Well yesterday I pointed out some flaws in upgrading the CPP system to a Universal Pension Plan.  That’s not to say I think we should do nothing.  Since doing nothing will have some issues like:

1. OAS - Payments come out of general revenue from the government, if we don’t fix pensions we could end up having a lot of people relying heavily on this meaning making any reduction in payments could be a very long and hard uphill battle as the tax base sinks after the baby boomers retire.
2. Government Defined Benefit Plans - These will become much more of a burden on the tax base if we don’t deal with plans sooner than later.
3. People Shouldn’t be Left Behind.  Granted there is case for offering retirees a minimum standard of living since we don’t want be heartless about things and second there is a basic economic idea behind this.  Poor people tend to use more government services that those that are better off.  If we do nothing we still pay in the end, so let’s be proactive and nice all at once.

So here’s the outline of my modest proposal.

1. Make the Default Option on all Retirement Savings Plans an Opt In.  The idea here is simple, people  are lazy, so let’s make saving easy for them.  Also people don’t tend to notice they are saving if it comes off their cheque.  So if you really don’t want to save in the plan you need to file paper work to that effect.
2. Raise the YMPE by $20,000 for CPP.  This would only be a one time adjustment to boost inflows to the CPP plan and raise the maximum payout by about $4700 per year (FYI: current YMPE is $46,300 and max pension is $10,905/year).  The brilliant thing about this adjustment is it won’t significantly alter benefits to boomers since CPP benefits are calculated with the average of your earnings during your working life.  So a raise of contributions by the boomers just a few years prior to their retirement will only very slightly increase their payouts.  This will also allow existing retirees to keep more pension money if their spouse dies and they take over their spouses CPP payout.  This is a good idea since right now if a spouse dies and you are both at the maximum CPP payout it can drop the surviving spouse into near poverty conditions  if they have no additional savings since they also lose their spouses OAS.  Also raising the YMPE won’t effect those in lower income jobs by taking any more money from them and will allow younger people who pay in for longer to get more of the benefit over their working life.  Total additional cost per person per month is $82.50 assuming you make up the maximum YMPE.  So it’s a modest impact even for those that are going to retire early.
3. Close off all Defined Benefit Government Run Plans.  Then switch all new workers over to a defined contribution.  We collectively can’t afford the unlimited liability from these defined benefit plans going forward.

So that’s my modest fix for pensions and retirement savings in Canada.  Now obviously I likely haven’t thought of every angle on this yet, so I want to hear your ideas on this proposal.  Is it good, bad, or do you have a better idea?  Please share your ideas with a comment.

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?

What would you do if your pension disappeared?  Would this significantly impact your retirement plans?

In recent months there have been many reports of pension plans collapsing or reducing benefits, eroding many retiree’s standards of living.  What triggered the problems being experienced?

1. The stock market collapse: Pension plans are basically big pools of money that are invested in the stock market on behalf of employees.  When the market dropped 50%, employers were on the hook to make up this difference, which was a problem because of the recession.
2. Recession: In an economy where many businesses are going bankrupt or barely hanging on, employers who are having trouble paying general operating expenses are not going to be able to make up significant shortfalls in their pension plan caused by the market collapse (or even stay in business).  An obvious example of an underfunded and tanking company is Nortel, which went bankrupt in January and whose pension plan holders can now count on either significantly reduced or no pension.  The company was unable to make enough income to keep itself alive, let alone the retired workers.
3. Poor regulation: Many employees have no idea whether their pensions are funded adequately or if a shortfall will leave their retirement plans significantly underfunded.  Just months before bankruptcy in 2002, Slater Steel received an excellent report from a actuary, only to find that they were in fact 40% underfunded, leading to significant cuts in benefits (35%) - the actuary examining the fund was fined $15,000 and his organization placed him under supervision for 6 months. Obviously, the people who are supposed to ensure that pensions are properly funded (the actuaries) do not see the massive miscalculation made to be a big deal in this case and the courts threw the case out - leaving little recourse to retirees and workers from the plant.

The first two points are probably more of a factor in the current problems pensions are experiencing, with the third being recognized as a problem after the fact as employees have no recourse once the business is bankrupt - there is no way they are going to get the pension pool funded.

The general aging of Canada’s population will put additional stress on pension plans in coming years.  With an aging population, the pension pool will have less money coming in then going out, leaving a deficit that may cause underfunding when the younger generation retires.  Couple aging with a severe market downturn and the economy at a low-point and it would seem there are bad times ahead for retirees dependent on their company’s plan.

Personally, I am involved in a defined benefit plan administered by a third-party and funded by a crown agency - I’m really not too worried about the fund at all.  Additionally, given that I am planning on retiring 20 years before I would be able to access the pension funds, a collapse would not really cause much change to my retirement funds.

I have mixed feelings for the retirees affected after reading various articles on pension fund (here’s a good one) collapses - on one hand I feel terrible for individuals involved because many of them are at an age where working is the last things on their mind.  On the other hand, most of the reports interview people who worked at the same factory for 40+ years and who are upset because they have lost 35% of their pension income.  I guess it’s foreign to me that these people didn’t have an alternative retirement fund and essentially banked on one source of income to fund them the rest of their lives.  In one case a Nortel employee stated they also owned mainly Nortel stock to go along with their Nortel pension(not exactly diversification at its best).  To me, putting all of my retirement eggs in one basket seems very risky - some foresight would probably have helped many of these people.

My suggestion to anyone involved with a pension plan is to treat it like any other investment in your retirement basket in such a way that if it were taken away, you would not be destitute.  I have a feeling that for readers of blogs such as this one, this may not be an issue, but for someone who does not address their finances on a regular basis, the collapse of a pension would cause significant problems that may not be able to be overcome.

I should  note, I am not overly concerned about the Canada Pension Plan.  After significantly increasing contribution rates in 2008, from all reports this fund will not collapse and should be able to provide the funds it is supposed to, making it one of the few public pension plans worldwide (along with Australia) that are going to be solvent for the foreseeable future.

Are you worried about your pension?  Is it going to be your sole source of income at retirement, or do you have other funds that will provide income after you are done working?

Following the market correction in 2008 we collectively have realized that pensions are not like diamonds - they don’t last forever.  So how does this effect our retirement and what can we do about it?  This series on pensions is going to explore the following: the basics of a pension, what’s wrong with pensions, some proposed solutions and what’s wrong with the cure.

So let’s look at the basics.  Despite the common belief that the pension has been about the worker the reality was pensions came about as a means to get rid of older, more expensive workers and replace them with cheaper, more productive (in theory) younger workers.  Pensions were for the benefit of the company.  So they created the rules such that few workers would collect benefits and then would die shortly after getting benefits.

Today things are significantly more complex: we have vesting periods, defined benefit, benefit formulas,  define contribution, minimum ages, group RRSP’s, LIRA, employer and employee contributions…and so on.  No wonder people get frustrated with retirement planning, you can get a headache just look at your work pension plan.  So here are some basic terms you need to know.

• Group RRSP - Technically this isn’t a pension plan at all.  It can often be similar to a defined contribution plan, but pensions are regulated either federally or provincially while a group RRSP is not.  The majority of pensions are provincially regulated making things even more difficult since the rules are not uniform across the country.  The great thing about a group RRSP is since it isn’t a pension it is easier to transfer the money to another account if you are not happy with your investment options or if you want to use the money for an early retirement.
• Defined Contribution - In this plan the idea is the worker takes the risk of investment lose.  The company often matches your contribution to a set amount and then provides you with investment options.  Once you hit the minimum retirement age you can retire and use the money to live off.  The catch here is there is no guarantee on the part of the employer on how much money you will get, yet on the plus side you can leave more easily with less risk of losing significant amounts of retirement income.  If your investments do well, great.  If they do poor, you have to keep working.  On the plus side for the company there is significantly less risk with these plans since they don’t have to cover short falls from a bad year in the market.  These pensions are much more common than defined benefit.
• Defined Benefit - Here the risk on investments goes to the company.  Hence you are seeing fewer and fewer of these types of pensions since if the market does poorly the company has to make up the shortfall.  On the plus side for the employee is you get a set benefit, determined by a formula, to replace a certain % of your pre-working income until you die.  It’s easy, no thinking required.  Yet there are downsides to defined benefit plans for an employee: 1) early retirement options are often very limited if they exist at all, 2) if the company goes bankrupt with a significant pension short fall your benefit can be reduced by a lot.  Recently a common reduction has been about 33%.
• Vesting Period - Often if you work only for a short period of time the company doesn’t want you to walk away with the money it put in your pension.  So if you leave prior to your vesting period you only get your money you put in the pension plan back, not the companies contribution.  After the vesting period you get to keep both even if you leave. Two years is a common vesting period.
• Lock In Retirement Account (LIRA) or Locked In RRSP - Once you have vested money and you leave that company, you might not be allowed to transfer your pension money into a regular RRSP (it depends how much money there is and where the pension is setup) if not then you could transfer it to a locked in retirement account or Locked In RRSP.  A LIRA is similar to an RRSP but often has some additional restrictions on it that carry over from your pension plan.  Typically there is a minimum age that you have to be prior to taking the money out of the account.
• Canada Pension Plan (CPP) - People often like to complain about how few people are in a defined benefit pension plan and completely forget about the CPP.  The CPP is about as close as you can get in this country to a near universal defined benefit pension plan, the problem is the payouts are tiny.  Yet we need to give the CPP credit, they made adjustments a long time ago to correct for the problems facing most other pension plans today (Dave will write more on this tomorrow).

Obviously that is just a short overview of some of the terms out there, I could go on for a very long time.  Yet that should be enough for a discussion for the rest of these series.  If you have any ideas to add to this list or expand a definition please leave a comment.

David Trahair is back again.  The author of Smoke and Mirrors is back with a new book called Enough Bull that suggests we should all tell the stock market to go to hell and put all of our savings into GIC’s.

To be honest I can understand the feeling that drives this book.  By investing in just GIC’s you may not get a huge return, but you will be guaranteed your principle back which given the pounding we all took in 2008 sounds damn good once in a while.  Yet the book isn’t strictly about avoiding the stock market.  Instead he lays out a six point plan which includes:

1. Avoid Financial Disasters - Where he points out you should never borrow to invest, never buy something you don’t understand and  if it sounds too good to be true it likely is.
2. You Don’t Need the Stock Market or Mutual Funds - The pro-GIC part of the book.
3. Buy a Home and Pay Off the Mortgage - Actually it’s fairly sound advice for most people.
4. Reducing Expenses Don’t Have to Be Painful - Go after the big stuff of interest on your debt and income tax.
5. Forget RRSP’s Until the Mortgage is Paid Off - If you follow the GIC method this makes more sense.
6. Ask Yourself if You Really Need an Investment Adviser - Again if you use just GIC’s this is obvious.

The one paragraph I like the most in this book was one where he stated you don’t have to follow everything he lays out in the book.  He points out use what you want in the six point plan and ignore the rest.  Good thing he said that or I might be a bit pissed off.  I do get his point of view, but I don’t agree with all of it.

Here’s my six point plan which I just corrected the points in his that I don’t agree with:

1. Avoid Financial Disaster - Yes never buy something you don’t understand and if it sound too good run away, don’t walk.  Yet borrowing to invest does make sense at some points and for some people.  I would agree that you should likely limit your exposure to perhaps 10 to 20% of your portfolio depending on your own comfort level.
2. You Need Much Less Stocks Than You Think in Retirement - People often grossly overestimate their ability to recover from a down turn in the market once you are retired.  Recall you will likely have no other income source so it pays to be way more conservative with it.  I typically would suggest that you set up your fixed portion of your portfolio to cover all of your basic expenses so you could have a 70 to 85% in fixed income with the balance in stocks to provide some inflation coverage.
3. Buy a Home and Pay off the Mortgage - if it makes sense in your local market.  If you don’t plan to retire there, then consider just saving up cash to buy a home elsewhere.
4. Reducing Expenses Don’t Have to Be Painful - Yes hit up the big things first: interest on your debt and taxes.  Then cut back on areas you don’t care about (power bill, water usage) to boost spending on those things you love.  Also consider free or low cost alternatives.  The idea isn’t to cheap, but rather frugal.
5. Don’t Panic Over Maxing Out Your RRSP’s - You don’t have to do this early in your career.  Focusing on student debt and credit cards makes a hell of a lot more sense.  When you income rises up to a higher tax level then start using the RRSP’s to cut back the government’s hand in your pocket.
6. Use an Investment Adviser if You Want To - You don’t have to use one for GIC’s or if you are using some index ETF’s.  If you do use one make sure not to give them everything, that way you will limit the damage if they mess up.

This book was useful for me to read for one little tiny piece of information on CPP.  If your spouse dies you get their CPP pension, I’ve always know that.   I didn’t realize that you can only get up the maximum pension amount for one person.  So if both of you are getting the maximum pension already and one of you dies then you lose all of the second pension.

So overall it was a short read and I learned something new.  So it is worth reading the book from your library.  You may not agree with all of it, but it does make you think.