Are Pensions Safe?
WHY CANADIANS CANNOT COUNT ON GOVERNMENT TO SECURE A GOLDEN RETIREMENT
Jeffrey Mills is only 24 years old, but he is getting ready to retire. Mills, who is studying for his master of business administration degree at Dalhousie University in Halifax, started contributing to a registered retirement savings plan (RRSP) four years ago. And he plans to continue those contributions, despite his irregular income as a part-time office worker. The reason for his disciplined savings plan is straightforward: Mills does not trust the backbone of Canada’s retirement income system, the 26-year-old Canada Pension Plan, to provide for his old age. “I don’t even think about the CPP being there when I retire,” said Mills, adding: “The thought of being 65 without much income is pretty scary.”
Mills’s apprehension is clearly justified. By the time he reaches retirement age in 2033, most pension experts predict that much of the safety net that Ottawa provides for the retired may be in tatters. The centrepiece of those programs, the Canada Pension Plan—created in 1966—has not invested the billions of dollars working Canadians and their employers have contributed to it to build a fund capable of supporting the pensions that taxpayers expect to receive on retirement. Instead, it relies on the willingness of future generations of wage
earners to contribute to the plan at more than twice the current rate, to keep up with its obligations.
At the same time, the other two legs of Canada’s three-part retirement security system offer only limited—and diminishing—support for most Canadians. Although Old Age Security is paid to all Canadians over the age of 65, it currently provides recipients with less than $380 a month—far from enough, by itself, to live on. The federal Guaranteed Income Supplement, meanwhile, is available only to the poor. To Paul Starita, president of Royal Trust’s mutual fund division, the looming danger of a generation without an adequate income for retirement is evident—and dispiriting. Said Starita: “The system is bankrupt. Nobody under 30 today will ever collect Old Age Security and CPP benefits unless they are destitute.”
Pressure: In fact, the mounting pressure on the CPP has already forced Ottawa and the provincial governments that share in its management (Quebec operates its own plan) to boost employee contributions to the plan. Under a new contribution schedule that came into effect in January, deductions from paycheques for CPP rose to 4.8 per cent of earnings from 4.6 per cent in December. That small rise, howev-
er, only hints at the increases to come. Even without further changes, the existing schedule calls for rates to more than double within the next two decades—eventually siphoning away as much as 13 per cent of each individual taxpayer’s earnings.
The looming gap between what Canadians expect to receive from the pension plan and what that plan can afford to pay will obviously strain the budgets of elderly retirees. As the cost of supporting the plan rises, it may also strain the social bonds between retirees and the young workers who will be expected to make up any CPP shortfall by paying more into the plan than they will be able to collect later in benefits. Already, a few young Canadians are expressing concern about the bills they are going to have to pick up for their elders’ retirement. Said Jason Ford, a 20-year-old University of British Columbia microbiology major from Vancouver: “I don’t think there will be an anti-CPP revolt. But if things don’t change, will my generation refuse to pay their taxes?”
Most alarming of all, however, are the consequences for the growing numbers of Canadians who will retire in the next 40 years. Unless they are lucky enough to have been longtime members of employer-sponsored pension plans, or unless they have contributed regularly to their own tax-sheltered RRSPs, their old age may prove to be more constrained than the golden period of carefree leisure to which most people aspire.
According to many experts, the seeds of the looming pension crisis were sown when its original designers introduced the CCP, along with the Quebec Pension Plan, more than two decades ago. In response to concerns about the number of elderly people living in poverty, the federal and provincial finance ministers of the day agreed to create the CPP as a so-called payas-you-go plan—in effect using the current contributions of workers to pay benefits immediately to the retired. Even then, many experts warned that that approach would lead to a widening gap between what the plan took in and what it was obliged to pay out. The country’s leaders, however, left it to future governments to order the huge increases in contributions that would be required to close the gap.
But as the population bulge of Canadians born between 1946 and 1966—the postwar baby boom—ages, the flaws in the plan’s original design are becoming more difficult to ignore. In 1990, about one Canadian in nine was over the age of 65. Within 30 years, that figure will rise to one in four. As a result, there will be proportionately fewer young Canadians working and contributing the money that the CPP will need to pay the pensions that the members of the baby boom generation will expect to collect after they retire. Says James Clare, a Toronto actuary who has followed the plan’s evolution: “As long as Canadians will tolerate paying more and more money, the CPP
will continue.” But, he adds, “whether they will or not, your guess is as good as mine.”
If they do not, the choices facing future governments will be stark. If future generations of voters reject higher contributions as politically unacceptable, governments will be forced to dramatically reduce the plan’s payouts. Predicted Robert Brown, 42, a professor of actuarial and statistical sciences at Ontario’s University of Waterloo and the author of Economic Security in an Aging Population: “Personally, I believe that something called the Canada Pension Plan might be there when I retire. However, I think that it will likely be heavily taxed or that the benefits will be pared right back.” Other pension experts share Brown’s view that as the shortage of funds worsens, the federal government will whittle away at the CPP until eventually only the truly destitute will collect benefits.
Winners: For its part, the current federal government publicly dismisses such dire predictions. Said Alain Roy, a special assistant to Monique Vézina, the Conservative minister of state responsible for senior citizens: “Canadians value their health care and their socialsafety-net programs, and that includes the CPP. If they are asked to make larger contributions, they will.” Added Roy: “I don’t sense that it is a problem now and I don’t foresee one. The plan calls for gradual increases and I don’t see any tension in the near future.”
That sanguine outlook may become hard to maintain, however, as the pressure to extract ever larger sums from working Canadians in order to maintain CPP benefits mounts. Indeed, the issue may quickly prove politically expíosive as the inequities between those who benefit most from the CPP and those who contribute most to the plan become increasingly evident. The big winners in that equation, says Brown, are those who are already receiving CPP benefits. The actuary says that anyone who has retired in the 25 years since the plan was introduced will take far more out of it than they paid into it—as much as seven times more, in the case of someone who was born in 1920 and retired in 1985 after working throughout his life. That is because those workers contributed to the plan for only a portion of their careers, but are drawing full benefits from it now that they have retired. By contrast, and assuming that the CPP continues to operate in the future as it does now, a Canadian bom in the year 2000 can expect to get back only about 80 cents for every dollar that he paid into the plan, a result of contributing for longer and at higher rates than previous generations—and of the burden of supporting legions of retired baby boomers. Said Brown: “That next generation is going to be asked to make contributions that will significantly exceed the benefits they can ever hope to receive from the CPP.”
JACK NARSTED, 38, and LEONA DECAIRE,
37, are accountants in White Rock, B.C., 20 km south of Vancouver.
Decaire now spends most of her time at home with the couple’s two children, limiting their combined income to about $55,000. For the past seven years, they have contributed the maximum amount to their RRSP, which is administered by Narsted’s ñrm, giving them a total of about $50,000. However, Narsted says that he and his wife can afford to set aside only about $8,000 for 1991— or about 60 per cent of the higher RRSP limits now in effect. Even so, Narsted says that he expects to retire at age
65 with an $800,000 nest egg. But he adds that factors including inflation and interest rates may eat away at the true value of his savings. Said Narsted: “It seems too good to be true—that is an astonishing number. ”
ESTIMATED MONTHLY RETIREMENT INCOME: $13,803
FORECAST REQUIREMENT TO MAINTAIN LIFESTYLE: $11,958
PENSION AND INCOME ESTIMATES: WILLIAM M. MERCER LTD.
Solution: Among actuaries and other experts in retirement planning, those looming crises have prompted a flurry of proposals to reform the CPP before it collapses under the combined weight of a growing number of retirees and a proportionately shrinking body of working contributors. Toronto actuary Clare, for one, calls the plan a form of “upside-down welfare,” in which Ottawa pays the highest benefits to those who need it least. In fact, because CPP benefits—like contributions—are pegged to a recipient’s income before retirement, the plan pays higher benefits to those who earned larger incomes during their working years—and who, as a result, should need less help in their retirement. By contrast, Clare noted that workers who earned lower incomes during their careers receive lower CPP payments, even though they are probably in greater need than those with higher incomes. And one of the poorest groups in society, elderly women who did not hold regular jobs during their working years, do not qualify for CPP at all under the present mies. Said Clare: “I do not think Canadians would choose to spend their tax dollars helping the well-off rather than the truly poor, if they really understood how the system works.”
For its part, the National Council of Welfare, an Ottawa-based group that advises the minister of health and welfare on issues relating to social welfare, has proposed a solution for both the inequities of the CPP and its underfunding. The council wants Ottawa to calculate individual contributions not only on the first $32,000 of a person’s income, as it now does, but on all of a taxpayer’s earnings, with no maximum. The council also has called for a faster phase-in of much higher contribution rates. In its view, by the year 2020 individuals should be contributing 20 per cent of their income to the CPP. Those amounts are dramatically higher than the current contribution rate of 4.8 per cent for individuals, and even higher than the contribu-
ALEXANDER SCOTI, 31,
is a Calgary construction worker and part-time musician.
In recent years, Scott, who is single, has earned close to $30,000 annually. But because few employers in the volatile construction industry have pension plans, he has not set aside any money for his retirement, apart from his Canada Pension Plan contributions. “I am not worried about saving money right now, ” he said. But he added: “There is no future in this. Pm thinking of going back to school to learn something else. ”
ESTIMATED MONTHLY RETIREMENT INCOME: $5,978
FORECAST REQUIREMENT TO MAINTAIN LIFESTYLE: $9,083
tion increases that Ottawa is already planning.
Other analysts advance more radical solutions. Paul McCrossan, for one, a former Conservative MP for the riding of York Scarborough and the first actuary ever elected to Parliament, says that one solution to the pension dilemma would be for the younger members of the baby boom generation to have more babies. If they did defy current trends, he submits, there would be more workers available in the next century to carry the costs of the boomers’ retirement. Other experts urge Ottawa to increase the number of working-age immigrants that it admits into Canada. That solution, however, carries with it the potential
to create yet other problems—both in the form of increased societal tensions and in the likelihood that a swelling immigrant population would balk at paying heavy CPP contributions to look after someone else’s grandparents.
Cost: With the fate of the Canada Pension Plan so uncertain, personal financial planners say that other sources of retirement income have become essential for any Canadian who hopes for a comfortable old age. Among those are the federal Old Age Security and Guaranteed Income Supplement programs, company pensions and private savings, especially in taxsheltered RRSPs (for which the deadline for 1991 tax-year contributions is Feb. 29). But in fact, those options provide a retirement safety net that is already fraying at the seams.
Actuaries, specialists in predicting future incomes and life expectancies, say that most Canadians will require retirement incomes equal to about 70 per cent of annual income if they plan to maintain their standard of living into old age. That amount is based on expectations that some expenses will be lower for retired people, who will have fewer debts and responsibilities. Assuming an average annual inflation rate of five per cent— close to the 4.8-per-cent rate that officials use to forecast Canada Pension Plan benefits —the chart (left) shows what Canadians at three different income levels will need after retirement to maintain their present lifestyles beyond the year 2000.
31, is a Montreal dentist.
He and his wife, Jennifer Ralston, 28, were married last year and pre expecting their ñrst child in May. The couple's combined annual income exceeds $200,000. Even before they were married, joth contributed the maximum amount allowed each year to RRSPs—a practice they Intend to continue. I knew I had to start saving the day I graduated, " said Hasegawa. 'That sets me apart rom a lot of profesiionals who prefer to ive a lavish lifestyle.”
ESTIMATED MONTHLY RETIREMENT INCOME: $64,125
FORECAST REQUIREMENT TO MAINTAIN LIFESTYLE: $60,958
Federal Old Age Security, for one, is subject to much the same demographic pressures and age as the CPP is. In an early move to limit the cost of the program, the Conservative government began in 1989 to tax back Old Age Security payments made to individuals with incomes above $50,000. And that trend is likely to continue. Indeed, many pension experts say that eventually the payments will be available only to the very poor. For many Canadi-
ans, employer-sponsored pension plans are the most important source of retirement income. But there are serious shortcomings to that source of retirement security, as well. For one thing, only about five million Canadians— roughly two out of five employed people—are currently members of company pension plans. Even for those people, retirement may be much less luxurious than they now anticipate. The reason: most employer-sponsored pension plans assume that retirees will be able to rely on the CPP and Old Age Security for roughly a third of their retirement incomes—a supplement that appears increasingly in doubt. If those programs are no longer available, many
ider the present system governing the inada Pension Plan, for people bom after '80, maximum benefits received after reement will drop below the amounts con-
tributed. For a person bom in the year 2000, the maximum CPP received after age 65 will amount to only 80 cents for each dollar contributed during his or her working life.
retirees will find that their employer-sponsored pension incomes will barely cover the necessities of life.
There can be further hazards to relying on employer-sponsored pensions for a comfortable retirement. One risk lies in the retirement benefits that are lost when an employee leaves an employer—either as a result of a layoff or in order to change jobs. Some workers will not remain members of a pension plan long enough to earn locked-in retirement benefits. Others, even if they pay into an unbroken succession of pension plans during their career, will find that their retirement benefits are significantly smaller than if they had spent their entire career with one employer (page 30).
Inflation: The 23 per cent of employed Canadians who work for governments have a different problem. Although most public-sector pension plans—many of them indexed to increase with inflation—provide more generous benefits than private-sector plans, they are often not as well funded. British Columbia’s auditor general, George Morfitt, for one, reported last December that his province’s public-service pension fund is $441 million short of what it needs to provide benefits for more than 30,000 provincial government employees.
With so much doubt surrounding both company pensions and public old-age security programs, many Canadians have concluded that their most reliable source of retirement income will be RRSPs. That is certainly true for Ernest Smith, 62, of Etobicoke, Ont., and his wife, Rita, a mother of four. In May, Ernest, a steam fitter, will retire from his partnership in a small contracting company, cushioned by $364,000 that the couple have managed to save in RRSPs since 1970. Said Smith: “I just wish I had been smarter and started saving earlier. But when you’re young, you don’t think about retirement.” Indeed, only about one in every two Canadians over the age of 18 has ever contributed to an RRSP, according to a recent survey by Decima Research.
At the same time, say experts, few Canadians possess an accurate knowledge of how much money they will need if they hope to enjoy a lifestyle in retirement even roughly equivalent to the one that they lead while employed. In fact, after decades of inflation, in the year 2030 it may require over $220,000 a year in retirement income to replace 70 per cent of the purchasing power of a present-day income of $50,000. Said Royal Trust’s Starita, who conducts retirement planning seminars in centres across the country: “Many people create this mental image of what they are going to do when they retire, but it is not built on reality.”
For many Canadians, especially those who are members of the baby boom generation, the reality is likely to be sobering indeed. Said Starita: “I tell them that they are going to be on their own. Welcome to adulthood.” For a generation of Canadians accustomed to comfort, however, that maturity may come too late to salvage the dream of a pampered retirement.