VRSP And ORPP: The Answer To The Retirement Savings Gap?
Published May 20, 2016
Both the Quebec and Ontario governments have a shared concern with the inadequate retirement savings of their respective residents. This lack of savings eventually leads to an inadequate retirement income relative to each individual’s annual earnings. The joint concern can ultimately be divided into three parts:
- workforce mobility
- insufficient savings rates
Each province is moving forward with very different solutions to address these issues. How effective is each option in addressing the above concerns? How do they compare to the Canada Pension Plan?
People are living longer. When it comes to retirement savings all we can do is manage this risk. So longevity risk either falls on the shoulders of the individual by having the bulk of their retirement savings in their personal investment accounts or it is transferred to a pension plan. A pension plan, especially a defined benefit plan, is likely better equipped to manage this risk and spread it out over its many members.
The Voluntary Retirement Savings plan (VRSP) is an individual savings plan and 100 per cent of the longevity risk falls on the individual account holder. This does not reduce longevity risk for a Quebec resident’s future retirement income.
The Ontario Retirement Pension Plan (ORPP) can pool its longevity risk across its plan members. The plan also has the flexibility to make changes to some plan features such as reducing inflation protection or increasing contributions. This flexibility can help ORPP income benefits remain sustainable over many future decades.
The Canadian Pension Plan (CPP) has the largest number of members of the three plans, which allows for even greater longevity risk mitigation. The Canadian Pension Plan Investment Board (CPPIB) is able to adopt a long investment time horizon that can exceed economic trends. Investing in infrastructure with an average holding period exceeding 20 years is one example of how the CPPIB can invest to pair long-term future liabilities with income or asset sales. In addition, the CPP can increase contributions or alter early retirement discounts (among other changes) to further mitigate these risks. We have seen both of these changes made during the history of the CPP.
Employees are switching employers more frequently now than ever before. This is especially true for younger workers. For an employer pension to provide retirement income as designed, it typically requires contributions over a long period of time, for example 30 to 35 years. Since employer pensions have traditionally been tied to a single employer, a mobile workforce would not accrue a 30- to 35-year benefit in any one pension plan. This reduces one’s future retirement income relative to previous generations of employees who were more inclined to remain with their employer for their entire careers.
While the VRSP can follow employees to their next employer, this portability has its limitations. The VRSP can continue to receive employee and employer contributions, but both are voluntary. There is no guarantee that either the employee or the next employer will contribute. Further, the next employer may have their own pension plan, adding another retirement savings vehicle to the employee’s portfolio. Of course, if the employee leaves the province of Quebec, the VRSP’s portability is further reduced as only Quebec employers can participate.
Similar limitations face the ORPP. Only Ontario employers can contribute and they are only required to do so if they do not offer a comparable workplace pension. How can an employee accrue close to 40 years under ORPP if they switch between an eligible employer and a non-eligible employer? While ORPP has some portability, it is limited and unable to fully account for the rate of mobility we see in the workforce.
To accrue benefits under CPP, employees can work for any employer in Canada (excluding Quebec) and still make contributions to CPP. For residents of Quebec, contributions are made to QPP. For those Canadians who have contributed to both, their future retirement benefit will be paid based on contributions made to both plans. International agreements are in place to allow Canadians to integrate benefits accrued in foreign social security plans with CPP. This gives all Canadians the most portable pension plan in the country.
Insufficient Savings Rates
Insufficient savings rates can be a product of competing financial objectives combined with the human nature of procrastination. Financial goals that are more immediate (child rearing, debt payments) tend to take priority over long-term future goals such as retirement. When people have a choice, they tend to lean towards their immediate needs.
The voluntary nature of VRSP contributions makes it identical to other savings options available to Canadians like RRSPs and TFSAs. We know that Canadians are under-utilizing other voluntary savings options, so why would the VRSP be any different? It possibly won’t be and insufficient savings may continue to persist even with this new savings option.
Contributions to ORPP would be mandatory which negates the two causes of insufficient savings, assuming all other retirement contributions remain intact. What if individuals reduce their current retirement savings by the ORPP contribution amount? What if companies that currently offered comparable pension plans opted to switch to ORPP? Would the employee’s retirement savings be set back if future ORPP benefits are lower than what their current savings and pension plan would offer? These scenarios are possible and would reduce the benefit that the ORPP was designed to have.
CPP contributions are also mandatory. It was, however, not designed to be the sole retirement income source for Canadians, but rather a foundation with other income sources such as employer pensions and individual savings providing additional income.
Since its inception in 1966, CPP has been the earnings-related component of Canada’s public retirement income system. Since that time, longevity has increased, the workforce is more mobile, and savings rates have declined.
The provinces of Quebec and Ontario now see a growing retirement savings gap. Quebec has offered its residents the VRSP. However, it keeps longevity risk in the hands of the individual account holder and does not address the lack of savings due to the voluntary nature of contributions. The account is portable, but only within the province of Quebec.
The ORPP allows longevity risk to be spread out across all plan members and mandatory contributions attempt to tackle insufficient savings for Ontarians. However, if individuals and employers reduce their current savings rates in response to the ORPP, Ontarians could end up experiencing the opposite result, exasperating the issue.
Like the VRSP, portability for the ORPP is limited.
CPP is best suited to address all three issues, but was never designed to be the sole retirement income source for Canadians. While it establishes a good starting point, it needs help to tackle the issues impacting Canadians’ future retirement income. Are the VRSP and ORPP the answer to the retirement savings gap? Time will tell, but if they open a national dialogue on the topic, a solution may follow.
Curtis Davis is director, tax and estate planning, at Mackenzie Investments.