Modifying the Canadian pension system

More than seven million Canadians will retire over the next two decades. The baby boomers (the 45- to 65-year-olds who make up 42 per cent of Canada’s workforce) will create the largest job exodus in Canadian history.

Retirement will be a very bleak place for the unprepared, and indications are that many boomers (and others) will be very poorly prepared.

In their very good new book, The Third Rail: Confronting Our Pension Failures, Jim Leech and Jacquie McNish make a compelling case that the Canadian pension system is flawed. While I agree that many of us will fall far short of the comfortable, worry-free retirement we desire, we disagree on the solution.

Puzzle Pieces
Poor savings rates

Two generations ago, Canadians were saving an average of 20 per cent of their disposable incomes for retirement. Today we save just 2.5 per cent. If those non-savers are counting on government or employer pensions to salvage their retirement, they’ll be in for a shock. A big one.

Related article:  Are you good at saving money?

Compounding the savings shortfall is the fact that the boomers will need more retirement savings than any other generation, given that they’ll live longer than any previous retirees.

Government Benefits

The Canadian pension system has three-tiers – the Canada Pension Plan, Old Age Security and Guaranteed Income Supplement – is intended to provide only a basic retirement income. A couple getting the average of those three income sources may have the bare essentials, but nothing more.

Related article:  Understanding Government Benefits

Pension Plans

Most working Canadians have no pension plan of any kind and the top-drawer defined benefit plans are being abandoned in favour of less secure defined contribution plans.

Related article:  Pension plans are the foundation of retirement planning

The book’s authors, Ontario Teachers’ Pension Plan CEO Leech and senior Globe and Mail writer McNish, contend that Canada’s retirement income system must be significantly revamped in order to close the gaps in our savings system.

Canada has the capacity to diffuse the ticking pension time bomb, says Leech, but it will require tough choices. It’s time for businesses, governments, unions and employees to save our pension system and, with it, the boomers’ retirement lifestyles. While the boomers are the immediate working generation affected, the changes would make the pension system sustainable for following generations also.

This is a very good book, certainly not the dull dissertation you’d expect given the topic. You don’t need to be a finance nerd to enjoy the book, and anyone interested in the Canadian pension system should consider reading it.

The problem with our pension system is that fewer than 40 per cent of working Canadians have an employer pension plan and, as inadequate as it is, we’ve come to depend on the combination of CPP, OAS and GIS. Those government benefits were never intended to provide more than an income floor.

Many middle-income workers will suffer significant declines in their retirement incomes.

In my view, the solution is easy, even if the execution is not. Our system of RRSP savings is excellent. Contribute to an RRSP early and often and a comfortable, worry-free retirement can be yours.

However, we delay, make inadequate contributions and stop contributing because markets are doing poorly or for some other excuse as we spend our money on other, less important things. I’d argue that it’s our fault if our retirement savings are inadequate, not that of the Canadian pension system.

Is expanding CPP the answer?

Regardless, Leech and McNish make the point that many public-sector plans must be redesigned in order to be sustainable. I can’t argue that, unless you’re talking about implementing significant increases in CPP contributions.

The current payroll contribution rate is 9.9 per cent (split evenly between employer and employee) on income between $3,500 and $51,100. A proposal from Prince Edward Island that has gained some support would roughly double the maximum pensionable amount and make the combined contribution rate 13 per cent on income between $25,000 and $51,000. The combined contribution rate would be 3.1 per cent – up from zero – on income between $51,000 and about $102,000.

Related article:  Should CPP be enhanced?

I disagree with across-the-board increases at this time as that would impede a fragile economic recovery. Many businesses are struggling and the increased contribution requirement would further impair their viability.

If you want to adequately provide for your retirement, do your own preparations. Properly fund your own retirement savings and stop depending on the government to provide for you. I think expanding CPP and OAS is a discussion for another time.

As they say, “If it’s to be, it’s up to me.”

Written by Wayne Rothe

Wayne Rothe, Certified Financial Planner/Branch Manager, Wayne Rothe & Associates Wealth Management, Manulife Securities Investment Services Inc., wrothe@waynerothe.com, 780-962-1146, Spruce Grove, Alberta. These comments are the author’s and not necessarily those of Manulife Securities.

7 Responses to Modifying the Canadian pension system

  1. I contribute to an RRSP, a company stock plan program in an RRSP and have a company DB pension plan. I have the option of contributing additional funds into the DB pension plan as well. My question is, where is the best place to add extra contributions – the RSPs or the pension plan? Or, is there a recommended balance to contribute to both?

    • The DB pension is locked in so it is difficult to withdraw. There are many rules on how much and when it can be withdrawn. RSP’s have less rules on withdrawal. Unless you get equal contribution from your employer, I’d contribute to your RRSP

      12/2013

    • Steve,

      I would say neither, I would max your TFSA first. The two plans you have are 100% taxable so you are looking at tax issues when you retire. Sure, you will miss out on the tax refund, however on the flip side you will have a large pot of tax free money at your disposal when you retire.

  2. Another significant reason goes back to 2008. This group were the ones with the savings safely tucked away in RRSP and company pensions when the financial collapse scared them into removing whatever remained of their investments. Sure the markets improved and if they had left their money in those rapidly falling investments they would have recovered all their losses by now but after saving so diligently, watching retirement income quickly disappear caused panic and remaining investments moved to safer vehicles like GIC’s. After losing a significant amount, and I have heard 25% was not unusual, rates of interest in safe savings vehicles has never returned to a decent level. Company pension plan investments managed by companies also lost significant funds so those with company pension plans also lost money there are well. With no time to make up these shortfalls, 2008 put significant pressure on retirement savings accrued from the private sector.

  3. There are some reforms that CPP needs that cost us all, but are seldom mentioned. Specifically there are social benefits and discriminatory aspects that cost everyone and benefit few.

    2 Examples:

    Disability payments. I think we should help the disabled but not from pension money! It is absurd to call it a pension plan then pay people disability benefits they have not earned or payed premiums on.

    Spousal payments: If you are married and die your spouse enjoys ongoing payments. If you are single the plan grabs the net worth of what was contributed and gives it to others. Fairness dictates that either continued benefit goes to the estate in either case, or that there is no continued benefit (probably makes no sense)

  4. I agree with the author 100%.
    I was wondering to myself where this, to me, sudden push for CPP increases was coming from. Consider this, most public DB pensions are pensions that take CPP into account. In other words, if the CPP payout goes up, the amount these, largely underfunded pensions, have to pay to their pensioners. So, by in large, the push is a backwards, dishonest, way to make these pensions viable without addressing the root cause of what made them underfunded in the first place.

    A craven attempt to make John Q. public in effect subsidize these gargantuan unsustainable pensions. To that I say firmly – No thank you.

  5. Generation squeeze feels it again.

    I am 35 years old. The baby boomer in this country created the social programs in Canada that created the debt. Now it is up to my generation to pay for their retirement and save for my own too. OAS should be eliminated.

    When the boomers’ parents pass away they will pass on an enormous amount of wealth to the baby boomers. The parents of the boomers saved every penny after living through the depression. Boomers keep on taking on more and more debt with no thought to the future.

    I am an employer and I will gladly pay the double CPP in Ontario if that is what our government decides. I just wish that there were safeguards in place to make sure that the fund doesn’t go bust as all the boomers retire.

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