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The first major expansion of the Canada Pension Plan in over a half century is looming and there is already a whiff of scandal in the air. Public sector pension plan sponsors should be scrambling to trim benefits in their own plans to keep contributions and pensions at a reasonable level, but instead a conspiracy of silence prevails.

To understand what is going on, we need to go back to 2015. At that time, the government of Kathleen Wynne in Ontario was pushing hard for a new universal pension plan – the Ontario Retirement Pension Plan (ORPP). The purpose of the ORPP was to fill a perceived shortfall in retirement income for the two-thirds of workers in the province who were not covered by a workplace pension plan. A slight majority of the other third are government workers. The latter group would have been exempted from participating in the ORPP since they already had rather generous pension coverage in the workplace.

The 2015 federal election changed everything as the newly elected Liberals agreed to work with Ontario and the other provinces to expand the CPP instead. Minister of Finance Bill Morneau reached an agreement with most of the country’s provincial finance ministers on the expanded CPP in June, 2016 (Manitoba and Quebec fell in line later). As a result, Ontario abandoned its ORPP.

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The CPP expansion, however, was fundamentally different from the proposed ORPP. No one would be exempted from participating, which meant that employers would have to change their workplace pension plans to prevent total pension benefits from becoming excessive. This was primarily a public sector problem since the pensions in private sector plans were generally more modest. And besides, a number of private sector sponsors have indicated their intentions to pare back the benefits in their plans to recognize the bigger CPP pension.

Most public sector plans, including the monolithic federal Public Service Pension Plan, are geared to providing a pension of about 70 per cent (actually a little more) of final average income to employees with 35 years or more of service. The 70-per-cent income target might seem reasonable until you consider three factors. First, for a reason I cannot fathom, it doesn’t include the Old Age Security (OAS) pension. As far as I know, the government is not paying out OAS with Monopoly money.

Second, pensions at this stratospheric level are possible only if the amounts contributed are higher than what individuals who save on their own can contribute to registered retirement savings plans (RRSPs). The government simply doesn’t allow people to make enough tax-deductible contributions to save enough to generate a 70-per-cent pension. Third, most workers can maintain the same standard of living after retirement with less than 70 per cent – often much less.

It is the third point that is the most contentious, even though the fallacy of the 70-per-cent target is easy to demonstrate. A 2017 study by Bonnie-Jeanne MacDonald and Lars Osberg of Dalhousie University and Kevin Moore of Statistics Canada found that more than 80 per cent of workers who retired with a gross replacement rate of 65 per cent to 70 per cent were able to improve their standard of living after retirement, and in many cases the improvement was dramatic. The example in the first table shows how a middle-income couple’s standard of living could improve by a whopping 71 per cent. (Note the example assumes that mortgage payments and child-raising costs would end by retirement.)

How a 70% pension can be excessive*

Average in the 10 years before retirement
Gross income (combined) $100,000
Less pension contributions ($10,000)
Less CPP contributions ($4,800)
Less income tax ($13,600)
Less work-related costs and EI premiums ($4,500)
Less mortgage payments ($10,000)
Less child-raising costs ($14,000)
Net spendable amount before retirement (A) $43,100
Amounts in first year of retirement
Gross income from workplace plan and CPP $71,000
OAS pension $13,500
Less income tax payable ($10,700)
Net spendable amount after retirement (B) $73,800
Improvement in living standard (B/A) 71%
*This is before reflecting the CPP enhancement. Source: Frederick Vettese

*This is before reflecting the CPP enhancement. Source: Frederick Vettese

For the public sector, a boost too far

How can this be true if practically no one is talking about it? Consider the stakeholders. Civil servants certainly wouldn’t be inclined to point it out. This is true even of the representatives on the employer’s side of the bargaining table since they also participate in these plans. Politicians are reluctant to act since they know that the public sector unions are a powerful voting lobby. Actuaries who provide pension consulting services cannot speak openly without jeopardizing their firm’s public sector business. Finally, the opaque nature of defined-benefit plans prevents almost anyone else from understanding what is going on.

The main argument put forth in defence of the 70-per-cent formula is that many civil servants do not have 35 years of service on retirement and so never reach 70 per cent. While this is true, they should be expected to save on their own in the years when they weren’t covered by a plan, the same as other taxpayers do; the pension offered for shorter periods of service should be proportionately less. And in case the 35-year requirement seems onerous, note that workers need to contribute to the CPP for 40 years to get a full pension.

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I have no reason to think the existing situation will be rectified given that no one at the table is truly representing the interests of taxpayers. It might not be too late, however, to prevent things from getting worse. Which brings us to the CPP enhancement.

Starting in 2019, contributions and pensions under the CPP will start to rise. While it will take a long time (about 40 years) before the enhancement in pensions is fully phased in, pension plan sponsors should be acting now to modify workplace pension plans so that the total pension including CPP remains at a reasonable level. After talking to many people in the pension industry, however, I have yet to find a large public sector pension plan that is committed to doing this. They have figured out that by doing nothing, they are essentially getting a boost in pension – a boost that the foregoing example shows is clearly not needed.

To show how a participant in a public sector plan will be affected in the long run, I have taken the previous example and built in a lifetime of participation in the enhanced CPP (but without modifying the workplace pension plan). The result is shown in the second table.

What the CPP enhancement does

Average in the 10 years before retirement
Gross income $100,000
Less pension contributions ($10,000)
Less CPP contributions ($6,100)
Less income tax ($13,300)
Less work-related costs and EI premiums ($4,500)
Less mortgage payments ($10,000)
Less child-raising costs ($14,000)
Net amount available to spend (A) $42,100
Amounts in first year of retirement
Gross income from workplace plan and CPP $78,700
OAS pension (for 2 people) $13,500
Less income tax payable ($13,100)
Net amount available to spend (B) $79,100
Improvement in living standard (B/A) 88%

Source: Frederick  Vettese

Conclusion

The second table shows that the standard of living for this couple is now higher in retirement by 88 per cent than it was before retirement. This compares with a 71-per-cent improvement in the absence of a CPP enhancement. This shouldn’t be happening. The 71 per cent should have remained 71 per cent, or even gone down. It is those workers without workplace pensions who should be helped. And the CPP enhancement, as it is unfolding, has done nothing to narrow the gap between public and private sector pensions. As flawed as it was, the ORPP at least had the virtue of preventing an unwarranted increase in pensions from happening since large public sector plans wouldn’t have participated in the ORPP.

It is not too late for the federal government to remedy the situation.

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Frederick Vettese was previously chief actuary at a large actuarial firm. He is also the author of Retirement Income for Life: Getting More without Saving More.

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