Tony Keller: why the obvious fix for the country’s collective pension problem is being ignored

By Tony Keller | Illustration by Paul Blow

Last fall, the Royal Bank of Canada—with $27 billion in annual revenue, $752 billion in assets and 74,000 employees, the biggest and most prudent bank in the world’s safest banking system—announced that new employees would no longer be eligible to receive what is probably the company’s most important workplace benefit: the comprehensive retirement insurance plan. It insures the Royal’s Canadian employees, or at least those hired before January 1, 2012, against all sorts of risks. The risk of reaching retirement age at a time when stock markets are down, or interest rates are low. The risk of outliving one’s retirement savings. Inflation risk. Risks you’ve probably never even heard of, like reinvestment risk and liquidity risk. Even the risk of earning below market returns.

This generous program wasn’t unique to the Royal. Many employers, particularly big companies, once offered similar plans. Some still do, though their numbers are dwindling. You may be wondering, “Why have I never heard of retirement insurance?” You have. It’s called a pension.

We’re heading for a pension crisis. The federal government says so. The opposition says so. Most provinces say so. The library shelves of the land groan beneath the weight of studies. The first class of baby boomers hit 65 this year, and we’re still not ready. The economist Michael Wolfson, formerly the assistant chief statistician of Canada and now at the University of Ottawa, estimates that half of all Canadians born between 1945 and 1970 who have average career earnings between $35,000 and $80,000 are facing a drop of at least 25 per cent in their post-retirement standard of living. Which is perhaps not surprising given that most of us don’t have a pension plan.

The logical fix would be to expand our modest national pension plan: CPP. The Ontario finance minister, Dwight Duncan, spent several years pushing the idea. Workers and employers would contribute more so that, come retirement, they’d receive more. Pension crisis solved. For a while it looked like Duncan’s federal counterpart, Jim Flaherty, was onside—and then ideology got in the way. (It can’t have helped that the NDP and the union movement both favour an expanded CPP.)

Flaherty opted instead for a private-sector solution. Don’t expect results. The Tory government’s big fix is the Pooled Registered Pension Plan (PRPP), expected to come into effect sometime next year. It has major defects—including the fact that neither employers nor employees are under any obligation to join. Canadians are already sitting on more than $600 billion in unused RRSP room, and in 2009, only 31 per cent of those eligible to contribute to an RRSP did so. Nevertheless, a country that isn’t saving enough for retirement through voluntary savings programs is going to try to fix the problem with yet another voluntary savings program. But the biggest problem with the PRPP is its dishonesty. It’s not a
pension plan.

There are two major types of pension plans. The first—the kind that RBC offered its employees until this year—is called a defined benefit pension, or DB plan. Thanks to the pooling of funds among contributors and beneficiaries of different ages and retirement dates, members are insured against retirement savings risks, and then some. Long before they retire, members know what kind of monthly payments they’re going to receive. The employer guarantees it.

Someone enrolled in a typical DB plan and earning $100,000 a year knows that he will be owed an annual pension of two per cent of his salary, or $2,000, for each year of employment. A 30-year employee at that salary would be eligible for roughly $60,000 a year until death. That pension is made possible by a forced savings plan, with the employer required to regularly set aside and invest some combination of employer and employee contributions. The math is complicated, but the pension and RRSP systems are based on the assumption that, if you were that $100,000 earner saving by yourself, you’d have to put aside $18,000, year after year after year, to achieve the same result.

New hires at RBC, along with increasing numbers of private sector employees, receive a different type of pension plan. It’s called a defined contribution pension, or DC plan. The employer may put money in, sometimes quite a lot of money, but as for what comes out at the other end, that’s unknown, and unknowable. The health of the plan is not the employer’s responsibility. Which is why, according to Moshe Milevsky, a finance professor at the Schulich School of Business, DC plans are not pensions. In a recent paper, he describes them as nothing more than “tax-sheltered investment plans with zero guarantees.” A DC plan is really just another RRSP. The individual bears all the risks. And returns, instead of being guaranteed, are guaranteed to fluctuate—wildly.

The shift from pensions to not-quite pensions—or no pensions at all—is happening all across corporate Canada. Only 39 per cent of employees have a workplace pension plan, according to Statistics Canada. And that figure, dismal as it is, paints too rosy a picture. It includes DC pensions. It includes government workers, most of whom have a pension, and a DB one at that. In the private sector, only one in seven workers has a DB pension plan. One worker in nine is in a DC or other plan. The remaining 75 per cent of us? No pension coverage at all.

If your entire knowledge of economics and finance theory is “free markets good, big government bad,” the above might rank as progress. Savings are being liberated from the dead hand of bureaucracy! But it turns out that a free market in retirement savings is nothing like a free market in, say, groceries. Most people aren’t going to forget to eat lunch. But what about planning for an event, like retirement, that may happen 20, 30 or 50 years hence? A growing literature in behavioural economics shows how the rational person is anything but when it comes to planning for a distant, uncertain future. Which may explain why Canadians on the edge of retirement, aged 55 to 64, have an average of just $55,000 in their RRSP. That’s enough to pay out maybe $300 a month. Pre-tax.

My own experience sadly confirms the short-termism of Homo Canadensis. Way back when, starting my first job, I had the option of taking part in my new employer’s defined benefit pension plan. I didn’t. Why not? Because like most 20-somethings, I wasn’t too concerned about saving for retirement. After two years, my collective agreement forced me to join—subjecting me to forced biweekly deductions, about which I constantly complained. A few years later, I moved to a job with no pension plan. No more deductions! I felt richer. But I was really just spending in the present by borrowing from my future.

And even if you have the discipline to save regularly and sufficiently on your own, you’ll run into another problem: Bay Street is not a safe space for individual investors. It’s sort of like that movie Dinner for Schmucks: if you can’t figure out who the schmuck is, it’s probably you. This country’s mutual fund fees are among the world’s highest, with the average equity fund carrying a management expense ratio of 2.3
per cent.

Given that long-term market returns aren’t likely to exceed six or seven per cent, you could wind up losing a third of your portfolio growth to fees.

Don’t blame Bay Street for overcharging you. The market charges what the market will bear. Don’t even blame corporations for getting rid of their defined benefit pension plans. Offering a DB plan means taking on risk and volatility, which will from time to time negatively shock the company’s earnings statement and balance sheet. Transferring those risks back to employees may be bad for society, but a CEO’s job is to do right by shareholders. He or she isn’t responsible for the well-being of society. Our elected
representatives are.

Ottawa and Queen’s Park are where the solution to our pension crisis lies. CPP is a defined benefit pension plan. Back in the mid-’90s, in an act of political cooperation that needs to be repeated, the provinces and the feds came together to save the Canada Pension Plan from insolvency. They prepared it for the baby boomers. Premiums were nearly doubled, bringing them into line with benefits. The plan is now solvent as far as the actuarial eye can see. CPP’s only remaining defect is its modesty: it was designed two generations ago, at a time when employers were expected to do much of the heavy lifting. As a result, CPP aims to provide a pension worth just one quarter of the average industrial wage. The maximum CPP pension at age 65 is currently less than $1,000 a month, and the average pension is just $512.64. It’s peanuts.

The Conservative government has been beating the drum, repeatedly and loudly, on the need for Canadians to save more for retirement. But there appears to be fundamental ideological discomfort with doing so through an expanded CPP, even though it’s obviously the cheapest and most efficient way to make sure we have more savings now, and more income later. A bigger CPP would even help the Tories accomplish their goal of lowering Old Age Security costs. The more we ramp up CPP, the more we can eventually scale back on taxpayer-funded OAS. A dollar saved today for retirement adds up to dollars worth of taxes that won’t have to be raised tomorrow to support indigent retirees. Stephen Harper even touted CPP’s virtues this year in Davos as an example of where Canada gets it right. But he never suggested that we needed more of this good thing to solve our retirement problem. Instead, he fell back on the usual mantras about less government.

More retirement savings through CPP looks, to those who aren’t looking carefully, like more government. Bad, bad, bad. And what about Joe Lunchpail, scratching together a few cents to take a flyer on one of Bay Street’s speculative, high-fee mutual funds? Why, that looks like freedom.