Pensions & peace of mind series
Retirement issues are hot these days. The Tories’ muse about increasing the retirement age and the words ‘pension reform’ are loaded ones. There is no question Canada is facing a pension crunch. In the coming years, the number of Canadian retirees will dramatically increase as Boomers age and there will be fewer working age taxpayers to support them.
Adding to the strain on the public purse will be rising costs in health care. As the population ages, so too do the demands. Extra health-care expenses will cut into Canada’s ability to provide adequate pensions. So what are the options? Cut public sector pensions, cut guaranteed pension income available to all from the Old Age Security (OAS), Guaranteed Income Supplement (GIS) and the Canada Pension Plan (CPP) or reform all pensions to create a more uniform retirement income level for all Canadians? Opinions are divided on how to ensure every Canadian senior retires in dignity and with only one out of three Canadians stating they will be able to retire comfortably, pension reform is needed – and fast. The political sensitivity of the issue was illustrated when the Prime Minister mused in Davos, Switzerland this January about reforms to Old Age Security, with the government then moving quickly to soften its stand in the face of a public backlash. While reforms may be needed, there are no easy options available able to maintain its regime of pensions at its current rate.
It is helpful to put the current system in context. It was created a generation ago when poverty rates were highest among old people. CPP, OAS and other elements largely succeeded in fixing this problem and ensuring that most retirees could avoid poverty in old age. However, as the population ages and life expectancies grow, funding comfortable retirements for all is a growing challenge. Here are some other facts. As it stands, two-thirds of elderly Canadians receive a total annual income of $25,000 or less and three quarters of their total income is from public pensions – Old Age Security and the Canada Pension Plan. While to some, this may seem bleak, internationally, Canada fares well. Elder poverty is defined as individuals over 65 years of age with a disposable income less than 50 per cent of the median income. According to the Conference Board of Canada, Canada has a 5.9 per cent overall elderly poverty rate (a poverty rate lower than that of working age Canadians), coming second place only to the Netherlands (which has an overall elderly poverty rate of 2.0 per cent) among OECD countries. Pensions play a key role in ensuring our seniors don’t fall into the poverty trap. Despite this, many Canadians within this select group live in poverty. Up to 43 per cent of unattached elderly women and 31 per cent of unattached elderly men lived in poverty in 2001.
Alarm bells are going off everywhere. In a report to the Ontario government in mid-February, economist Don Drummond stated pension expenses are spiraling out of control. Drummond arrived at his conclusions after a year long examination of Ontario’s economy that resulted in 362 recommendations. The federal government estimates Canada’s liability in public-service pension plans is $147 billion a year. William Robson, chief executive of the C.D. Howe Institute, a Toronto-based think tank puts it even higher. In a study released December 2011, Robson concluded the federal government’s pension liability was $80 billion higher at $227 billion. Either way, trouble lies ahead.
The nature of pensions with different categories doesn’t help the situation. There are “defined benefit” DB pension plans and “defined contribution” (DC) pension plans. Nearly all public-service plans in Canada are DB plans, meaning future benefits are guaranteed regardless of how the fund does financially. Those benefits are based on a formula that might include the employee’s earning history, age and length of service. By contrast, DC plans – in which the employer’s annual contributions are specified but the ultimate pension provided will depend on investment returns – are increasingly common in the private sector. Over two-thirds of pension plans are DC, and they tend to be for small and medium-sized businesses, since large private sector employers have traditionally offered DB plans. But this is changing as many large private sector employers shift to DC plans in order to better manage costs for the employer.
What this means is the defined benefit plans for public sector employees have guaranteed payouts – regardless of the government’s or the taxpayer’s ability to pay. Returns on defined contribution plans however, depend on the vagaries of the market. Furthermore, a key variable in the calculations actuaries make to determine if a DB pension fund is properly funded or not are interest rates- the lower rates, the more likely a fund is to be in deficit. In today’s low interest rate environment, many DB pension funds face staggering deficits straining the finances of employers.
There is no question that guaranteed pension returns strain the public purse. As an example, the City of Montreal saw its annual pension contributions increase to $609 million in 2011, up $132 million from a year earlier. Other municipalities are experiencing the same situation. Saint John has a $163 million shortfall in its civic pension plan. In both cities, city officials are reducing municipal services or increasing the tax burden on municipal taxpayers to cope. In Ontario, select public sector employees are experiencing reductions in benefits. The Ontario Teachers’ Pension Plan shortfall was $17.2 billion as of 2011. Then there is the disparity in the ratio between the number of senior Canadians and working age Canadians. Recent Statistics Canada findings indicate there were just over five people aged 15 to 64 for each person aged 65 years and older. (This compares to 1956 when there were eight working age adults to every person aged 65 years and older.) If Canada continues at its current rate, there will be a further decline to 2.2 working-age persons for each elderly person. Associated with the increased ratio of seniors are health care costs. With age comes disability. Seniors have the highest disability rate of any group. While 11.5 per cent of working aged Canadians (those aged 15 to 64) has a disability, 43.4 per cent of seniors do. A third of recently retired seniors defined as aged 65 to 74 have even higher rates of disability. More than half or 56.3 per cent of seniors aged 75 and above have a disability. – While not directly related to pensions, the combination of rising health care and pension costs with an aging population will simultaneously strain public finances.
Frank Swedlove, President of the Canadian Life and Health Insurance Association which represents the vast majority of Canada’s life and health insurance industry and whose members manage more than two–thirds of Canada’s private sector pension plans, has a few ideas on solutions to the crunch.
Front and centre is the concept of Pooled Registered Pension Plans (PRPPs.) PRPPs are government regulated, private sector fund workplace pensions aimed at the more than 50 per cent of Canadians working in the private sector who do not have access to a retirement plan at their workplace.
PRPPs would play a role in supplementing or replacing Register-ed Retirement Savings Plans and other retirement savings vehicles. A major advantage of PRPPs would be their easy accessibility in the workplace and their affordability. The federal government tabled legislation in November 2011 to introduce PRPPs. Stipulated in the legislation is a legal requirement that financial institutions provide the funds at “low cost.” (One of the problems with mutual fund RRSPs is that they usually have very high management expenses, lowering returns and making it harder to earn a good rate of return on investments over time.) Ted Menzies, Minister of State of Finance, stated the PRPPs would be aimed primarily at the self employed and workers at small and mid-sized firms, which lack the resources to administer a private sector plan.
Swedlove views Canada’s pension challenge as an unprecedented opportunity for Canada to get it right on pensions. “We are at a moment of opportunity to build on existing strengths and to create a better retirement savings system for future generations. We need to expand and promote more use of workplace-based programs.”
But DB and DC pensions and PRPPs are not the only options. In addition to the government-run OAS, GIS and CPP/QP, there is a veritable alphabet soup of pension and retirement plans, including DPSP’s, EPSPs, group and individual RRSPs, LIRAs, LIFs and TFSAs to name a few.
At the heart of the debate over these options is whether DC plans or DB plans are the most effective and affordable solution for Canadians. While many argue that Canada cannot afford to keep up its defined benefit plans provided to the public service, there is also evidence that they are a better option long term. A 2008 study by the U.S.-based National Institute on Retirement Security found that DB plans trump DC plans as being more affordable and that DB plans yield pension results that are three times those of a typical DC plan. Can the public sector continue to have a DB system while the private sector moves increasingly to DC? Can this disparity be resolved by raising benefits for those lacking them or does affordability dictate that the only affordable way to bring about equity is to lower retirement security for those enjoying the most generous plans?
No matter what solutions are selected in the end, ensuring all Canadians have an adequate or better still a comfortable retirement won’t be easy. According to the experts, $20 of savings is required for every dollar of retirement income you wish to receive. For instance if you would like to retire on $50, 000 a year, you would need to save $1 million by retirement age. For $25,000 a year, you would require half this amount. Problem is the average Canadian has only around $60,000 in his or her RRSP at the time of retirement.
Either way, Canada’s pension crunch makes for interesting times. But less interesting perhaps, than that of the Greeks where a blowout in public sector wages including pensions has resulted in a financial crisis. Austerity measures agreed to by the government to stem the financial bleeding of the state include reductions in the minimum wage and annual salaries of government employees as well as substantial reductions in pension benefits for retirees.
Though it is highly doubtful that Canada will ever reach this point, it is clear that action needs to be taken, so Canada can find its way out of its current pension crisis and ensure every Canadian’s later years truly are golden.
***Pension Facts***
ALL FIGURES FROM STATISTICS CANADA, 2009.
• Canada’s population aged 65 and older has more than doubled in the past 35 years to 4.3 million, or 13 per cent of the population, in 2006. Medium-growth scenarios suggest the senior population will grow to 23 per cent in 2031.
• Most Canadians (65 per cent) approaching retirement anticipate that their retirement income will be adequate or more than adequate to maintain their standard of living. However, 19 per cent of Canadians expect it to be barely adequate and 9 per cent less than adequate.
• Canada Pension Plan (CPP), Old Age Security (OAS) and Guaranteed Income Supplement (GIS) benefits are key components of Canada’s public pension program.
• As of January 1, 2012, the maximum basic OAS pension, paid to people 65 years of age and over, will be $540.12 per month. GIS and Allowances payments will also increase by 0.4 percent.
• Since July 1, 2011, seniors with little or no income also receive a GIS and Allowances top-up benefit of up to $600 for single seniors and $840 for couples.
• The number of registered pension plans (RPPs) in the country, as of January 1, 2009, was 19,200.
• Only 38 per cent of all employees had an RPP in 2008. The coverage rate in the public sector was 84 per cent. In the private sector, it was only 25 per cent. It is not known how these uncovered individuals will sustain themselves in their retirements.
• Membership in registered pension plans increased 1.7 per cent during 2008 to stand at 6 million. All of the growth in pension membership in 2008 came from the public sector. Overall, membership in pension plans in Canada is about half men and half women.
• Due to the economic downturn, 75 per cent of RPPs had a funding deficiency at the end of 2008. In other words, their liabilities were greater than their assets.
• On average, Canadian workers had family disposable incomes at age 75 (when most are retired) that were 80 per cent of their incomes at age 55 (when they were working).
