Research shows few will opt out of automatic enrolment
The solution to shortcomings in workplace pension plans and individual retirement savings lies in a mandatory national supplementary plan for non-covered workers, according to a paper from the Toronto-based C.D. Howe Institute.
The Canadian Supplemental Pension Plan (CSPP) would address two major weaknesses: The 3.5 million Canadians without a workplace pension plan who are not accumulating sufficient retirement savings and the 5.5 million households with retirement savings invested in retail products paying high fees, making it difficult to generate adequate pension income at affordable rates, said author Keith Ambachtsheer, founder and president of KPA Advisory Services in Toronto.
“The CSPP offers all Canadians a realistic chance to achieve post-work income adequacy in a transparent, fair, cost-effective and portable manner,” he said.
While the guaranteed income supplement, old age security (GIS/OAS), Canada Pension Plan and Quebec Pension Plan (CPP/QPP) provide full coverage and high-income replacement rates for low-income Canadians, additional pension income is needed for middle- and higher-income Canadians to maintain their pre-retirement standard of living, said Ambachtsheer. To help, the CSPP has three elements: A retirement savings accumulation/decumulation formula; complete workforce coverage and job-to-job portability; and pension delivery institutions that operate solely in the best interests of members.
The plan would automate key life cycle financial decisions, starting at the end of the cycle and working back to the beginning. For example, a workplace pension plan could set a final earnings income replacement target of 60 per cent, including other benefits such as CPP/QPP and GIS/OAS, and make realistic assumptions about the length of the person’s prime earnings years, return on retirement savings and longevity and then calculate the saving rate required. Reality checks along the way would test whether course adjustments (such as changes to contribution rates or investment policy) are required.
The CSPP would use the CPP/QPP payroll deductions mechanism to maximize simplicity and minimize costs, said Ambachtsheer. It would operate as a financial institution with a risk-optimizing portfolio (ROP) and hedging portfolio (low risk) and offer several annuitization options. So below age 45, all contributions would automatically be invested in the ROP but after that, an automatic deferred annuity purchase mechanism would kick in, with a target of annuitizing 50 per cent of accumulated assets at age 65.
“As the destination approaches, annuity contracts purchased along the way insure against investment volatility and longevity risk,” said Ambachtsheer, adding there should be an opt-out element for employers and employees.
An automatic default contribution rate for employers and employees would be set, such as 10 per cent of earnings, and all non-covered workers would be automatically enrolled (subject to opt-out provisions).
“Even with an opt-out option, they stay in because they don’t want to have to worry about it,” he said. “Research shows you get high take-up on automatic enrolment.”
There are many important questions for people to address when saving for retirement, such as the post-work income-replacement rate, he said, and “the average person can’t deal with it, not because they’re stupid but it’s not in the realm of the average person to be able to string it all together.”
Small-business appeal
This kind of approach could be very attractive to employers that are considering offering a pension plan and are faced with the challenges of finding a service supplier and making decisions about matching contributions and investment options.
“All that stuff goes away,” he said. “I would expect the CSPP to be an attractive option even for employers that have already set up a group RRSP or a DC registered pension plan (or have just closed their DB plan). In a CSPP context, their only decision and involvement is the employer contribution rate and thus their legal liability is reduced.”
Many small firms use group registered retirement savings plans but there are red-tape hurdles so the economies of scale possible with an existing CPP are much more attractive, said Catherine Swift of the Canadian Federation of Independent Business (CFIB).
“You just treat it as a source deduction like the existing CPP premiums,” she said.
The CFIB has advocated a similar approach and initially had concerns the CSPP would be mandatory for employers, she said, but the opt-out provisions make it better for businesses already facing other costs.
“The simpler you can make it for small business owners the better, the more likely they are to do it,” said Swift.
However, the CPP requires both provincial and federal agreement so there could be technical challenges or delays to establishing the CSPP, she said, but it’s a welcome complement to the tax free savings account introduced in the 2008 federal budget.
“The more the merrier — the more options you can give people to save in a supplementary way for their own retirement is good, with some kind of tax sweetener so people are tempted to do it, because we foresee quite a problem down the road with this mass of baby boomers retiring,” said Swift.
Plan has detractors
While something has to be done given the number of people without a pension plan, latching onto the CPP is not the way to go because the fund has been badly mismanaged and benefits coming out are not even at a sustenance level, said James Cartin, president of Calgary-based pension and benefits consulting firm Cartin & Associates.
“There are a lot of employers that don’t provide pension plans and that void has to be corrected and if it means legislating, I would agree with that. How you do it is another matter,” said Cartin. “I’m not inclined to think the government does it well.”
A bank account or pension account for each individual is better, he said, so people could see their money grow each year, know where it’s invested and the “government can’t get its hands on it.” High administrative costs and management fees are not the problem, it’s the bad investment choices people make, said Cartin, and group RRSPs are a very popular option because of their flexibility.
The dilemma could take 20 years or more to achieve results, he said.
“We have to start somewhere and we’re not going to solve the problem until either CPP benefits are increased dramatically or until we set up a supplementary pension plan like this or some sort of legislation to dictate every employer has to have a pension plan.”
The Canadian Supplemental Pension Plan (CSPP) would address two major weaknesses: The 3.5 million Canadians without a workplace pension plan who are not accumulating sufficient retirement savings and the 5.5 million households with retirement savings invested in retail products paying high fees, making it difficult to generate adequate pension income at affordable rates, said author Keith Ambachtsheer, founder and president of KPA Advisory Services in Toronto.
“The CSPP offers all Canadians a realistic chance to achieve post-work income adequacy in a transparent, fair, cost-effective and portable manner,” he said.
While the guaranteed income supplement, old age security (GIS/OAS), Canada Pension Plan and Quebec Pension Plan (CPP/QPP) provide full coverage and high-income replacement rates for low-income Canadians, additional pension income is needed for middle- and higher-income Canadians to maintain their pre-retirement standard of living, said Ambachtsheer. To help, the CSPP has three elements: A retirement savings accumulation/decumulation formula; complete workforce coverage and job-to-job portability; and pension delivery institutions that operate solely in the best interests of members.
The plan would automate key life cycle financial decisions, starting at the end of the cycle and working back to the beginning. For example, a workplace pension plan could set a final earnings income replacement target of 60 per cent, including other benefits such as CPP/QPP and GIS/OAS, and make realistic assumptions about the length of the person’s prime earnings years, return on retirement savings and longevity and then calculate the saving rate required. Reality checks along the way would test whether course adjustments (such as changes to contribution rates or investment policy) are required.
The CSPP would use the CPP/QPP payroll deductions mechanism to maximize simplicity and minimize costs, said Ambachtsheer. It would operate as a financial institution with a risk-optimizing portfolio (ROP) and hedging portfolio (low risk) and offer several annuitization options. So below age 45, all contributions would automatically be invested in the ROP but after that, an automatic deferred annuity purchase mechanism would kick in, with a target of annuitizing 50 per cent of accumulated assets at age 65.
“As the destination approaches, annuity contracts purchased along the way insure against investment volatility and longevity risk,” said Ambachtsheer, adding there should be an opt-out element for employers and employees.
An automatic default contribution rate for employers and employees would be set, such as 10 per cent of earnings, and all non-covered workers would be automatically enrolled (subject to opt-out provisions).
“Even with an opt-out option, they stay in because they don’t want to have to worry about it,” he said. “Research shows you get high take-up on automatic enrolment.”
There are many important questions for people to address when saving for retirement, such as the post-work income-replacement rate, he said, and “the average person can’t deal with it, not because they’re stupid but it’s not in the realm of the average person to be able to string it all together.”
Small-business appeal
This kind of approach could be very attractive to employers that are considering offering a pension plan and are faced with the challenges of finding a service supplier and making decisions about matching contributions and investment options.
“All that stuff goes away,” he said. “I would expect the CSPP to be an attractive option even for employers that have already set up a group RRSP or a DC registered pension plan (or have just closed their DB plan). In a CSPP context, their only decision and involvement is the employer contribution rate and thus their legal liability is reduced.”
Many small firms use group registered retirement savings plans but there are red-tape hurdles so the economies of scale possible with an existing CPP are much more attractive, said Catherine Swift of the Canadian Federation of Independent Business (CFIB).
“You just treat it as a source deduction like the existing CPP premiums,” she said.
The CFIB has advocated a similar approach and initially had concerns the CSPP would be mandatory for employers, she said, but the opt-out provisions make it better for businesses already facing other costs.
“The simpler you can make it for small business owners the better, the more likely they are to do it,” said Swift.
However, the CPP requires both provincial and federal agreement so there could be technical challenges or delays to establishing the CSPP, she said, but it’s a welcome complement to the tax free savings account introduced in the 2008 federal budget.
“The more the merrier — the more options you can give people to save in a supplementary way for their own retirement is good, with some kind of tax sweetener so people are tempted to do it, because we foresee quite a problem down the road with this mass of baby boomers retiring,” said Swift.
Plan has detractors
While something has to be done given the number of people without a pension plan, latching onto the CPP is not the way to go because the fund has been badly mismanaged and benefits coming out are not even at a sustenance level, said James Cartin, president of Calgary-based pension and benefits consulting firm Cartin & Associates.
“There are a lot of employers that don’t provide pension plans and that void has to be corrected and if it means legislating, I would agree with that. How you do it is another matter,” said Cartin. “I’m not inclined to think the government does it well.”
A bank account or pension account for each individual is better, he said, so people could see their money grow each year, know where it’s invested and the “government can’t get its hands on it.” High administrative costs and management fees are not the problem, it’s the bad investment choices people make, said Cartin, and group RRSPs are a very popular option because of their flexibility.
The dilemma could take 20 years or more to achieve results, he said.
“We have to start somewhere and we’re not going to solve the problem until either CPP benefits are increased dramatically or until we set up a supplementary pension plan like this or some sort of legislation to dictate every employer has to have a pension plan.”
