Reform Coming to the Canada Pension Plan -- Why?

Great Debates
1

http://www.theglobeandmail.com/news/politics/pension-reform-wont-be-easy-jim-flaherty-warns/article1771086/
http://www.theglobeandmail.com/news/national/expansion-of-cpp-emerging-as-preferred-option-for-pension-reform/article1772248/
http://www.theglobeandmail.com/news/politics/let-canadians-decide-whether-to-raise-retirement-age-report-says/article1801771/

It seems that the Canadian Government has run out of things to do. Apparently the federal deficit – and I swear that I’m not making this up – is just going to fix itself. And so the government has decided that it’s time to reform the Canada Pension Plan(CPP). I’m at an utter loss to explain this. Thanks to the most recent reform in the 90s, the CPP is projected to be fully funded past the life expectancy of anybody currently contributing to it. And yet the Conservatives are going on about the necessity of instituting large premium hikes.

As near as I can tell, the problem that the Conservatives are trying to solve is that many middle-class Canadians don’t save enough for retirement, and wind up surviving just above the poverty level on government benefits. And I really have to say: who gives a damn? That’s the choice they’ve made. The government offers some really fantastic programs for retirement savings. If Canadians aren’t taking advantage of them, forcing them to participate in a comparatively worse program isn’t the answer.

What really galls me about this is the paternalism of it all. Personally, I max out my RRSP, and now it looks like the government is going to step in and force me to save even more because it knows better than me. Ok, I’m probably pretty rare, especially in my age group(I’m in my mid-20s). But I really don’t understand why they’re leaning towards implementing a policy that hits the good savers and the poor savers equally.

Currently the Liberals have a proposal out there to make the premium increase voluntary(clearly Canada has become economic bizarro-world). I think that’s a much better plan. However, it’s pretty clearly not going to do much to help the problem. If middle-class Canadians aren’t contributing to their RRSPs, they aren’t going to contribute to a voluntary CPP. So, if the government really has to do something to force Canadians to save, give them an option. They can either opt to contribute the premium increase to the CPP and increase the CPP benefits at retirement, or they can choose to contribute the premium increase to their RRSP. My preference would be to not count that contribution against the RRSP limit(or, equivalent and simpler to implement: increase the RRSP limit by the premium increase if it’s contributed to the RRSP). I mean, if the government is going to force me to save more for retirement, they should at least give me the flexibility to invest my money as I choose.

I suppose that I should at least take solace in the fact that nobody is seriously considering the “everybody else is doing it, so let’s arbitrarily raise the age for qualifying for CPP benefits” espoused in the last article that I linked to.

2

FWIW, the UK Conservative party has also got a similar idea into their heads. Apparently Britons aren’t saving enough either, with many falling into poverty in old age, so every employer, no matter how small, is being forced to set up a mandatory pension plan for their employees with matching contributions from employer and employee.

3

From a (small c) conservative point of view, it’s not just that there are going to be a lot of old, broke people; it’s that increasing the savings rate is probably a necessary step to insulate Western economies from another Great Recession.

4

This is one instance where I agree with the Liberals and disagree with the Conservatives. A mandatory increase in CPP contributions is not the way to go.

If you want to affect the savings rate, there are a couple of things that could be done. Cass Sunnstein, one of President Obama’s advisers, has an idea that might be useful here: ‘Nudging’ people towards better savings behavior by simply changing the defaults around savings. For example, instead of demanding mandatory increases in contributions to CPP, set up a system whereby additional funds are withheld from your paycheck for your retirement and put into a fund that you can convert to an RRSP at any time, or withdraw completely by paying the income tax on it. The program would be opt-out, so people don’t have to participate if they don’t want to, but it would be up to them to take steps to remove themselves from the program.

Behavioral economics tells us that if you set the default up that way, a significant percentage of people will stay in the program who otherwise wouldn’t save for their retirement. For the same reason that savings rates are higher for employees who have savings programs set up where their bank automatically deducts savings from their paycheck deposit.
Another problem with saving for retirement in Canada is that the marginal tax rate on small retirement incomes is ridiculous. And if you have saved through an RRSP, money you withdraw to live on is treated as income.

For example, consider three main supplemental programs that exist to increase the standard of living for poor retirees: The Guaranteed Income Supplement, the age credit, and Old Age Security.

These programs are ‘clawed back’ for people who have retirement income. The effect of this is to make the effective tax rate on withdrawn savings very high:

The Guaranteed Income Supplement is a supplement of up to $7,608 of tax-free income paid to seniors with an income under $15,240. Essentially, for every $2 of taxable income, the GIS is reduced by $1. That alone creates a marginal tax rate of 50% on withdrawn retirement savings.

The age credit is a tax credit of $5,177 that is reduced by 15% for any dollar of income above $30,935.

Maximum OAS is a taxable income of $6,028 that is also reduced by 15% for incomes above $63,510.

The first clawback, the GIS, is the one that really hurts middle-class savers. Let’s say you saved your entire life, and have $200,000 in retirement savings. You go to your bank on your 65th birthday, and turn that into an annuity that pays you $15,000 per year. That is taxable income, and you immediately lose $7500 of it to the government.

At certain income levels, and considering the other smaller clawbacks on various retirement services that are available, the overall marginal tax rates for middle-class savers can be as high as 73% on retirement income.

One of the justifications for an RRSP is that it’s smart to save money tax-free while you’re working and in a high tax bracket, then withdraw it when you’re retired and presumably move down in tax brackets. Because of clawbacks, there is a range of incomes where this just isn’t true - your tax rate will increase in retirement, and you’d have been better off not saving that money in an RRSP.

The other reason to save in an RRSP is because income and dividends and capital gains can accrue and compound without taxes eating away at the compounding rate. But now that the Harper Government has instituted Tax Free Savings Accounts, you can achieve the same thing without having to push the income itself into retirement.

Maybe this is the problem the Conservatives are trying to solve. I’ll have to read all the links and see if that’s where they are going with this. I’m generally in favor of means-testing retirement benefits above the actuarial value of your own contributions, but it does have this nasty side effect of depressing the savings rate.

As a practical matter, if you’re in a reasonably low tax bracket now, and you want to save money for retirement, it may be entirely possible that a Tax-Free Savings Account is a much better way to do it than an RRSP, even though you won’t get the tax refund now. Because you’re taxed on the principle already, it’s not income when you withdraw it in retirement, and not subject to the clawbacks. This is going to be true for certain ranges of income and levels of retirement savings, and it’s one of the choices that can make retirement planning hard. But if you’re a heavy saver, you should look into this.

5

Reading those links, it appears that the government really believes that the current CPP structure is not enough alone to provide for people in retirement. I think that’s ridiculous.

Let’s say you are a retiring this year at age 65, and have no other savings, retirement plans, or anything. Let’s further assume that you’ve earned enough income to pay the maximum monthly CPP contribution. This is what you’ll get:

Canada Pension Plan: $934.17
GIS: $658.40
OAS: $521.62

Total: $2114.19

Now consider that at retirement you have no work-related expenses, and that there are seniors discounts available for everything from food to entertainment to travel. And health care is free.

This amount is also not subject to tax, making this probably equivalent to a taxable income of over $30,000 per year.

If you’re a married retired couple, you’ll be received direct cash from the government of over $50,000 per year. And if one spouse dies, the other spouse gets a death benefit to allow them to maintain the standard of living.

Now add in the number of people who have assets like homes and paid off vehicles, I’m having a hard time seeing that this is not adequate. No, it may not maintain your pre-retirement standard of living, but is that the job of a mandatory government program? As far as I’m concerned CPP should be set such that you can live a comfortable retirement without worrying about food and living accommodations. Anything above that should be the individual’s responsibility.

In fact, I wouldn’t be surprised if the retirement savings rate is so low because people look at what they are going to get from the government and think, “Hey, that’s not so bad. I don’t need to save much.”

Now, where you get hurt is if you never paid much in to CPP in the first place, either because you didn’t work your entire life, or because you worked in very low income jobs where you didn’t contribute much. But in those cases, your standard of living was already low, and you don’t need as much money to maintain it.

There are certainly circumstances where people run into real difficulties in retirement. But you don’t need to reform the entire system to cover them.