CPP Changes: Don’t Pop The Champagne

The proposed changes to the Canada Pension Plan (CPP) were agreed to on June 20th by the federal government and all the provinces except Manitoba and Quebec. They are mildly useful, and will have some unexpected consequences.

The CPP is one element in a three part public system of retirement income programs. The second part is Old Age Security (OAS), for which everyone is eligible starting at age 65, although it all gets taxed back for higher earners. Thirdly, the Guaranteed Income Supplement (GIS) provides additional pensions for low income earners.

Pension plans are complicated. Nevertheless, the news release announcing the biggest change since the plan was established in 1965 contained fewer than 550 words. There are lots of details to be filled in later.

The broad outlines are clear. The pension will increase from 25% to 33% of eligible earnings, and the eligible earnings will increase by 14%. The first will increase the maximum benefit from roughly $12,000 to $16,000; the second will add another $2,000 (for the purpose of this article, all numbers are in 2016 dollars. In practice, both contributions and benefits will grow with inflation and other factors).

Contributions will increase by 1% of earnings up to the existing benefit maximum, and 4% on the increase in the maximum.

The program will be gradually phased in starting at the beginning of 2019, and it will take 40 or more years to earn the maximum benefits. It is perhaps not coincidental that all of the participating governments except Saskatchewan will have their next election before taxpayers notice another dip in their take-home pay.

The impact of all this will be far from uniform.

John is a low income earner who will be eligible for GIS when he retires. Paying for a bigger CPP benefit is bad news for him because it will offset what he would have received from GIS. The government says it will address this problem with an enhanced federal Working Income Tax Benefit. John is likely to find all this pretty confusing.

Sarah is a 40 year old executive making $200,000. When she reaches 65, she will have 20 years’ credit on the plan enhancements so they will be worth only about $3,000 per year, less than half that after tax.

Jason is 25, making $55,000 per year. If he works til age 65, his combined CPP and OAS will be about $24,300. That is 44% of his pre-retirement income, useful but certainly not enough to maintain his lifestyle. His twin brother Kyle makes $120,000 per year. All of his OAS will be taxed back so even with an expanded CPP his combined public sector pension will be $20,000, less than Jason.

Mary is a school teacher who will reach age 65 in 2020. She will get no discernible benefit from the new program. Her sister Susan, also a teacher, will reach 65 in 2030, and will barely notice the extra CPP she is receiving from the plan changes.

Susan’s 25 year old daughter Brittany is also a teacher. Most of her benefit increase will be offset by a decrease in her pension from the Teachers’ Pension Plan (TPP).

All three teachers will be paying an additional 2.4% of payroll on the 14% increase in CPP maximum (their TPP contributions are 1.6% lower on earnings up to the CPP maximum).

These three will, to an even greater extent than before, be subsidizing inflation indexing for those who retired before Aug. 1st 2006, a benefit that Mary, Susan, and Brittany are unlikely to ever receive.

The claim that Canadians have a serious shortfall in their retirement savings is exaggerated. If there is a real problem, these modest changes are certainly not going to solve it.

Likewise, the frenzied hand-wringing by Conservative finance critic Lisa Raitt (higher contribution rates “will have a devastating effect on hard-working middle-class families”) seems rather overdone.

The CPP is a cost-effective way provide retirement benefits. It is nice to see the federal and provincial governments (well, most of them) finding some improvements they can agree on.

The changes are directionally correct but modest in scope. Taxpayers should not think that they can now cash in their RRSPs and use them for a vacation or a new Harley.


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Reference Material

Pensions in Crisis

Voters trying to understand the various positions being advocated for the Canada Pension Plan have every reason to be confused.

The initial incarnation of CPP required only 3.6% of pensionable earnings as contributions, and provided benefits to people well before they had been earned. This was eventually repaired in the nineties; otherwise, the plan would have gone broke.

Today’s CPP provides a pension at 65 of up to $12,780, for which employees and employers annually contribute a combined 9.9% of pensionable earnings. It is simple and cost-effective, but even when combined with Old Age Security (OAS) it does not provide an adequate pension.

After fruitless discussions with the federal government, Ontario proposes to go it alone. Details are not yet finalized and the scheduled start is not until 2017, no doubt reflecting a hope that federal policy will change and save them the trouble. Ontario’s plan, mandatory only for those not already in a pension plan, would require a worker to contribute for 40 years in order to receive an unreduced benefit. The only examples provided on the Ontario website are for employees who work the full 40 eligible years.

The Canadian Labour Congress (CLC) has one of the many proposals to increase the existing CPP. The CLC loves to quote a 2014 Nanos survey in which 88% of Canadians support “increasing the benefits Canadians receive through the Canadian Pension Plan.” Of course the survey does not mention the corresponding need for a substantial increase in contributions, nor the 40 year wait for unreduced benefits. (The same survey makes the shocking discovery that most Canadians would like lower taxes.)

The strongest support for improving benefits was from the oldest respondents, who would get only small benefit from the CLC proposal. There is one group who should actively oppose it. Low income workers are typically able to receive the Guaranteed Income Supplement when they retire, in addition to OAS and a small pension from the present CPP program. An increase in CPP will be largely offset by reductions in GIS. This needy group will be paying something for nothing.

As a result, some proposals for reform, otherwise similar to that of the CLC, do not require contributions or provide benefits on earnings below $25,200. These proposals have considerable merit as a cost-effective and comprehensive improvement to retirement savings for Canadians. 

But that virtue will be much clearer to actuaries and economists than to voters. Most Canadians, given a clear and detailed understanding of proposed changes, would be much more tepid in their enthusiasm for a program that takes so long to mature.

Hence, the rather vague communications from the three political parties. One can search their websites in vain for any indication of what they have in mind.

The Conservatives have argued, incorrectly, that CPP contributions are just another tax. Unlike unemployment insurance, the CPP funds have for five decades been operated entirely outside of government accounts and are only used to pay CPP beneficiaries. Having been opposed to any change, the Conservatives now say that they are willing to consult Canadians about a possible optional program.

How that might work is anyone’s guess. It appears to be just creating a different RRSP opportunity. Are there limits on how much can be contributed? Is it optional for employers too? Are contributions locked in until retirement as is the case for the base plan? This “plan” does not offer much.

The Liberals favour a mandatory program. Liberal Critic for Seniors John McCallum points out that changes would require the agreement of two thirds of provinces with two thirds of the population, so an agreement would have to be negotiated. Their position would tilt toward a large amount of excluded earnings to protect low income earners. Good.

More troubling is that they are not committed to adequate funding, which suggests that they might , as happened with the original CPP, cheat young contributors by paying older ones more benefits than their contributions have earned.

The NDP, which might be expected to follow the CLC recommendation, is so far silent about what exactly they have in mind—although it will clearly be a mandatory program. Caucus Press Secretary Greta Levy promises that “The exact figures on CPP will be announced before the election as part of an NDP government’s approach to retirement security.”

So voters actually trying to understand this complex issue don’t have much to work with.

The Conservatives are trying to fog the issue by musing about a no-hoper voluntary plan.

The Liberals appear to prefer a mandatory plan, but have not drawn any lines in the sand about how it must look. They may be willing to consider an irresponsible funding choice, or to be pushed that way by the provinces.

The NDP say they have advocated a CPP expansion for years—as well as strengthening GIS and reverting the age of OAS to 65. This adds to a growing list of expensive promises with no indication of how they are to be paid for.

Today’s CPP plan is appropriately funded and provides a cost-effective but modest portion of retirement funding. A long term reform is possible that would allow that portion to become more substantial.

The Conservatives have no real intention of making any changes. The Liberals and NDP say they do, but if they choose a wrong model they could do more harm than good.

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