Personal finance readers love two for the price of one.  So we thought we’d give the people what they want!

We’re trying something a bit new in personal finance circles today (but blatantly ripping off folks like Bill Simmons and Malcolm Gladwell).  Instead of both Robb Engen and myself writing separate articles about the upcoming Canada Pension Plan (CPP) debate, we’re doing a mash-up.  Below is a free-wheeling conversation that Robb and I conducted over a series of emails.  We had no pre-destined conclusion in mind and decided to embark on our take-no-prisoners look at what retirement support should look like in Canada.

Please let us know what you think of the format and make sure and keep an eye on Robb’s site over at Boomer & Echo for a follow up conversation on financial literacy!

CPP – We’ll Do Your Saving for You

Before we begin discussing where the CPP talks should go from here, let’s quickly review where we currently stand when it comes to the basics of the Canadian Pension Plan.

  • The CPP is one of “three legs” that financially support seniors in Canada. The other two are the Old Age Supplement (OAS) and Guaranteed Income Supplement (GIS).
  • The CPP is for Canadians across Canada with the exception of Quebec, which has the Quebec Pension Plan (QPP).
  • The general age of eligibility to begin collecting full CPP is 65. You can begin collecting reduced CPP at age 60, or wait until age 70 for an increased monthly payout.
  • Every Canadian resident that is over 18-years-old and who earns over $3,500 per year must contribute to the CPP.
  • Employees pay half of the overall contribution, while employers pay the other half. If you are self-employed you pay the whole amount.
  • Canadians contribute to the CPP based on their income. To figure out the exact amount everyone owes, the government looks at your annual earnings (up to a maximum of $53,600 in 2015) and then subtracts the minimum amount people are allowed to earn “CPP-free” ($3,500).  The contribution rate in 2015 was 9.9% of the above figure – split between employer and employee.  This means that if you earned $53,600 or more in 2015, you and your employer would each pay $2,479.95 into the CPP.  A self-employed person would pay $4,959.90.
  • Your contributions go into a massive pot of money from across Canada, and gets invested by the CPP Investment Board – NOT THE FEDERAL GOVERNMENT. The Board invests in a massive diversified portfolio with assets from around the world.  This year saw the CPPIB rake in an impressive annual return of 18.3%, and it’s overall 10-year average is 8% (6.2% real return after inflation).
  • How much you receive when you begin collecting CPP depends on factors such as how long you have been contributing to the plan, how much you contributed, and several other considerations you can read about here. The maximum amount you could potentially receive at 65 in 2015 was just under $1,100 per month.  Keep in mind, that’s a maximum.  The average CPP monthly cheque is around $630.

What CPP Changes Mean for You

New and… Improved?

Kyle Prevost: Robb, does Canada need a new CPP?  If so, what proposals that are on the table do you like best?

Robb Engen: Kyle, Canadians need to save for retirement and frankly we’re not doing a very good job of putting away money for our future. CPP is a way for every working Canadian to have access to a defined benefit pension plan that will provide up to 25% of the national average wage in retirement. In an age where employer pension plans are fading away and average Canadians are coping with the highest debt-to-income ratio in our history, it is imperative of our government to revisit mandatory savings plans to ensure the financial well-being of our post-retirement citizens.

I work at a University in the public sector and so I’m one of the lucky 3 out of 10 Canadians who still have a defined benefit pension. I contribute about 12% of my salary towards the pension plan, which the University matches, and that will form the bedrock of my income in retirement.

But what do I hear from my peers and our newly hired employees? It’s not gratitude that they have access to such a rich savings plan. It’s more like, “I wish that such a big chunk of my paycheque wasn’t going into this pension plan. I could really use that money right now.”

Now Kyle, you’re probably the kind of guy who – if given the choice – would rather take the reigns and invest that money on your own rather than being subject to the whims and restrictions of a public pension plan. And I trust that you would invest those funds wisely and, hell, you might even end up with more money at the end of your career.

But what about the 90% of employees who we know wouldn’t be very good stewards of their extra money? I mean we could argue that people need to make better and more responsible financial choices but the fact is that savings rates for Canadians are very low by historical standards and the average Canadian family saves just $1,332 per year.

One area that CPP reform will discuss, among other things, is whether to make the additional contributions voluntary. But Canada already has voluntary savings plans in the form of RRSPs and TFSAs, vehicles that Canadians don’t even come close to maxing out.

When given the choice between consuming now and saving for later, most people will choose to live for today. Imagine instead of mandatory payroll deductions, my colleagues and I had to opt-in to our workplace pension program. How many would willingly choose to contribute?

Behavioural economist Dan Ariely shared a fascinating chart that explained the psychological difference between opting-in and opting-out. He said that countries in which organ donation was the default option had a nearly 100% participation rate among its citizens, whereas countries that require citizens to opt-in to consent to organ donation had a remarkably lower participation rate (between 4 and 27%).

I believe we need CPP reform, not because I want another “tax” on my income, but because I want to live in a society that takes care of its citizens and doesn’t leave its old, disabled, widowed, victims, or simply unlucky in the lurch.

You’re a teacher, Kyle, and so I’ll close with a quote from John Green about education that I’m sure you’ve heard before:

“Public education does not exist for the benefit of students or the benefit of their parents. It exists for the benefit of the social order.

We have discovered as a species that it is useful to have an educated population. You do not need to be a student or have a child who is a student to benefit from public education. Every second of every day of your life, you benefit from public education.

So let me explain why I like to pay taxes for schools, even though I don’t personally have a kid in school: It’s because I don’t like living in a country with a bunch of stupid people.”

Let’s apply that same parallel to a universal and basic level of retirement income.

The Prevost Plan

Kyle: There is certainly a lot to chew on there Robb.  I’m not completely for or against increased CPP contributions.  I will say this though – I have a fundamental ideological problem with the government telling me what to do with a growing part of my own compensation.  I think you actually highlighted the real flaw in our society with the quote you provided.  We ARE currently living in a society full of uneducated people – when it comes to personal finance.  Instead of treating the symptoms of financial illiteracy, let’s fix the underlying disease, by really focusing on creating impartial (re: not made by banks and insurance companies) educational resources to use with all age groups across Canada.

That being said though, we live in a practical world – not an ideological one.  I don’t think having our money managed by the CPPIB is inherently bad – as you pointed out, most folks will get a much a better return on their money in the CPP than investing it themselves.  Indeed, I’ve written in Canadian MoneySaver Magazine that voluntarily contributing $2,500 per year to the Saskatchewan Pension Plan (open to all Canadians) would be a great use of retirement savings space.

BUT I’m not entirely sure why the myth of Canadian seniors eating dog food continues to persist, and if we even need to be all that worried about this “problem”.  I’m almost finished Fred Vettese’s book The Essential Retirement Guide: A Contrarian’s Perspective, and he makes a pretty solid case that most Canadians will be just fine in retirement.  He puts forth the viewpoint that most of us greatly overestimate how much of our prior gross income we will actually need once we hit 65.  I think with a solid push in financial education, most of us will be quite comfortable when we hit our golden years.  The only group that is really at risk of seeing their discretionary income shrink significantly upon retirement is upper-middle-class, and upper-class Canadians.  Are we really that worried about a slight dip in the standard of living to the highest two quintiles of Canadians?  Especially given all the opportunities we already present to help yourself out AND the far bigger problems our lower quintiles have?

So here’s my compromise plan in a nutshell:

1) Much like the SPP, let’s open up the CPP to yearly voluntary contributions within an RRSP and/or TFSA.  It can’t be that hard logistically if Saskatchewan is already doing it on their own.

2) Let’s provide some sort of incentive from federal coffers – maybe a 50% match – or whatever we could afford.  Essentially making it a defined contribution plan.

3) Many people will ask where the money will come from for the pension match.  Every new CPP proposal I’ve read about has employers contributing more to the CPP right alongside their employees.  It’s fairly common sense to note that whether you call this a tax or not, it increases expenses for a business and thus will inevitably lead to higher prices (show me the shareholders that are volunteering to take a hit to their margin).  In this way, Canadians are already paying for the pension match in the form of increased prices anyway (some ideologically-powered folks might call this a “hidden tax” and point out that “there is only one taxpayer”).  Let’s just keep things simple and either reform programs like the OAS, or levy new taxes that will be used to essentially provide the same sort of defined contribution incentives we see with some private employers within Canada.

4) I’ll even meet you halfway in saying that in the Prevost Plan (nice ring to it eh?) all Canadians without DB plans already in place will be enrolled in the plan by default – BUT, there will be an extremely easy way to opt out of the increased contribution plan.  I don’t want this to get bogged down in unnecessary paperwork.

5) The real benefit of my plan is that it places no extra strain on employers.  You and I have defined benefit pension plans that are largely paid for out of tax dollars, but most companies don’t have this luxury.  If we as a country agree that we all need help saving for retirement, then let’s put the onus on ourselves to pay for it – not employers that are already struggling to compete in an ultracompetitive marketplace (Canadian banks and telecoms aside).  In a worst-case scenario, I’d like to see any increase to the current CPP model completely paid for out of our own pockets.

Now that we’ve heard about the extremely modestly titled Prevost Plan, what would the Engen Entitlements look like?  Something similar to what Ontario is rolling out?

Why Not a Defined Benefit Pension Plan for Everyone?

Robb: Kyle, I think you’ve hit the nail on the head in your point number four of your plan – everyone without a defined benefit plan will automatically be enrolled in the newly expanded program (sorry, no opt-out though). We don’t need to expand CPP for government workers and public sector employees – they’ll be fine.

It’s the other 70 percent of the workforce without access to a defined benefit pension that needs the expanded program to help fund their retirement savings. I’m not worried about seniors today, you’re absolutely right that the vast majority of them won’t be eating cat food in their old age. Far from it. But retirees today represent an era of gold-plated pensions (for both the corporate and government worker) and saw unprecedented growth in the housing market, which translated (or will translate) into enormous, tax-free wealth.

Think of today’s 30-something employee living in one of the bigger cities in Canada. They’re starting to get established in their careers, maybe settling down and getting married. But their employer doesn’t offer a pension program or health benefits for that matter, they’re still paying off student loan debt, and they’re trying to save up for a down payment on a $400,000 condo. Not a chance they are saving for retirement unless it’s through some form of mandatory savings program.

I know what you’re going to say: “Wait a minute Robb, how could they afford these additional monthly contributions when they’re obviously struggling with so many other competing priorities?” To that I say; people remarkably find ways to adapt to the money available in their chequing accounts. If they have $800, they’ll find a way to spend $800. But if they only have $600 (because $200 went toward expanded CPP contributions) they’ll find a way to spend $600 and be okay. That’s the power of paying yourself first. If it’s there, you’ll spend it. If it’s not there, you won’t miss it.

Now, you talked about the Ontario Retirement Pension Plan, which you can read about more in detail here, but my understanding is that Ontario would scrap this plan if the federal government can come up with something similar.

Right now the maximum one could receive for CPP and OAS is about $20,000 per year, which is designed to replace up to 25% of the average national wage. Expanding CPP in the way Ontario had proposed would top up that amount by up to another 15% to replace 40% of the national average wage.

One interesting bit of research that came out of the Ontario government was that, after accounting for some reduction in personal savings in response to the ORPP, personal household savings should increase by an average of 25 percent thanks to the ORPP.

That falls in line with something David Chilton told us at the Canadian Personal Finance Conference last fall: that people with pension plans tend to save even more outside of their pension than their private sector non-workplace pension peers. Saving begets more saving!

I’m not sure what exactly the Engen Entitlements program would look like, but I do think we’ll have a crisis on our hands in a generation if we don’t look at some kind of pension reform today.

One added benefit of enhancing a program on a massive scale such as CPP: Canadians currently have over one trillion dollars invested in mutual funds and pay the highest investment fees in the world. Your investment advisor sure won’t like more of your paycheque going towards a low-cost and well-run vehicle like the CPP but investors might be better off with less of their money going toward high MER mutual funds.

Crisis?  Not so Much…

Kyle: You know just what to say to smooth things over eh Robb?  Anything that scores a hit to Canada’s wealth-destroying high-MER financial sector is bound to get my support.  I’ll certainly concede that opting to voluntarily place money in the hands of the CPPIB is a major upgrade over probably 97% or so of Canada’s mutual funds (and no one knows how to predict the 3% winners in advance) over the long term.


What sort of generational “crisis” are we talking about here?  That middle-income and upper-income Canadians will possibly have to cut their spending back a little bit in retirement?  Maybe they’ll warn their children not to make the same mistakes they did?  That seems like a small price to pay for our financial freedom! *Cue the Braveheart scene

In all seriousness though, Vettese points out in his book that most Canadians will be just fine on 40-50% of their working-years’ gross income when they retire – as long as they have their mortgage paid off that is.  When you consider how much income people put towards items like transportation, mortgage payments, children, education, and family vacations, I think we’ve likely grossly overestimated our retirement needs (the 70% figure is pretty ridiculous in hindsight).  If the current system provides 25% of the average national wage (keeping them above the poverty line) is it really too much to ask folks to save a little here and there in order to cover the last 15-25% in retirement?  Perhaps these grasshoppers will have to work a few hours per week during parts of their golden years in order to enjoy the same quality of life as the saver ants.  I’m OK with that – as long as we start educating our youth on how to be efficient ants instead of instant-gratification grasshoppers.  The nanny state has to stop at some point (and maybe it even has to begin to limit the generous defined benefit plans that you and I receive – if that’s what taxpayers agree on).

The other interesting thing to note is that increasing the CPP won’t actually help the most vulnerable seniors in our society: the folks who didn’t make enough income to maximize their CPP contributions over the years.  Many Canadian workers don’t even come close, and will face a much more meaningful shortfall in retirement than the upper-middle class crew we’re worried about.  I’m more concerned about the Guaranteed Income Supplement (GIS) than I am increased CPP contributions.

Perhaps young seniors that didn’t make ideal long-term retirement decisions when they were younger will have to look at a used car or public transportation as they hit 55+.  Perhaps they’ll have to look at downsizing from a large family home.  Perhaps they might even have to postpone retirement a little bit.  Is any of that really a tragedy?  Aren’t there far more worrisome problems out there in Canada right now?  We’re living longer than ever before, isn’t a couple more years of work a reasonable price to pay for choosing to spend in your youth?  Instead, let’s show people that renting makes more sense than purchasing a $400,000 condo.  Let’s show people how to set up their own automatic savings plans if they so choose.  What if someone wants to work their whole life and spend as they go?  Shouldn’t they have the freedom to do that?  Sean Cooper just proved there is still a huge range of choices available to us – it’s simply up to us to prioritize what we want to do with our limited resources.

I worry most about the increased costs to businesses under some of the current plans that are on the table.  For example, my dad was self-employed his whole life.  Since he has to cover both his share and the “employer share” of the CPP, these mandatory raised contributions could represent a significant strain to his immediate finances.  In his younger years I’m sure he would have much rather had the freedom to re-invest that money back into his company and subsequently see a much higher growth rate.  Eventually the money that goes into CPP will come back into the economy via seniors spending more; however, in the short term there will undoubtedly be negative downward pressure on employment.  My father will immediately feel the pinch to his bottom line – while the benefits of an increased CPP will take decades to make their way into the system.  I don’t think it’s likely businesses will wait for that money to come full circle.  If they can, they might choose to raise prices, but it is just as likely that they will have cut costs – and the odd job in order to control their balance sheet.

Let’s put the responsibility for our retirement where it belongs – on our own shoulders.  Not on the backs of businesses and politicians.

Empathy and Longevity Risk

Robb: I’ll concede that the 70% rule is either out of date or was never realistic to begin with. By the time you retire, the mortgage should be paid off, you’ll no longer be contributing to CPP and EI, and you’ve stopped saving for retirement. Whatever’s leftover might leave you with a basic, no-frills lifestyle in retirement rather than a middle-class lifestyle in retirement, but at least you know that a minimum standard will be covered.

I also tend to agree that folks who decided to indulge in the present while wilfully ignoring the future should have to face the consequences of a lower standard of living in retirement. But my issue is that we act like there are only two types of people, ants and grasshoppers, while ignoring all the grey in between, such as the unlucky or ill-timed entrepreneur whose business failed.

We’re not all trying to keep up with the Kardashians; some people are legitimately struggling to get by and that is the point of widening the safety net of CPP. We need to recognize that it’s damn tough to save in today’s economic climate. Think of a couple who wants to start a family and diligently saves 10 percent of their paycheque every month to put towards a down payment on a house in a year. But in a year, the cost of the house they were looking at has risen by 20 percent. That’s a tough situation.

Increase the band of CPP so that our contribution rate is a little bit higher and the yearly maximum limit is a little bit larger so that society as a whole can benefit from the increased savings, and in turn, the increased consumption in retirement. Then design some favourable and flexible rules around those who are self-employed or who are already blessed with a defined benefit pension.

The last thing we haven’t touched on is longevity risk and the very real possibility of outliving our savings as we get older. Our needs may change and healthcare costs may become a challenge. Wouldn’t you rather have access to a predictable monthly income that rises with inflation and is guaranteed to be with you whether you live to 75 or 125?

Sledgehammer vs Scalpel

A better man would give the last word to his guest – but I’d rather be right than polite 😉

A paper released last week by the Macdonald-Laurier Institute titled “From A Mandate For Change To A Plan To Govern” stated that:

“Concerns about a so-called retirement income ‘crisis’ are overblown and a CPP expansion is the public policy equivalent of a sledgehammer when a scalpel is more fitting”, write Cross and Speer.

I couldn’t have said it better.  What we need are minor tweaks to our system and much more widespread information on how to use financial literacy to customize your own retirement – not more government interference in our lives.

That being said, if I’m being honest, I have to admit that forcing everyone without a defined benefit plan to save a little bit more (in a very efficient investment plan) isn’t the worst thing in the world.  I’d just rather everyone made the choice for themselves!

A big thanks to Robb Engen and a reminder to look for our upcoming conversation on his site.

What do you think about some of the various CPP changes that are being proposed?  Why do you favour one approach over another?