Retirement Income System Consultations Spring 2010
(The following, with minor changes, was sent as input to Canada’s Department of Finance request for input on Retirement Income System reform.)
The current Pillars 1 and 2 (CPP/OAS/GIS) work adequately for population earning less than median Canadian incomes.
Pillar 3, the DB and DC/RRSP system, which is the primary mechanism used to protect the retirement of Canadians with above median income, has been a failure for those working in the private sector. Given the rapidly growing proportion of retirees, Canada’s economy is condemned to significantly slower future growth and potentially even a serious contraction if retirees’ income drops dramatically as a result of fundamentally flawed Pillar 3.
Recommended changes to Pillar 3 are indicated in bold:
- 1. DB plans: Must secure existing/earned pension commitments, even if plan sponsor unable/unwilling to continue with DB pension plan. Pensions are deferred wages with tax-code based restrictions on workers ability to save by other tax-deferred means, are governed by federal and provincial legislation, and are regulated/overseen by government regulators to insure that promised pensions are delivered. Trust fund based pensions must be protected by pension guarantee funds and/or changes to BIA giving pension trust funds priority in case of employer bankruptcy in a manner analogous to the vast majority of developed OECD countries.
- 2. The new/next generation DC/RRSP system must have some key attributes, absent in the existing Pillar 3 system:
(i) Ensure adequate level of savings: introduce auto-enrollment with mandatory or at least default settings for payroll-deduction based savings which insure adequate retirement income and provide feedback on likelihood of achieving objective
(ii) Access to national or regional large-scale employer-independent low-cost professionally-managed investment vehicle (e.g. Ontario Teachers or CPP-like from investment management point of view) with market risk borne by investor based on his/her risk-tolerance/asset-allocation) Savings should be locked in except in some very specific circumstances (e.g. home-buying and serious illness). It’s not more flexibility that Canadians need, but lower-cost and professionally-managed investment vehicles.
(iii) Access to a national or regional low-cost national scale longevity insurance on a mandatory or at least voluntary basis (Characteristics of such a longevity insurance are like a deferred payout annuity-like with life-contingent lifetime income starting at age 85; other potential implementation could be based on the current CPP system by either allowing deferral of CPP start as late as age 85 from current maximum age of70 and/or adding a longevity insurance option to CPP with premiums collect during one’s working life or via a single payment at age 65.) Group longevity risk would be borne by participants, and but individuals’ longevity risk is borne by the collective.
(iv) Increase tax deferred savings opportunities in line with those available to public servants, to improve chances of financially secure retirement for all Canadians
Unless changes are made to address the above list, given the approaching wave of retirees, Canadians are condemned to a significant drop in standard of living during retirement, and Canada’s economy will have a correspondingly reduced growth rate or might even contract. Low savings rates and Canada’s high fund management fees which result in 50% lower accumulated assets at retirement, result in >>50% lower retirement income. Lack of low-cost annuity-like products exposes longer living retirees to a life of poverty.
This is not about government handouts. It is about Canadians getting what’s due to them. It’s about Canadians getting their fair share of the returns available in the markets, without the Canadian financial services industry removing its 2-3% annual fees. In a recent Financial Times article “Jeremy Grantham: We add nothing but costs” , Grantham quotes “Paul Volcker’s observation that the only truly useful financial innovation in the past 20 years is the cash (ATM) machine. The rest, was only of benefit to the guys who came up with it, and who paid the price when it all went wrong?” It’s refreshing to hear from a financial industry insider that “The business is a zero-sum game, he points out, and “we (the financial industry) collectively add nothing but costs”. Costs have grown because there is no fee competition, due to the agency problem and the information advantage the agent has over the client. Growing complexity has increased the client’s dependence on the industry.”
The recommended changes will protect Canada’s seniors from drastic drop in their standard of living and help fuel sustainable Canadian economic growth. The time to act is now, before it’s too late!