employees participate in a Registered Pension Plan. And, clearly, Canadians are not filling the void with increased personal savings. Instead, they take on ever-increasing levels of debt.
Many employers have also stopped sponsoring defined benefit (DB) pensions finding them costly. At the same time, the financial crisis of 2008/9 has shown the frailty of achieving retirement income security through defined contribution (DC) plans.
Workers without workplace pensions must manage their own investment creating investment risk. They can mitigate the risk by hiring an investment advisor. However, this only shifts the investment risk to an expense risk.
Advice can cost as much as three percent of the gross rate of return. If funds earn, for example, five percent and inflation runs close to two percent, then that worker is actually receiving no real return at all.
They must also manage their assets to provide cash flows in retirement to cover their unknown life expectancy. Two outcomes are possible. One can draw down one’s assets very slowly to guarantee they don’t run out, but then live at a very low standard of living. Or one can live at a higher standard of living but run out of assets and fall back on taxpayer-funded welfare.
Study after study has shown that large defined benefit plans are more effective and efficient than accumulation accounts managed by individual workers since they can be operated with much lower investment expenses. Further, they need only accumulate enough funds to cover the average life expectancy of all plan participants. The fund can also invest in less liquid (and higher yielding) assets since the average life expectancy is known.
So, we can continue to dither or we can act. If we are to act, finding an efficient and effective means of increasing retirement income security would clearly lead us towards a compulsory, large, defined benefit plan.
Now, that just so happens to look a lot like an expanded CPP.
