Two in three Canadians either don’t believe or aren’t confident that the Canada Pension Plan (CPP) will be around when they retire, according to a 2016 survey. Indeed, financial advisors often talk about clients who want to do their retirement math as if the country’s massive public pension program didn’t exist.
The current maximum CPP benefit is over $13,000 a year. That’s a lot of money to ignore, especially if you don’t have a plush workplace pension to rely on.
So does it really make sense to exclude CPP from your retirement plan?
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CPP gets the bulk of its money through contributions from working Canadians. If you’re an employee, the government shaves a bit of money off your paycheques every year up to a certain cap and gets an equal amount from your employers. If you’re a freelancer, you pay the full applicable contribution amount along with your taxes. It’s a mandatory savings program, so there’s no opting out.
When you retire – normally, for now, at age 65 – you get your payback: The CPP will pay you a regular income that replaces a certain percentage of your past average earnings for the rest of your life. And payments are indexed to inflation. (All of the above applies to Canadians outside Quebec, which has its own Quebec Pension Plan.)
CPP is only one of three main sources of government income for retirees. There’s also the Old Age Security (OAS) pension for everyone 65 and older, regardless of whether they’ve been working or not. And there’s the Guaranteed Income Supplement (GIS), which boosts OAS payments for low-income seniors.
Still, if you’ve been working all your life, the biggest chunk of government money will likely come from CPP.
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CPP skeptics generally call it a ponzi scheme. A ponzi or pyramid scheme is an investing scam that uses money from newly acquired investors to pay returns to older investors. The scheme works only as long as the fraudsters are able to bring in fresh money by duping new clients. When that no longer works, the whole thing typically comes crashing down.
It’s easy to see the analogy between a ponzi scheme and most government pension plans, which generally use contributions from workers to pay retirees. Theoretically, governments, unlike private companies, could keep that going as long as there are new generations entering the labour force. The trouble with that, though, is that people don’t necessarily reproduce at a steady rate.
Many Western countries have been grappling with the tsunami of baby boomers who are starting to retire, leaving behind a smaller pool of younger workers. The U.S., to cite just one example, may have to start trimming back Social Security benefits as early as 2034, according to official projections.
The good news in Canada is that we started panicked about this earlier on – and did something about it. In 1997, the government took several steps to reduce the CPP’s reliance on the pay-as-you-go model. One of them was increasing contributions above what it would cost to cover current benefits to create a surplus pot of money that could be invested. Another one was to create an arms-length body, the CPP Investment Board (CPPIB), to run the retirement investment fund.
That investment income is meant to avoid the need to jack-up contributions rates when the outflow of payments to retirees grows bigger than what’s coming in from workers, something that’s expected to happen starting in 2021.
Today, whether you can still call the CPP a ponzi scheme seems a bit of a philosophical question among experts.
“At one point in time that was true,” said Fred Vettese, a partner at human resources giant Morneau Shepell, the company once led by Finance Minister Bill Morneau.
Vettese described the perception among some Canadians that the CPP is a ponzi scheme as a hangover from the public debate of the 1990s.
William Robson, a retirement expert and president and CEO of the C.D. Howe Institute, noted that, technically, a chunk of the CPP is still reliant on the pay-as-you-go system. However, he added, the reform of 1997 certainly put the CPP on a much more sustainable path.
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The Chief Actuary, an independent body that checks CPP finances every three years, says the plan is sustainable until at least 2090 without increasing contributions or scaling back benefits based on annual investment returns of around four per cent after inflation.
That’s not a spectacular rate of return. Financial advisors generally tell clients they can expect at least four to five per cent average returns over the long term from a plain-vanilla investment portfolio split between stocks and less risky holdings like bonds.
In the last decade, the CPPIB has done much better than that. Over the last 10 years, its average rate of return was 5.7 per cent per year. Over the last five years, it was a whopping 10.4 per cent.
And “CPP can invest in all kinds of things that an individual investor can’t,” Vettese noted, like infrastructure projects.
Still, maintaining even the slower returns of the past five years may become trickier in the future due to low interest rates, he added.
And as the CPP becomes increasingly dependent on investments, Robson is calling on the government to explain to Canadians that there are inherent risks.
Those risks are higher for the so-called CPP2, the pension plan boost introduced by the government of Prime Minister Justin Trudeau in 2016. The Liberals’ reform gradually raises contributions from the current 9.9 rate starting in 2019 to significantly boost retirement benefits for future generations. Once the plan is fully in place, the maximum CPP benefit will grow to more than $20,000 annually in today’s dollars, according to the government.
But even with bigger contributions, investment income will be even more critical for CPP2, accounting for 70 per cent of revenues by 2075, according to the Chief Actuary.
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Chances that CPP won’t be there when you retire are extremely slim, both Vettese and Robson agree.
Of course, the future is unknowable and, technically, anything can happen. But saving up for retirement without taking into account any income from CPP seems a bit like stocking up on canned beans to prepare for a nuclear holocaust.
According to Vettese, if CPP does face a shortfall in the future, any adjustments will likely be small, and the government will likely try to raise contributions before it trims benefits.
Robson is more cautious, especially when speaking about the younger generation that’s just starting to enter the labour force, which, he said, might not receive everything it has been promised.
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