The recent labour disputes at Air Canada and Canada Post are just another signal that Canada's pension system needs fundamental reform. Only a quarter of working Canadians are now covered by workplace pension plans that promise defined benefits at retirement, and many employers, like those at Air Canada and Canada Post, are finding these plans unsustainable.
Canadian finance ministers have begun to discuss pension reform options, with the next meeting now planned for sometime in the fall. Options include the idea of expanding the Canada/Quebec pension plans, but the recent focus has been on voluntary saving in individual or employer-sponsored, defined-contribution vehicles called Pooled Registered Pension Plans.
The PRPP initiative might help encourage more saving, but it won't be enough. It doesn't recognize the significant shift now occurring in the balance of Canada's retirement income system, away from the defined benefits provided through Old Age Security, the CPP/QPP, and employer-sponsored plans toward the more uncertain income derived from saving in employer-sponsored defined-contribution plans and RRSPs.
And, it doesn't recognize research showing that contributions to individual and small-employer plans are much less effective in generating retirement income than saving in larger defined-benefit pension plans or the even larger CPP/QPP. Problems with small plans include high administration costs that eat up much of the investment return, less-expert investment management, and contribution levels that are often inadequate to provide the pension income needed. Increasing life expectancies and an anticipated environment of low investment yields will exacerbate these problems.
Studies show that 25 to 30 per cent of modest- and middle-income earners are currently not saving enough to avoid a significant drop in their standards of living at retirement. The ongoing shift to small-plan saving can only worsen these outcomes.
In response, several groups have proposed introducing a new form of government-sponsored pension plan to address these concerns. In a recent study I published with the IRPP, I compared three different options for such a plan: a national, mandatory defined-benefit plan, and two defined-contribution plans, one mandatory and the other voluntary. The defined-benefit plan I propose entails a modest expansion of the CPP/QPP that would raise the benefit rate from 25 to 40 per cent of earnings up to $48,300 and from 0 per cent to 25 per cent of earnings between $48,300 and $96,600.
Looking at plans with the same contribution structure, I conclude that the defined-benefit plan would provide higher benefits per dollar of contribution than either of the defined-contribution plans. By enabling risk pooling among age cohorts, defined-benefit plans can achieve higher returns through longer investment horizons and slightly greater exposure to risk. The defined-benefit plan would also provide participants with more secure and predictable retirement income than the defined-contribution plans. In a national defined-benefit plan, a serious investment shock can be dealt with by small contribution and benefit adjustments spread over the whole population of workers and retirees, rather than its effects being concentrated on individual savers according to their investment choices and age at the time of the shock.
A new nationwide plan on the CPP/QPP model would not suffer some of the drawbacks of existing single employer defined-benefit pension plans, which tend to hamper labour mobility and encourage early retirement.
With any mandatory plan, one must be concerned with the possible negative effects of increased pension contributions on employment, particularly at lower income levels. For this reason, I propose only a modest-scale expansion of the CPP/QPP as well as measures to limit the contribution rate increases for lower-income workers.
The proposed pension reform would serve a second purpose. By boosting future retirement incomes, it would limit the significant increases in Guaranteed Income Supplement benefits that will occur as individuals shift more of their retirement savings into Tax Free Savings Accounts over time. Currently, the income withdrawn from TFSAs is non-taxable and is ignored in determining eligibility for GIS and other benefits. Without reform, we could end up with large numbers of middle-income seniors paying no income tax and drawing GIS benefits intended for those in need - an untenable outcome in a context of an aging population facing rising costs of health care and public pensions.
Keith Horner, a former Finance Department official, is the author of A New Pension Plan for Canadians: Assessing the Options, published by the Institute for Research on Public Policy.
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