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public policy & economics
The Wobbly Third Pillar
Problems with private pension plans jeopardize Canadians’ retirement income
Canada’s politicians – both federal and provincial – have been giving a lot of thought to retirement lately. Not their own, but the retirement of their constituents. That’s good, because as CGA-Canada’s latest research into private sector pension plans shows, the problems that have plagued the system for years have been exacerbated by the recent financial crisis.
CGA-Canada began conducting research into private Canadian pension plans and illuminating those problems in 2004. The association’s newest research report on the subject, Gauging the Path of Private Canadian Pensions, paints a very grim picture indeed. It reveals that
The economic downturn of 2008 prompted Canada’s governments to launch consultations and debate different ideas for addressing the challenges facing the country’s pension system. Federal finance minister Jim Flaherty charged his parliamentary secretary Ted Menzies with advancing the issue and holding extensive public consultation sessions across the country. But as Menzies wrote in a recent issue of Policy Options magazine, those consultations reshaped the discussion from one of pensions to the broader issue of retirement income.
“While I would attempt to underline that we – as the federal government – could study only federally regulated private pensions, the conversations quickly moved into other areas. At each meeting, without fail, once the public microphones were opened to the participants, they made it clear they were looking to have a broader discussion of retirement income security in Canada,” he wrote.
This broader discussion is welcomed by CGA-Canada. In a submission to the minister of finance in April, the association said: “Policy makers are pressed into action now to look at the retirement system from a holistic point of view. Canadian legislators have the unique opportunity to design a pension system that can be sustainable in the long term, fair to present and future generations, simple to administer, and most importantly, cost effective. While a comprehensive overhaul of Canada’s registered retirement system may by premature, it is clear some meaningful fixes, adjustments and regulatory changes will be well received. Moreover, it may be timely to seize the opportunity to broaden coverage to Canadians through the mandating of employer plans and supplementary tax relief for registered retirement savings plans; particularly for lower wage earners.”
First two pillars are sound
Canada’s retirement income system is based on three “pillars”. The first pillar is Old Age Security (OAS), a government-funded universal program that provides a minimum income to all Canadians 65 years or older, as well as the Guaranteed Income Supplement (GIS) which provides supplemental income to low income seniors. The system’s second pillar is the Canada Pension Plan (or Québec Pension Plan), a mandatory pension plan to which all Canadian employers and workers contribute, providing a minimum replacement level of income to retirees. Employer-sponsored registered pension plans (RPPs) along with Canadians’ individual retirement savings through programs such as the Registered Retirement Savings Plan (RRSP) program together comprise the third pillar of the retirement income system.
The first two pillars are considered to be on relatively sound footing. A report prepared for the federal government by economist Jack Mintz at the end of 2009 noted that: “Overall, the Canadian retirement income system is performing well, providing Canadians with an adequate standard of living upon retirement. The evidence does strongly suggest that some Canadians do not have sufficient replacement income. It is not always clear precisely which Canadians are
Mintz’s report relies heavily on statistics from the Organization for Economic Cooperation and Development’s (OECD) 2009 survey of member country pension systems. It found that Canada’s public spending on pensions is
Essentially, Canada is doing a good job of providing seniors with a basic level of retirement income. But it is very basic and as
“The global events that eroded pension asset values, interest rates, and investment returns had a devastating effect on Canadian pension plans,”
What those numbers mean is that even those Canadians fortunate enough to be members of a defined benefit pension plan have reason for concern. DB plans are generally thought to be secure in that they pay a predictable amount of retirement income to the plan member for the rest of the person’s life. However, if the pension plan is underfunded and the company runs into financial difficulty, the company may default on its pension obligations. Nortel Networks, AbitibiBowater, Fraser Papers and CanWest are recent Canadian examples of this.
Defined contribution (DC) plans are those where the employer and employee make fixed contributions to the plan, but the pension income depends on the performance of the plan’s investments. The
“The third pillar of the system needs to be strengthened by affording greater protections or replacing unsustainable DB plans and inadequate DC plans with hybrid plans that draw upon the best elements of each,” suggests the report, which was released on
Enormous gaps between public and private pension plans
For the roughly two-thirds of Canadian workers who are not members of registered pension plans of any sort – defined benefit or defined contribution – the central challenge is to save an adequate amount of money without employer assistance. But as the
A backgrounder from the CD Howe Institute proposed that contribution limits be raised from
“Currently and given the make-up of the Canadian economy, major gaps exist within the retirement income system. Canada has more than 2 million small businesses (0-19 employees), employing
Although Canadians with employer-sponsored pension plans face different issues than those without pensions, the central concern remains the same for all: Will I have enough money to live comfortably in retirement? Beyond the problems with Canadian pension plans, CGA-Canada research has identified a number of convergent trends that should concern Canadians:
- Aging population – Canada’s aging population will result in fewer workers supporting Canada’s social programs, while a higher proportion of retired people will create more demand on services such as healthcare.
- High debt, low savings –
CGA-Canada’s research into household debt levels finds that debt continues to rise, while Canadians resist saving for the future. - Participation in RRSP program is declining – Canadians are not taking full advantage of their most effective vehicle for retirement savings, RRSPs.
Canadians are also living longer and are generally healthier and more active in their senior years. While these may be very welcome trends, they have implications for retirement planning. As FCGA John Nagy pointed out in a previous Dialogue article, the reason that old age benefits take effect at 65 years-of-age is because when OAS was introduced in 1952, life expectancy was not much more than that. Canadians retiring at 65 years-of-age today can, on average, look forward to another two decades of life – and its cost of living.
Governments considering options
The federal, provincial and territorial governments have been working individually and collaboratively to improve their understanding of the challenges facing Canadian retirees. At a June meeting of finance ministers, some general agreement was reached to push for expansion of the CPP. However, there will still be much more debate about private pensions and retirement income security in general.
In addition to those already noted, the CGA-Canada pension report offers a number of recommendations for the finance ministers to consider, including:
- Recognize pension benefits as deferred compensation;
- Establish a private pension authority to monitor the “third pillar” of the retirement system and adherence to the principle of “one law, one regulator”;
- Examine the prospect of introducing universal and compulsory coverage of all working Canadians;
- Consider consolidation of the oversight of private sector registered pension plans under the authority of the proposed private pension authority for achieving efficiency and economy of scale;
- Harmonize more fully the tax treatment of all pension plan transactions, including funding and payout irrespective of their origin and structure; and
- Codify a set of guiding principles aimed at guarding the system against human error and external shocks.
And beyond these specific pension reforms, the report recommends that all Canadians should have equal opportunity to build retirement income outside of
