Retirement Solution?

Photo © Pgiam

Headline #1 – More Canadians plan to work past age 65.

Headline #2 – Bank president calls for expansion of CPP.

Those two stories caught my attention last week because both speak directly to the evolving pension crisis in this country.

Headline #1 refers to a new survey from Sun Life Financial which found that only 27 per cent of respondents between ages 30 and 65 expect to be fully retired at 66. Almost as many, 26 per cent, said they will still be working full-time while 32 per cent expect to be working part-time. The rest were uncertain.

The insurance company said the number of people who expect to retire at 65 has fallen by almost 50 per cent from five years ago. Even more alarming is the fact that 39 per cent of those who continue to work will do so because of economic necessity. Otherwise, they don’t believe they will have enough money to maintain their living standard.

“The dream of being able to afford a full retirement at age 66 is declining among Canadians, it’s being replaced by the reality that many people expect to be working beyond the traditional retirement age,” said Sun Life president Kevin Dougherty. “The aftermath of the financial crisis of 2008 has had a lasting impact with more Canadians expecting they will need to work longer as a result.”

The survey is just the latest of several which show the same broad trend. The expectation of stopping work at age 65 is a fast-fading dream as Canadians face up to the harsh new realities of retirement. The combination of low savings rates, prolonged low interest rates, longer life expectancy, and the rapid disappearance of defined benefit pension plans from the private sector is forcing people to rethink how they will spend their later years. Increasingly, that rethink ends with the conclusion that the only way to maintain their standard of living is to keep working.

This brings me to headline #2 and I have to say that it both surprised and encouraged me. Gerry McCaughey, CEO of the Canadian Imperial Bank of Commerce, went on the record as advocating an expansion of the CPP through voluntary contributions.

Coming from a bank executive, this borders on heresy. Financial institutions earn big profits from the billions of dollars that pour into RRSPs and TFSAs. Why else do you think they spend all that money during RRSP season to encourage you to make a contribution?

In fact, one of the reasons that companies like Sun Life publish these polls is to persuade (some might say frighten) people into taking retirement savings more seriously. Based on the evidence, it hasn’t been working; the percentage of tax filers claiming an RRSP deduction has been gradually declining in recent years.

Mr. McCaughey’s proposal, were it to be adopted, would siphon off a lot of those savings from the banks and insurance companies and into CPP coffers. His shareholders are not going to like that idea at all so it’s difficult to understand at first glance why the CIBC president would be prepared to go out on a limb to advocate a plan that is counter to his company’s self-interest. The answer, it seems, is that he is genuinely alarmed about what lies ahead for many people if something is not done.

He told an audience of senior government and business leaders in Fredericton that, according to new research conducted by CIBC’s economics group, nearly six million Canadians will face a drop in living standards of more than 20 per cent if current savings rate trends continue.

“Our research found some 8.4 million people will experience a decline of more than 5 per cent in their standard of living at retirement,” he said. “Far more troubling is the fact that 5.8 million Canadians are on pace to experience a significant decline – meaning a reduction in living standards of more than 20 per cent.

“And, here is perhaps the most alarming takeaway: when we look at those 5.8 million people we see that most of them are young. In fact, our economists estimate that almost 60 per cent of adults in their late 20s or early 30s can expect to experience a significant decline in their standard of living when they retire.”

The CIBC president is to be commended for going public on this issue. Moreover, his proposal makes so much good sense that Finance Minister Flaherty should seize on it immediately and incorporate it into his upcoming budget. Here’s why.

One of the reasons Canadian are facing a retirement crisis is a lack of certainty in the income they will receive. Defined benefit (DB) pension plans – those which guarantee a specific payout at retirement – have almost disappeared from the private sector.

According to Statistics Canada, only 38 per cent of workers have any kind of pension plan at all. But here’s the real shocker: only 25 per cent of private sector employees have a pension plan compared to 84 per cent in the public sector. Over time, public sector coverage seems bound to erode as private sector taxpayers become increasingly resentful of seeing some of their money used to pay for pension plans they can’t have.

The Canada Pension Plan is a DB program. The amount you receive at retirement is determined by the number of years of contributions and your income level, up to an annual maximum. Defined contribution (DC) pension plans, the new norm in the private sector, offer no such guarantees. The amount of the pension will be determined by how much is contributed to the plan and how well the invested money performs. RRSPs, TFSAs and the new and as yet unproven and generally unavailable Pooled Retirement Pension Plans (PRPPs) operate in the same way.

Mr. McCaughey’s plan would enable Canadians to voluntarily increase their CPP contributions and hence add to the amount of the guaranteed pension they would receive when they begin to draw benefits. The extra contributions would be administered by the Canada Pension Plan Investment Board which has an excellent track record in terms of returns, protection of assets, and low costs.

Furthermore, the plan would not cost cash-strapped Ottawa one nickel as the voluntary contributions would be made on an after-tax basis, in the same way as TFSAs and RESPs. Mr. Flaherty’s oft-expressed concern about an expanded CPP imposing an additional payroll tax that would be a job-killer could be defused by not requiring employers to match the voluntary contributions.

Mr. McCaughey says that for his idea to work, the voluntary contributions must be locked in until retirement, just as current CPP contributions are. There would be no provision to dip into the fund, for any reason, thus setting it apart from RRSPs and TFSAs. However, people could choose to stop making new payments if they wished. The offsetting reward is a higher guaranteed pension at retirement as well as “date certainty and real dollar amount certainty”.

He said that CIBC research shows that such a solution would help close the retirement savings gap for young Canadians by as much as 80%. And it would “reignite a culture of savings” in this country.

It will be argued that the voluntary aspect of the plan would make it virtually worthless. If Canadians won’t contribute to RRSPs now, why would they put more money into the CPP?

I believe that many people would take advantage of such an opportunity for two reasons. First, they don’t trust their own investment skills and still bear the psychological scars of the 2008-09 crash, Second, the guarantee of a higher pension at the end of the day will be a compelling incentive,

Of course, one of the side-effects would be the diversion of funds away from RRSPs and TFSAs and thus away from the banks. It appears that CIBC, for one, is prepared to live with that.

Gordon Pape’s new books, Tax-Free Savings Accounts and Money Savvy Kids, are now available for purchase at 28% off the suggested retail price here. For information on a three-month trial subscription to Gordon Pape’s Income Investor newsletter go here.