Reforming The Canada Pension Plan
By: Jean-Pierre A. Laporte & Reena Goyal
Underfunding of pension funds due to poor stock markets, rising costs of administering pension plans in 11 different jurisdictions, and activism of pensioners who can now unite to pursue class action litigation against their former employers are but a few of the ailments afflicting our pension system. Moreover, employers are gradually reassessing the benefits of providing a pension plan to their staff in light of rising costs and increased liability whereas the vast majority of Canadians labouring in the private sector are not provided access to a registered pension plan (RPP).
Ironically, Canadians have developed the means to address these issues in creating the Canada Pension Plan (CPP). This paper suggests that the CPP should be enlarged to allow Canadians to take full advantage of its features thereby restoring the health of Canada’s retirement system.
A System Under Attack
Our Canadian retirement system is based on the three-legged stool theory where Canadian retirees call upon three sources of income in order to meet their daily needs: public pensions (the CPP and Old Age Security), private pensions (RPPs provided by employers) and private savings (monies saved through registered retirement savings plans (RRSPs) stocks, bonds, guaranteed income certificates (GICs), etc.). Ostensibly, Canadians can rely on all three sources and should therefore be able to retire comfortably so long as they take responsibility for their private savings. The reality, however, is that most Canadians are only able to call upon the single leg of public pension plans1.
There are a number of factors that explain why participation rates are lacklustre in the private sector. Smaller private employers do not have the deep pockets of government. As a result, they prefer to offer non-RPP forms of retirement plans, such as group RRSPs, or nothing at all.
When one appreciates the complexity underlying an RPP, it is easy to understand why it becomes virtually impossible for a small business owner to provide one to his/her employees. Canada currently has 11 pension jurisdictions (one in each province and one for federal employers and the territories). In addition, all pension plans must comply with the Income Tax Act (Canada) in order to benefit from the preferential tax treatment accorded to RPPs. To fund such plans, actuaries are called upon to regularly calculate whether the assets in the pension plan are growing fast enough to deliver on the pension promise. Assets must be carefully invested in Defined Benefit plans by trustees acting upon the advice of investment managers. In short, the world of pensions is populated by a plethora of experts, advisers, and other intermediaries (accountants, pension lawyers, record-keepers to name but a few) who are often compensated by the pension assets set aside to pay pensions.
Recent corporate insolvencies have also highlighted the inherent weaknesses of the current pension system. For example, when Algoma Steel became insolvent, the Pension Benefits Guarantee Fund of Ontario depleted virtually its entire war chest to rescue a single pension plan.
Finally, for many employees who work in industries with a high turnover rate, the provision of a pension plan may be a mirage. This is because pension standards laws allow a pension plan to stipulate that a plan member must have participated in the plan for a period of up to two years before the employer’s contributions made on his or her behalf ‘vest’ with that employee. Those who are terminated prior to that twoyear window are usually entitled to nothing more than their own contributions with interest.
We argue that the CPP could be amended to address all of these inherent weaknesses.
The Elements Of The Reform
The reform proposed would be based on the following principles:
- The CPP would be amended to enable both employers and employees to voluntarily contribute in excess of the maximum legislated contribution limit currently in effect ($1,801 in fiscal year 2003).
- The current maximum contribution limits under the Income Tax Act (Canada) of 18 per cent of earned income up to a fixed maximum amount would remain unchanged.
- The additional contribution would be pooled with all of the other CPP contributions currently invested by the Canada Pension Plan Investment Board (CPPIB) and would be reinvested in the economy.
- The current rules applicable to CPP benefits would remain unchanged.
- The CPP would be able to invest abroad if it was found that its increased size created a crowding out effect on the Canadian capital markets.
- The administration of the CPP would remain with the federal government and the investment of the funds would continue to be the domain of the CPPIB.
- Additional CPP contributions would entitle the employee to a deduction from income up to the maximum contribution limits of the Income Tax Act (Canada). Employers would also be entitled to obtain a deduction for such additional voluntary contributions, up to a prescribed maximum.
- (To avoid a depletion of the CPP fund), once funds were voluntarily contributed to the CPP, they would have to stay invested until the plan member reached early retirement or retirement age or if he or she could demonstrate financial hardship or a life-threatening illness, as is currently provided for in the Pension Benefits Act of Ontario and for a number of provinces.
How This Simple Reform Addresses The Weaknesses Of The Current System
Because of its voluntary nature, the reform would not affect current RPP members and retirees. We further anticipate that public sector pension plans and unionized plans will, at the request of their members, continue to operate. Because plan administration under this enhanced form of CPP does not rest with the employer, we predict that many small to medium-sized employers who did not previously offer pension plans will match employee voluntary contributions. This would dramatically increase the participation rate in the private sector.
Most of the weaknesses of our current retirement system are also settled by the reform. For example, because the CPP is a form of jumbo multi-employer pension plan, the likelihood that all Canadian businesses will simultaneously close their doors means that reduced benefits due to the insolvency of any one plan sponsor is extremely unlikely. Moreover, the jurisdictional quilt and its accompanying administrative costs and inefficiencies would also disappear since the CPP is a federal statute that all Canadians2 participate in, regardless of the province or territory in which they work.
Additionally, because the CPPIB and the federal government already provide the administrative support required to administer the CPP’s pension assets, the management of the additional dollars set aside in the CPP fund would not require a proportional increase in administrative support. This would mean that the CPP monies currently paid to pension intermediaries could instead be used to provide enriched benefits to plan members or to reduce mandatory contribution rates.
The issue of vesting would equally become irrelevant under the new CPP. Because employees start contributing as soon as they earn employment income under the current CPP rules, the CPP already offers immediate vesting to all Canadians.
Critique And Analysis
We now turn to addressing the following criticisms that might be levelled against the proposed reform:
Objection: “If you allow people who never had a pension plan before to taxshelter income, this will mean less government revenues and everyone will suffer…”
Although this argument is perfectly sound from a mathematical point of view in the short-run, it fails to appreciate that the Income Tax Act (Canada) currently provides (and presumably intended) that all Canadians are given the right to tax-shelter up to 18 per cent of their earned income up to statutorily mandated maximum. In any event, the current situation in which those who are not fortunate enough to have an RPP are paying taxes that ultimately benefit those whose tax-shelter is less than ideal.
Objection: “Why bother with this reform when one knows that those who could use it simply don’t even have enough disposable income to save in RRSPs, let alone trust it to the CPP.”
We anticipate that newly proposed incentives to employers (tax deductibility, no fiduciary duties, no administration costs) would cause smaller employers to offer a CPP-based pension plan as a pension plan equivalent, thereby enabling lower income earners to save towards retirement without affecting their current consumption patterns.
Objection: “Why not ask one of the banks to set up an RRSP product that simply tracks the investments made by the CPP? Wouldn’t that be simpler than amending the CPP?”
RRSPs are not protected from creditors as are CPP benefits or RPP benefits, and lenders will often ask the RRSP funds to be pledged as security for business or personal loans. By having an easily-accessible financial asset at one’s fingertips, the CPPtracking RRSP may not achieve the public policy goal of ensuring that Canadians have sufficient resources to retire. More importantly, if at retirement time the RRSP is used to purchase an annuity, the RRSP holder will be subjected to the volatility of the annuities market (which depends on prevailing interest rates at that time). Finally, should the stock market suffer prior to retirement and the value of the RRSP account were to shrink accordingly, the RRSP holder will have less money to retire than if she had invested in the CPP since the CPP is a Defined Benefit plan which enables market fluctuations to be smoothed over generations and numerous members.
Objection: “Would you really want to trust your pension money to a bunch of bureaucrats?”
The CPPIB makes extensive use of private sector investments managers who have the experience and market discipline necessary to deliver consistently superior returns. From a supervisory point of view, it would be easier for the Office of the Superintendent of Financial Institutions to monitor the investment practices of the CPPIB than to track the hundreds of thousands of individual plan administrators currently administering the pension assets of Canadians. Furthermore, the CPPIB makes information about its various investments publicly available as opposed to the secrecy that may shroud some private sector pension plans.
Objection: “Because of foreign content limits, if everyone switches from their current pension plan to the new CPP, the funds of the new CPP will crowd out other market participants.”
Sophisticated pension plans are already notionally ‘exceeding’ the foreign content limits as prescribed under the Income Tax Act (Canada) without incurring any penalties. If crowding out did occur, simply allow the CPP to invest outside of Canada on an exceptional basis3.
The CPP is already the pension cornerstone for many Canadians and should be enhanced to provide more security for the increasing number of employees who will soon enter retirement.
The proposed reform would substantially reduce the large administration costs and fiduciary risks inherent to RPPs while providing an incentive to employers to offer a pension program where none existed. The reform does not impose costs on the government’s budget and, by diverting funds away from consumption into capital investments, may enhance Canada’s saving rate thus potentially fuelling new growth and opportunities for the future. Sometimes, bigger is truly better.
Jean-Pierre A. Laporte is a lawyer and Reena Goyal is a student-at-law at Fasken Martineau DuMoulin LLP.
1. While many Canadians do participate in some form of RPP, the concentration is mainly in the unionized and public sectors. In the private sector that is not unionized, the participation rate is much lower.
2. With the exception of Quebeckers, who benefit from the Quebec Pension Plan and who could also adopt this reform.
3. An economic analysis of the expected crowding out effect would be in order to conclusively decide this point, but cannot be undertaken in the context of this policy-centred paper.
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