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Retirement puzzle (GETTY IMAGES)
Retirement puzzle (GETTY IMAGES)

OPINION

New lens needed on pensions Add to ...

After five years of debate on pension reform, the long-term sustainability of our retirement system remains in doubt. The crux of the problem is that our notions about pension entitlement do not align with our ideas about aging.

We regard the commencement of social security pensions at age 65 as a fundamental right while rejecting mandatory retirement at age 65 as discriminatory. These two beliefs are inconsistent and will eventually have to be reconciled.

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Mandatory retirement at 65 was abolished in recent years, essentially because Canadians believe they are capable of working productively beyond age 65. And not only capable but willing: A Harris/Decima survey in January shows that a majority of those polled intend to work after retirement in order to remain mentally or socially active.

The original purpose of social security pensions was to protect against the loss of income in old age when one can no longer work. In 1889, Bismarck made Germany the first country to introduce social security by providing pensions from age 70, an age that was considered a good proxy, at the time, for the general onset of disability. It was also felt that by making room for younger workers, pensions allowed the economy to operate at maximum efficiency.

Over time, the idea of pensions as a protection against the disability of old age morphed into pensions as an age-related entitlement, even when not accompanied by disability. The idea of social security pensions as a mechanism to replace older workers has also fallen by the wayside. So we have discarded the original ideology underlying social security pensions but have replaced it with an ideology that is murky at best, and even counter-productive.

Providing Old Age Security and Canada Pension Plan benefits from age 65 at present has little to do with protection against disability. It has even less to do with allowing the economy to operate efficiently, since it entices able-bodied workers to leave the work force prematurely, which is something we won't be able to afford much longer. In 2010, Canadians age 25-64 outnumbered those 65 and over by a ratio of 4 to 1. By 2036, this ratio is projected to drop to 2 to 1. The only way to maintain age 65 as our normal retirement age will be through progressively heavier taxation or contributions on the part of the working age population. This will depress disposable incomes and hence living standards.

To take a different perspective, consider the ratio of average working years to pension years, something I will call the "pension deal." When the Canada Pension Plan was established in 1966, a Canadian male age 65 could expect to live another 14 years. This would have followed 40-odd years in the work force. Thus, the "pension deal" for the typical (male) Canadian was 3 to 1; that is, three years of work for one year of pension receipt. (The deal for female workers was a little better than that.)

Since 1965, life spans have lengthened by about one year per decade. Today, private-sector workers tend to retire at about age 62, when males can expect to live another 21 years. The pension deal has thus dropped from 3:1 to 2:1. The situation is even more extreme in the public sector where the pension deal is now just 1.3 to 1. Part of this improvement can be justified by increases in productivity and work force participation rates, but not all of it. The rapidly declining ratios have been driven by demographics and confirm the suspicion that we have a sustainability problem.

If cost weren't an issue, we could continue paying social security pensions at age 65 and count it as one of the benefits of living in a prosperous nation. Cost, however, is a problem and one that will grow over time as Canadians continue to live longer and our working-age population continues to shrink.

So how do we square the circle? A starting point is to accept the reality that aging is a gradual process and that there is no magical age when highly productive individuals suddenly become incapable of gainful employment. This transition phase occurs on average over the decade from 60 to 70, though evolving demographics may shift it in the future. One possibility, then, is to reflect this transition phase in our pension laws and employment standards.

For instance, governments could create incentives to encourage companies to hire workers who are in the transition phase, at least on a part-time basis. Partial government pensions could still be payable during this time, but the amount might have to depend on one's attachment to the work force. Finally, employers should be able to initiate discussions with their employees about moving to part-time status in the transition phase. The goal is a more-sustainable retirement system that better reflects the capabilities and preferences of older workers, as well as shifting demographics.

Fred Vettese is the chief actuary at Morneau Shepell.

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