I have been following pension reform and the introduction of the new Pooled Registered Pension Plan (PRPP) since it was first proposed. I have also been quite vocal on how I think the PRPP should work. Now, the government has just introduced it’s framework for a new option called the Pooled Registered Pension Plan (PRPP). Ted Menzies, Minister of State for Finance, said the Pooled Registered Pension Plan (PRPP) will be aimed at the self employed and workers at small-and mid-sized firms, companies that often lack the wherewithal to administer a private sector plan.
Do we really need a brand new plan to target the needs of these small business and self employed individuals? Being someone who is constantly on the street talking to and teaching employees in the workplace, I think very few people understand the existing options properly (DC plans, DB plans, DPSPs, Group RRSP, LIRA, LIF, LA, CPP, OAS, GIS, etc) and now the PRPP is going to add another option to the mix.
The bottom line is I don’t think we need a new program and more rules, more options and more confusion. We have great options already and could have just made modifications to what we have to help Canadians save for retirement. Here’s my two cents on the current issues around pension reform and the new Pooled Registered Pension Plan.
Defined Benefit plans are not the easy solution
Many union organizations criticize the PRPP because it’s susceptible to market drops and these market drops can negatively impact retirement. Just like a Defined Contribution Pension and a Group RRSP, if an employee retires with a PRPP just as the markets are correcting or falling, they may have to re-think the timing of their retirement. Defined Benefit Plans appear to over come this issue because the benefit is defined by a formula but it’s important to remember that the contributions have to increase when the investment performance falls and these plans become underfunded. In some cases, contributions have to go up significantly.
Defined Benefit plans are great but they are expensive and require significant contributions to fund the benefit. If you think about people who retire with a good Defined Benefit pension, what is the key to their success? It has less to do with low fees or the markets. They keys to success are:
- their participation was mandatory,
- their contributions were significant and increased as they got older and made more money and
- their employer help fund the contribution.
If you took a Defined contribution plan or the new PRPP for that matter, and you applied these same characteristics (mandatory participation, significant contributions and employer matching) any employee would have more retirement savings.
Some argue that enhancing Canada Pension Plan is the best solution because CPP is really a Defined Benefit pension plan. Although this may sound great in theory the math is not very attractive. All you have to do is look at how much Canadians have to contribute to CPP compared to the income they get and that option may not be as appealing.
Missing the incentive?
There is no magic to this . . . if you want people to save money for retirement, you have to make it easy and accessible but also give them an incentive to do so. Studies have shown that people will save with a little incentive.
Workplace savings plans are very important to helping Canadians fund the retirement gap because they have all the right qualities . . . they make savings easy, accessible and the successful plans have employer matching which is the incentive to save. In my opinion, matching is the key incentive so maybe the government should think about giving business owners an incentive to match retirement contributions through tax breaks. Ask people why they buy RRSPs and most will tell it's because of the tax deduction. Ask people why they buy TFSAs and most will tell you it's because they are tax free. Ask people why people contribute to a Defined Benefit Pension and most will tell you it's because it's mandatory. Ask people why the contribute to a Defined Contribution Pension and they will tell you it's because of the employer matching. These responses are telling you something about people's incentive to save.
Low cost option
I’ve been an advocate of low cost investing for quite some time now and mandating low fees for employees is a good thing. However, I’m not sure that low fees are the main driver to save more money. If low fees were the primary driver of savings, why is there still so much money in high fee mutual fund products? Why are so many employees of existing workplace savings programs completely in the dark of how much they are paying in management fees?
When you ask employees who participate in a group retirement savings plan, why are you putting money in the plan, rarely will you hear some one say it’s because I get access to lower fees. Low fees may be a benefit to a workplace savings program but it’s not a key incentive for the employee to save. Ironically low fees (or cost) is how to get people to spend). I’m not sure the proposed low fees of the PRPP will entice many employees because they have no idea what fees they are paying in the first place.
Some people need help
The other challenge to a low fee product is there is unlikely to be support or advice around a low fee product. This may create a new set of problems because most people do not have the knowledge, desire, experience or time to manage their retirement portfolios themselves. Even many of the financial institutions I have talked to suggest that in a low fee environment, the distribution, education and advice around the plan must change as a result. In order for the PRPP to be successful, it must address the financial education and advice for the self employed and the small businesses they are targeted to. My biased belief is a workplace savings plan is only as good as the financial education of the plan.
My two cents
Based on the main points of the newly proposed PRPP, I think the PRPP missed the point completely. The main benefit of a workplace savings program is the matching of contributions. Matching is one of the big differences between a great plan and a crappy plan.
My wish is that the government would have taken all the money they spent on developing the PRPP and put that money into tax breaks for employers to give them incentives to match employee contributions using the existing Group RRSP, Deferred Profit Sharing Plans, and Defined Contribution Plans.
Employees would save more money, employers would be more likely to implement a group retirement savings plan and we would not have a new set of rules for a new acronym.