The Pension Series – Part III – Universal Solution

So with all of this mess around pensions what should be done?  Well there has been discussion from various groups with potential solutions.  One of the more interesting ones was a proposal from CARP (Canadian Association of Retired Persons) which was discussed on the Wealth Boomer blog.

Here’s a summary of the key points:

CARP says pension experts agree retirement income from all sources must replace between 60 and 70% of working income. Currently, the CPP provides at most 25% of Year’s Maximum Pensionable Earnings (YMPE): $46,300 in 2009. Thus, for those without employer-sponsored private pensions, the maximum CPP benefit this year is $10,905.

CARP suggests gradually phasing in a UPP so that coverage would eventually cover 70% of pre-retirement income to a maximum pensionable earning limit of $116,667 (which is the 2009 limit for Registered Pension Plans).  Like the CPP, the UPP would be a mandatory enrollment plan. CARP is wary of any version that would let individuals “opt out.”

The issue with a truly universal pension plan is someone still has to fund it.  In this case that someone would be you and your company (ie: they raise prices and their customers pay it).  So let’s assume for the moment we want to double the coverage of CPP to 50% replacement of YMPE and raise the YMPE to $166,667 (It’s not exactly the CARP proposal, but similar to some others I’ve seen).  That would mean that we would need to first double our contributions for both the worker and employer from 4.95% each to 9.9% each and then have to keep paying CPP on just about every dime of income you make.

In a realistic sense this would change the contributions of someone making $75,000 a year from the maximum of $2118 per year now to $7425 under the new proposal.  That would be an increase of over 250%, that your employer would also have to match.  No wonder CARP is wary of any version that let’s people opt out because you would see a huge number of people willing to take the risk of doing it on their own and keep their money.  This would be like the government jacking up taxes by 5% just about every person and business in Canada at every level of taxation.

This unfortunately is the issue with any radical reform to a mandatory plan is it places a huge burden on everyone and I think most of us are not really willing to make that trade for a benefit that we won’t see until we turn 65.  I know some people might be with that trade off, but the whole idea is working under this proposal is basically that people are idiots and can’t manage to save for retirement by themselves.  We don’t need a nanny state where the government does everything for you since you can’t be trusted to do it yourself.

So where does this leave us?  Well I’ll take a try at proposing a solution tomorrow, but in the mean time what do you think of increasing mandatory savings plans?  Would you stay in a plan like I outlined above or not?

18 thoughts on “The Pension Series – Part III – Universal Solution”

  1. Tim,

    Great article and great series that you have going right now. I am really enjoying reading it.

    This CARP idea really bugs the heck out of me. We already have a UPP it is the CPP. If we increase the costs on a person and a business I can see a lot of small businesses that will do with out hiring new workers because it becomes to cost prohibitive to hire a new person. I say we have the CPP and lets let others just fend for themselves and make there own investing decisions.

    Rocky

  2. Excellent analysis of the impact on CPP payments that a UPP-like plan would cause. If you factor in the coming demographic changes, things will get even worse. Our CPP payments aren’t saved up for us when we retire. They get paid out to current retirees. Each year the number of working people per retired person drops a little. This means that future CPP premiums will have to rise to even more to pay for a UPP-like plan.

  3. Rocky,

    I somewhat agree with your point of view. You don’t want to do too much for everyone, but at the same time there should be some standards.

    Michael,

    Good point. Any excessive increase in CPP payouts would be a problem in the long run.

    Tim

  4. The Canadian Dream’s analysis of CARP’s proposed CPP expansion is serioulsy flawed because it rests on the inaccurate presumption that doubling the CPP benefit rate from 25% to 50% would require a doubling of the contribution rate from 9.9% to 19.8%. Doubling the CPP contribution rate would require an additional contribution rate of about 5.5% rather than 9.9% because any improvement to the CPP shall, by virtue of the CPP Act, be funded in advance. If the CPP had been funded in advance in the first instance in 1966, the contribution rate would have been about 5.5% (it was actually set at 3.6% and remained at this level for 20 years) and benfits would have accrued on a gradual basis over about 40 years (full benefits did actually fully accrue after only 10 years). The current CPP 9.9% contribution rate is higher than 5.5% in order to help offset the effect of the deficiencies in past contributions. The 5.5% estimate rests on the statements made in the statutory actuarial reports on the CPP.

    Financing a CPP expansion would indeed be a burden. However, this burden would be less than that already incurred by the more than 1/3 of employers who sponsor a 70% defined benefit (DB) pension plan for their employers. Not only are CPP costs less than a comparable private DB plan but it also provides disability benefits. The main reason for the lower CPP cost is that its normal pensionable age is 65, while it is generally lower under typical private DB plans.

    Bernard Dussault
    CPP & OAS Chief Actuary 1992-1999

  5. It’s great to have a true expert like Mr. Dusseault weight in. If I understand you correctly, sir, only a portion of the CPP rate needs to be doubled to be able to double benefits. However, CARP’s proposals call for benefits to more than double. Do you have an opinion on how high the CPP rate would have to go to cover CARP’s proposed benefit levels in their Universal Pension Plan (UPP)?

    It seems very unlikely that the government would adopt something similar to the UPP but only increase benefits slowly over 40 years. The current attempts to catch up mean that today’s workers are (at least partially) paying for the CPP payments of current retirees. If benefits jump sooner (possibly immediately) it will mean that current retirees will continue to partially pay for current CPP payouts. Given, this, do you have any insight into how CPP rates would be affected in the future as the ratio of workers to retirees drops, assuming that UPP-level payouts are adopted?

  6. I meant to add in my last comment that it makes sense to me that an expanded CPP would be more efficient (and more reliable) than the system of DB plans run by employers. My interest is in figuring out what level of CPP benefits (and possibly OAS and GIS) would be affordable.

  7. If the CPP was to be expanded by increasing (a) the benefit rate from 25% to 70% and (b) the YMPE ($46,300) to the ITA limit applying to RPPs ($122,222), then in accordance with the estimates provided on full funding in the CPP statutory actuarial reports the following contribution rates would need to be added to the existing contribution rate of 9.9% that applies to the portion of salary from the YBE up to the YMPE: 9.9% of salary up to the YMPE plus 15.4% of salary from the YMPE to the ITA limit.

    Considering the size of this expansion, it would need to be done in two steps by increasing the benefit rate first from 25% to 50% and then from 50% to 70%. For each step, the required additional contribution rate would be phased in over 5 years.

    Full details will be provided in my upcoming monograph on the full-scale expansion of the CPP.

    Federal and provincial governments are listening very carefully to this proposal. True the CPP payments of current retirees are paid partly by current workers (and this will never change, the 9.9% rate is there to stay). But that would not be the case with the proposed CPP expansion because under a true full funding approach benefits do not jump sooner. Each cohort/generation of contributors pays for its own benefits and is not supported by its descendants.

    The above estimated 9.9% and 15.4% contribution rates are not affected by the decreasing ratio of workers to retirees because they are determined on an (advance) full funding basis. Each cohort of workers pays in advance for all of its own future benefits.

    The above 9.9% and 15.4% contribution rates for the CPP expansion say it all about its affordability. Actual sponsors of typical defined benefit plans already pay more for these plans. Their replacement by the CPP expansion would reduce their pension-related expenditures.

  8. Bernard,

    Welcome and thank for your pointing out my error. I appreciate your detailed knowledge of the topic and your correction on the actual % required.

    So then an employee’s portion of the increase would be 7.7%. Therefore someone making about $75,000 would contribute about $5500 per year, which is a lot less than my incorrect estimate. Yet it is still an increase of 160% of their current contribution.

    That’s still a fairly big increase but I think your point about each generation paying it’s own way would put many more people at ease to at least discuss the proposal. Currently most people are assuming that the baby boomers would get a ‘free’ ride and are rejecting the proposal on a knee jerk reaction.

    Thanks,
    Tim

    Michael – Excellent question!

  9. Mr. Dussault,

    Thank you for the analysis. What you describe sounds like a sensible plan. To keep the new system operating on an advanced-funding basis, I assume that the benefits an individual receives would be some sort of blended amount based on how long they contributed at the higher rates. In particular, current retirees would not be affected at all. Is that right?

    I suspect that the members of CARP would not be happy with the plan you describe (not that I’m agreeing with them). With the first step phased in over 5 years, and the second step phased in over a later period, most baby boomers would miss out on almost all of the increased benefits, and current retirees would get nothing extra. I would be interested in knowing the cost of more radical approaches. For example, many CARP members would assume that CARP is advocating an immediate increase in benefits. See their discussion paper:

    http://www1.carp.ca/PDF/Universal%20Pension%20Plan%20FINAL.pdf

    Suppose that in addition to the plan you describe, there is an immediate increase in CPP payments so that every current and future retiree gets a total of at least 70% of their pensionable earnings from a combination of CPP+GIS+OAS. Can you comment on how much CPP contribution rates would have to rise to accommodate such a plan?

    More radical proposals can be inferred from CARP’s discussion paper. I’m sure that some CARP members would be unhappy with 70% of pensionable earnings and would want 70% of pre-retirement income (up to a new YMPE of $122,222) immediately for all current and future retirees. I’m interested in what this would cost as well to get an idea of what is possible and what isn’t.

  10. Good evening Michael (James)

    Thanks for pursuing this interesting and important dialogue.

    Yes, you are right, the amount of CPP expansion-related benefits payable to an individual would be depend on how long (and how much and some other factors) he/she contributed at the additional expansion-related contribution rates. Still, the expansion would have no effect whatsoever on contributors already in receipt of a CPP retirement pension upon the expansion date.

    I might be missing something but I do not see that the CARP’s proposal is advocating an immediate increase in benefits. You might consider contacting Susan Eng (S.ENG@carp.ca) in this respect.

    If there were to be an immediate increase in CPP payments so that every current and future retiree gets a total of 70% of their CPP average adjusted pensionable earnings, the active contributors would then have to pay about twice the estimated cost of the CPP expansion (I could explain upon request). However, this doubled cost would apply only to the cohorts of contributors aged between 18 and 65 upon the expansion date. All younger/later cohorts would pay the “regular price”.

    If the 70% CPP benefit rate were coordinated with (encompassing) OAS and GIS benefits, then the estimated contribution rates for the CPP expansion (9.9% of salary up to YMPE plus 15.4% of salary from YMPE to ITA limit, i.e. $122,222 for 2009) would be reduced by maybe (very rough approximation) 30% and 10%, respectively, thereby reducing them to about 7% of salary up to YMPE plus 14% of salary from YMPE to ITA.

  11. Bernard,

    Thank you for the clarification and further information. I agree that the CARP discussion paper and other materials on their web site never specifically say that benefits for current retirees should be increased. However, the paper says “The majority of the CARP ActionOnline
    subscribers are CARP members between the
    ages of 65 and 74,” and it speaks of “providing an adequate level of
    retirement security for all Canadians.” I think most CARP members would be shocked to learn that CARP seeks to improve the lot of young Canadians, but not those currently retired or near retirement. I would be pleased if CARP were more specific about what changes they would like to see. Perhaps I will try asking Ms. Eng about this.

    Please indulge me while I try to add the various numbers together to make sure I haven’t misunderstood something. The plan you described earlier involved CPP contributions totaling 19.8% of earnings between YBE and the YMPE, and 15.4% from YMPE to ITA limit.

    If we add in an immediate increase in CPP payments so that every current and future retiree gets 70% of their CPP average adjusted pensionable earnings, the current cohort would pay about 30% on all earnings between YBE and the ITA limit. This would be reduced somewhere in the vicinity of 25% contributions on all earnings between YBE and the ITA limit if we coordinate OAS and GIS benefits so that the total with CPP hits the 70% of pensionable earnings target. Presumably, this 25% of earnings contribution level would have to go up further if we were to try to base the benefits of all current and future retirees on their actual pre-retirement earnings (below the ITA limit) rather than basing it on their pensionable earnings that were limited to YMPE.

    While I can’t foresee a scenario where CPP contribution rates could climb quickly to 25%, 30%, or more on earnings between YBE and the ITA limit, these percentages are lower than I would have guessed.

    Thank you for your help.

    Michael James

  12. Michael (James)

    As I far as I know, CARP is also proposing increases in OAS and GIS benefits. Therefore, their global proposal would benefit all Canadians.

    Getting back now to the figures.

    1. Contribution rate for the existing CPP:

    9.9% of the portion of salary between the YBE (constant $3,500) and the YMPE ($46,300 for 2009, $47,200 for 2010)

    2. Estimated contribution rate for the proposed full-scale expansion of the CPP:

    9.9% of salary up to the YMPE (no YBE)
    plus
    15.4% of salary from YMPE to the ITA limit ($122,222 for 2009) applying to RPPs

    3. Total contribution rate for the fully expanded CPP (existing + expansion):

    9.9% of salary from YBE to YMPE
    plus
    9.9% of salary up to YMPE
    plus
    15.4% of salary from YMPE to ITA limit

    4. This means that the estimated contribution rate for the expanded CPP would not exceed 19.05% of salary, which would be the case if salary equals YMPE. For a salary equal to the ITA limit it would be 16.78% and for a salary equal to $25,000 it would be 18.4%. Therefore, about 18% on average.

  13. Bernard and Michael,

    I am enjoying your conversation here. But my big question would be in what you are proposing would this CARPesque plan be mandatory or would it be optional.

    Thanks,

    Rocky

  14. It makes sense to me that any expansion of CPP should be mandatory, or else the expansion should not take place at all. I haven’t decided whether I would support a CPP expansion of the type described by Bernard (not that I’m in a position to significantly influence future directions in pension plans), but it is clearly sensible enough to be debated as a fix for future generations of retirees. However, by itself it does nothing for current retirees and little for baby boomers (nor is it designed for this). The gap between this CPP expansion and the expectations CARP has set for its membership is vast. So, I would not call the plan Bernard describes “CARPesque”.

  15. Michael
    In response to your comment of December 4 at 6:15 am.

    As explained hereafter, the employee’s portion of contributions for the CPP expansion would be 6.0% rather than 7.7%, which would bring the employee’s portion for the expanded CPP to 8.83%.

    Here is the total (employer plus employee) amount of CPP contributions required in 2009 terms for someone with annual employment earnings amounting to $75,000:

    1. Existing CPP
    9.9% of the difference bwetween $46,300 and $3,500 = $4,237.20 (or 5.65% of $75,000)

    2. CPP expansion
    (a) 9.9% of $46,300 = $4583.70
    (b) 15.4% of the difference between $75,000 and $46,300 = $4,419.8
    (c) Total for CPP expansion = $9,003.50 (or 12% of $75,000)

    (employee’s portion = 50% of 12% = 6%)

    3. Expanded CPP
    $4,237.20 + $9,003.50 = $13,240.70 (or 17.65% of $75,000)

    (employee’s portion = 50% of 17.65% = 8.83%)

  16. Bernard and Michael,

    I have to completely disagree with the need to make it manditory. I think that what we already have should be enough to supplement retirement. This should not be a persons only source of income.

    I should not have to put anymore of my money into the government program. I think that if people want the option to do so, then set it up as an optional program.

    In my opinion adding more taxes to business is just going to stop businesses or at least limit how much hiring they do.

    Rocky

  17. Whether a new universal pension plan should be mandatory or not is a matter of opinion. Personnally, I am stongly in favour of the mandatory approach for the following reasons so well spelled out in the CARP paper:

    “The UPP recommended by CARP is a mandatory enrolment plan as is the CPP10. To make the idea of additional enforced savings more palatable, some have recommended a single opt-out window either unconditionally or if the employer or employee already has a workplace pension plan. However, if
    only a relatively small number of people opt out, then the costs of administering the opt out process could outweigh the advantages. If a large number of people opt out, then the
    objective of a large broadly based, and
    therefore affordable, plan may be lost.”

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