A significant proportion of future Canadian retirees are going to suffer measurable deterioration in their standards of living
The case for an expanded Canada Pension Plan (CPP) is all about providing secure retirement income.
The Fraser Institute recently argued that the federal government has failed to make a convincing case for CPP expansion.
But any perspective depends heavily on trying to determine how much income Canadians need to retire with dignity.
Do we require 50 per cent of final working-life earnings? More? Does spending go up or down when we retire? Can you sell your house and move to a less expensive region?
Since none of these questions have solid, precise answers, the Fraser Institute can claim the feds have not made the case for an expanded CPP.
Watching the U.S. presidential debates, I often yell at my TV: “You haven’t answered the question!” I feel the same way about the Fraser Institute’s analysis on CPP. While it’s accurate, it doesn’t shed any light.
So do we really need an expanded CPP?
Thankfully, there’s some solid research on whether future Canadian generations can retire with dignity.
A 2015 McKinsey report uses survey results to conclude that 17 per cent of future elderly face a decline in their standard of living in retirement. A 2009 study for the Research Working Group on Retirement Income Adequacy used income tax data and concluded that 22 per cent of future elderly will suffer a significant decline in standard of living.
Two other studies used the Statistics Canada’s LifePaths microsimulation model to simulate future outcomes. The C.D. Howe Institute in 2010 suggested future elderly will face declines of 44 per cent. And a 2011 study from the Institute for Research on Public Policy showed a 50 per cent decline in standard of living.
Essentially, the best available Canadian data all have the same bottom line: expect a significant decline in standard of living at retirement.
All four studies show that the risk of a declining standard of living in retirement is largely a middle-and-upper-income problem, concentrated among the youngest age groups and those not participating in workplace pension plans. For low-income workers, the combination of Old Age Security and Guaranteed Income Supplement will replace more than 100 per cent of their final earnings.
Do these studies prove the need for expansion of the CPP?
Certainly no more than the Fraser Institute made the case against expansion.
What the studies do demonstrate is that a significant proportion of future Canadian retirees will suffer measurable deterioration in their standards of living.
So what should be done?
One answer is to do nothing. We’ve done that for the last several decades and seen the steady erosion of retirement income security systems. Fewer modern workers have workplace pensions. Only 38 per cent of employees participate in a registered pension plan. And Canadians are not filling the void with increased personal savings. Instead, their debt is ever-increasing.
Many employers have stopped sponsoring defined-benefit pensions, finding them costly. And the financial crisis of 2008-9 showed the frailty of achieving security through defined-contribution plans.
Workers without workplace pensions must manage their investments, creating risk. They can mitigate the risk by hiring an adviser. However, this only shifts the investment risk to an expense risk.
Advice can cost as much as three per cent. If funds earn five per cent and inflation runs close to two per cent, then that worker actually receives no real return.
They must also manage their assets to provide cash flows able to cover unknown life expectancy. They can draw down assets very slowly to guarantee they don’t run out but live at a very low standard. Or they can enjoy a higher standard of living but run out of assets and fall back on taxpayer-funded welfare.
Study after study shows that large defined-benefit plans are more efficient than accumulation accounts managed by individuals, since they can be operated with much lower investment expenses. Further, they need only accumulate enough funds to cover the average life expectancy of all plan participants. The fund can also invest in less liquid (and higher yielding) assets since the average life expectancy is known.
So we can continue to dither or we can act. If we are to act, finding an efficient and effective means of increasing retirement income security would clearly lead us towards a compulsory, large, defined-benefit plan.
That just happens to look a lot like an expanded Canada Pension Plan.
By Robert Brown
Robert L. Brown is an expert adviser with EvidenceNetwork.ca and a fellow with the Canadian Institute of Actuaries. He was professor of Actuarial Science at the University of Waterloo for 39 years and a past president of the Canadian Institute of Actuaries