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Canadians Need a Policy Nudge to Enhance Pension Contributions

06/24/2015 06:06 EDT | Updated 06/24/2016 05:59 EDT
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Pension reform continues to hold interest across the country, especially given the willingness of the federal Conservatives to at least talk about expanding the Canada Pension Plan (CPP). Pundits and politicos are weighing in now with blunt talk of "voluntary" or "mandatory" enhancements to CPP. Neither may be exactly what Canadians want. Here's why.

What do Canadians want out of a national pension system?

I think it's safe to guess they want at least the following: a system that can be trusted, the lowest cost possible, high rates of return on investments, but within a range of prudent safety, transparency and a governing process that puts the interests of the plan participant (and not agents) first and foremost.

More importantly, perhaps, they want a system that will stay with them even if they change jobs and employers -- turning savings into monthly cheques in retirement, until death.

So who is at retirement income financial risk today? A large number of workers.

We know only 32 percent of workers have workplace pensions of any type. In the private sector, only 24 per cent of workers have anything. Further, the superior Defined Benefit Plan coverage is down everywhere.

We also know that very poor workers should not be forced into a mandatory system. Why? Because, after paying their mandatory contributions, they will receive very little to no extra benefits because of the claw back provisions in our Guaranteed Income Supplement (GIS) (usually alongside provincial supplements). In fact, the working poor can easily lose a full dollar for every new dollar of monthly income they produce on their own. Not to mention that the Old Age Supplement (OAS) and GIS benefits, now payable at age 65, will not be paid until age 67 starting in 2029.

Can we provide Canadians with a better system? The answer is a hearty YES, although it will take some will on the part of legislators, both federal and provincial, since Pension Benefits Acts and the Income Tax Act will have to be amended.

Here is how it would work. The government makes it possible for institutions and agencies to create large pooled Retirement Income Funds to which any worker can contribute (within some tax limits). After a very short establishment period, these funds must achieve a minimum size (at least $10B in short order but even larger later). The funds must have a Board of Directors of experts who will guarantee good governance and guarantee that the plan participants' needs are paramount and more important than any agent within the system. Expense ratios will be capped (and policed). Forty basis points (0.40 per cent) seems appropriate since many larger pension plans today operate with expense ratios below 25 basis points.

You would be automatically enrolled, with an automatic payroll deduction if you are not in a Registered Pension Plan -- but you can take action to opt out. This "nudge" (according to the evidence) should result in ultimate participation rates in the 80 to 90 per cent range. But, it will also allow poorer workers to opt out, as they should.

You and the fund will decide on your retirement income goal stated as a Defined Benefit. From this goal, one would subtract the benefits anticipated from OAS and CPP. The balance is what the fund is meant to provide.

Using slightly conservative actuarial assumptions as to rates of return and life expectancy, the fund will decide what contributions are necessary to attain your goal. Every year you will get a statement showing the record of the fund over the past year and whether you are ahead or behind the projected values necessary to reach your goal.

At retirement, you will continue in the fund and it will pay your monthly benefit cheques. Behind the scenes, the fund can carry the longevity risk of the group (not very volatile given the size requirements of the fund) or they can buy annuities (on a group basis -- more competitive than for individual annuities).

Your benefits will be highly probable as to their attainment, but they will not be fully guaranteed. If we have another 2008 financial meltdown, you may face a short- term decrease in benefits. Note that what you get is a monthly benefit for life, not a lump sum at retirement.

Who can offer such a fund? Anyone who can meet the capital requirements -- likely any banks, insurance companies that exist today could expand into this activity. But, also, large pension funds would be invited to offer this product.

It can be done. It just requires some imagination and a few (but important) tweaks to existing pension and income tax laws. Canadians want this. They deserve no less.

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