Reforming Canada's retirement savings system--solutions for a non-existent problem?

Author:Jog, Vijay

    In the current political and economic climate in Canada, one issue that has come to the forefront of political debate amongst politicians, economists, policy analysts, think tanks and unions concerns the adequacy of the Canadian retirement system. (1) The relatively recent interest in this issue may be the result of major changes to the overall global and Canadian macro-economic environment due to the 2008 global financial crisis.

    Our intent in this paper is to contribute to this important theoretical and public policy debate by providing and analysing existing evidence and positions undertaken by various parties including governments and question whether there is a retirement income adequacy challenge in Canada and whether it requires a public policy response. We review and question whether the current and proposed policies properly address the challenge. In addition, we provide our own overview and recommendations.

    We will show that the crux of the argument rests on the definition of savings to be considered as a source for income during retirement and the amount of income required during the post-retirement period. Accordingly, the two essential questions that need to be analysed and discussed are whether or not all household assets less debt (net worth) be included as potential savings for retirement or the focus should only be on personal savings and funds invested in group or individual registered pension funds pursuant to the Income Tax Act? Any ambiguity in these two areas has the potential to lead to the wrong policy response.

    The paper is organised as follows. In the next section, we provide a brief but necessary background and definitions that are important to understand the Canadian retirement savings environment, evidence and issues. Next, we briefly describe and review the key components of the current system that are central to our understanding concerning retirement income adequacy. Then, we provide the available and ample empirical evidence. The evidence presented in that section allows us to reflect on the abundant recent statistics and published studies available in order to dissect various arguments that argue for or against any changes to the current system including those proposed by the various provincial governments; we do not believe that additional evidence or research is necessary to reach conclusions. Accordingly, in the last section, we provide our own observations and recommendations. Our intent in this section is to rely on the data and facts provided in the earlier part of the paper and not from any particular political philosophy.


    Canada has a very rich history to ensure that Canadians as a whole have access to a broad and diverse menu of savings vehicles to plan for their retirement years. This history began with the introduction of the Old Age Pensions Act that established a small flat benefit in 1927 that was means-tested for those 70 years and with costs shared between the federal and provincial governments. This was replaced by the Old Age Security (OAS) Act of 1952 that transformed the pension to a universal pension for all Canadians at 70 or above supported exclusively by the federal government from general taxation revenues (although an account was nominally established in the Consolidated Revenue Fund). (2) This became known as the first pillar while the second pillar --the Canada Pension Plan--was established as a statutory mandatory contributory pension plan in 1967. Actually, the current regime consisting of five pillars and is described in more detail below.

    To further address elder poverty, in 1967 Canada added the Guaranteed Income Supplement (GIS), a means-tested benefit for low-income retirees funded out of general revenues. Then in 1968, the eligibility age for an Old Age Security pension was reduced from 70 to 65 where it remained at 65. (3) In the 1970s, payments made from these programs were indexed to inflation. The GIS program was originally contributory, but it has been funded from general revenues since 1973. The GIS was also expanded several times between 1971 and 2006 to further target low income elders who were below the poverty line. (4)

    Overall, GIS has been expanded several times in its forty eight year history, which has had a substantial impact on the incomes of those at the bottom of the senior income distribution. Collectively, GIS and OAS are considered to be the first pillar of the pension system that is designed to provide for adequate retirement for all Canadians. These programs have contributed to the significantly lower overall poverty rate in Canada for elder poverty which declined from over a third of Canadian elders at the time to less than 5% after these programs were introduced.

    The second pillar consists of government-sponsored and managed compulsory contributory earnings-related plans. Starting in 1965, the federal government began building a multi-tiered system with the phase-in of the Canadian Pension Plan (CPP), a social insurance program that, like Social Security in the Unites States, provides a pension benefit during retirement years funded by equal compulsory payroll contributions made by the worker and the employer over that worker's lifetime that is based on earnings. (5) In general, benefits under CPP depend on annual earnings up to a cap called the Year's Maximum Pensionable Earnings (YMPE) and the contributory period starts at age 18 and goes until benefits are taken up, or age 70. The benefits during retirement years are calculated using three components: the basic replacement rate (25% of covered earnings), the average ratio of earnings to the Year's Maximum Pensionable Earnings and the average of the last five Year's Maximum Pensionable Earnings numbers. The pension payments are treated as taxable income and the main eligibility age for the Canada Pension Plan is 65.

    In 1987, an early retirement provision was put in place allowing for benefits to be taken up as early as age 60 and as late as age 70 but with an actuarial adjustment. CPP also has a spousal survivor benefit that is paid to the surviving spouse in the event of death. The survivor benefit is 60% of the benefit that was received by the deceased spouse for those whose age is 65 and over, and 37.5% of the benefit plus a flat amount for those under age 65. However, when the surviving spouse also has a Canada Pension Plan pension of his or her own, the combined benefit cannot exceed the maximum Canada Pension Plan payment annually. (6)

    The third pillar includes employment-related pension plans which can be either Defined benefit (DB) plans or Defined contribution (DC) plans similar to the 401(k) plans in the United States. These are tax-assisted plans wherein contributions made to these plans are tax deductible and subject to an annual cap/limit and tax on investment income on assets while in these plans is deferred and is taxed only when withdrawn or received. The income received from these plans through withdrawals also impacts eligibility for the income-tested guaranteed income supplement benefits. This pillar also includes savings made under individual tax-assisted plans for those individuals who do not participate in employer-sponsored plans. These are of two kinds: Registered retirement savings plans (RRSP) which are treated the same for tax purposes as the DB or DC plans and a plan introduced in 2009 called Tax-Free Savings Accounts (TFSA) where there is no tax deduction for contribution to the plan but neither investment income while in the plan nor the withdrawals from the account are subject to income tax. Both plans have annual caps or limits which are indexed and are cumulative in nature. (7)

    What is interesting concerning this "mixed" or hybrid public and private pension plan system that constitutes these three pillars in Canada, is the implicit design principle that no Canadian should live below the poverty line. For example, the first pillar is a pure social welfare program as no contributions are necessary, the two programs--OAS and GIS--are funded out of general taxation revenues. The second pillar, the compulsory CPP, has a forced savings component built into it with compulsory premiums of 9.9% of salary by both the employer and the employee, and the caps or limits placed on contribution levels ensure that the savings component is not excessive so as to impact consumption but sufficient enough to provide a reasonable amount of retirement income.

    The third pillar maintains neutrality between those who are self-employed or without participation in either a DB or DC plan while maintaining flexibility with respect to timing of contribution and individual trade-offs between current versus deferred consumption and tax planning.

    To provide the relative importance of these programs in the overall retirement savings statistics concerning DB versus DC, private versus public sector are summarized below. (8) The total Canadian population in 2012 was approximately 35 million with a working population of 18.5 million. Membership in public sector pension plans rose 0.6% to 3,179,300, while the number of members in private sector plans increased 1.7% to 3,005,700. The public sector accounted for 51.4% of total membership in RPPs. The pension coverage rate, the proportion of all employees covered by an RPP, was 38.4% in 2012, virtually unchanged from the previous year. More than 4,422,800 employees were in defined benefit pension plans, down 1.2% from 2011. They accounted for 71.5% of employees with an RPP, compared with more than 84% a decade earlier. Membership in defined contribution plans, the other most frequent type, increased 2.7% or 27,000 to 1,030,300. These plans accounted for 16.7% of all RPP membership. Nearly 86% of members in defined contribution plans work in the private sector. Other plans, such as hybrids or composites, continued their upward trend. In 2012, over...

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