In a nutshell

We don’t know what it is, but ‘Voluntary CPP’ can be a powerful addition to existing CPP. It presents an opportunity to offer effective retirement vehicles to all Canadians and deliver superior outcomes in concert with existing CPP.  A ‘Voluntary CPP’ addition: can overcome the current exclusion of homemakers/caregivers, can ‘nudge’ Canadians to a higher level of retirement savings without the potential impact on businesses with a mandatory matching, can offer opportunity for incremental lump-sum contributions by working and retired Canadians, can add a low-cost (passive) investment vehicle with systematic withdrawal option for those who prefer it to the current (actively invested) insurance/annuity only option in existing CPP, can make available incremental inflation indexed and longevity annuity to Canadians. And finally, it can allay the fears of those who are concerned that Canadians will have too many eggs in one (existing CPP) basket or that CPP is expensive (active) or that it comes with liquidity/valuation risk. So let the consultations begin so implementation can follow swiftly, because pension reform is long overdue in Canada.

Background

We don’t know what it is, and we don’t know why the about face on ‘voluntary CPP’ (maybe just “When the facts change,  change my mind”), but when Canada’s Minister of Finance, who is actually the one individual in the best position to make pension reform happen says he is interested, I sit up and pay attention. The need for pension reform is long overdue. So politics aside, we must understand what the ‘voluntary CPP’ could be!

Much ink has been spilled since Finance Minister Joe Oliver dropped his bombshell in the middle of question period that the government has decided to “study whether to allow Canadians a voluntary option to contribute more to supplement their retirement savings (actually more like income) … but they won’t force larger CPP deductions on employees and employers” as reported by Garry Marr in the National Post’s “Ottawa to consider voluntary Canada Pension Plan expansion, Joe Oliver says”.  C.D. Howe’s Poschmann opined that if it is actuarially fair it might be attractive to people who like the perceived security which comes government especially if it comes with some subsidy. CARP’s Susan Eng wants it immediately, but would prefer it with an employer match.

 Rob Carrick in the Globe an Mail’s “CPP expansion would be a big win for investors”  likes it and quotes Fred Vettese that it “solves the investment problem for the unsophisticated investor and outcomes will be superior to investing in expensive mutual funds even though CPPIB is not cheap at around 1%…(this)would be run more like a DC than a DB plan…superior outcomes may be possible but uncertain.”

Curry and Chase’s Globe and Mail piece “Tories propose voluntary expansion of Canada Pension Plan” quotes a shocked Rob Brown that while this about face by the government is a surprise, he sees value because “younger generations are not saving enough for retirement and a voluntary increase to the CPP should help”. Brown observes that right now all we have is a promise of consultation on this subject. Labour groups argued for mandatory rather than voluntary contributions, but to employers’ lobby group CFIB mandatory employer contributions are an anathema which would cause economic harm. And the Ontario government, which recently announced and is committed to deploy the mandatory ORPP for those without employer pension plan, is unimpressed.

Bill Curry in the Globe and Mail’s “Tories previously rejected voluntary CPP expansion party now proposes”  quotes Keith Ambachtsheer that “whether or not such a plan is a good idea depends on the details”; for example voluntary might be acceptable so long as enrolment is automatic.

In the Globe and Mail’s “Plan for voluntary CPP contributions concerns private fund industry” Jacqueline Nelson notes that some “Critics fear a large-scale expansion would crowd out private banking and wealth management, putting the government in competition with the private sector in helping people save and invest to improve their standard of living rather than helping them maintain a base level of necessary income.”  C.D. Howe’s Laurin argues that “If the plan is a limited top-up of an employee’s existing CPP contributions, then there’s unlikely to be a major impact on the private sector…but if it’s just like another mutual fund…(then) there is an impact…” Laurin also pointed out that it was unclear if and how withdrawals if any would be permitted, as this might be a deal breaker for many Canadians. David Berman’s Globe and Mail article  “Wealth managers applaud voluntary CPP contributions plan” quotes investment industry lobbyists indicating that they believe “that the competition would be welcome if it encourages Canadians to save more”, though others were less sure that the industry would not be significantly impacted by loss of assets to the CPPIB, because investor of interest to the industry (i.e. with assets >$600K) really need custom solutions rather that “one size fits all” approach.

But Andrew Coyne takes the axe the voluntary CPP (and CPP) in the National Post’s “Whether voluntary or mandatory, there is no need to expand the CPP” by arguing that unlike the “notional CPP that often gets talked about: the one that, thanks to its large size and public purpose, keeps costs low and manages efficiently”, the actual one is “a bloated corpocracy on a runaway expansion tear, making massively risky bets in the name of the fund’s “long time horizon” knowing that no one will be around to hold them to account if they don’t pay off.” It started out ‘passive’ with a staff of five, whereas now it shifted to ‘active’ management with “Staffing levels now exceed 1,000, while the average compensation in the executive suite exceeds $3 million. And the result? About the same as you’d expect for any actively managed fund: in any given year, the fund is as likely to underperform its benchmark “reference portfolio” as it is to outperform.” Instead he argues that if you must have a forced savings plan, make it look like and RRSP “only one limited to a mix of broad, low-cost index funds, like Exchange Traded Funds”. Mark Wiseman, CPPIB CEO defends (himself and) the CPPIB in a Globe and Mail commentary “Pension funds need to focus on the long view, not a single year” adds some perspective the strong performance in the past year as a means of managing future expectations, answers critics about the high costs associated with CPP.

What is this ‘voluntary CPP’?

So far, nobody knows what a ‘voluntary CPP’ will mean if/when implemented. So let’s explore some of possibilities of what a ‘voluntary CPP’ might be? Such as:

• Nature of contributions: income related only or lump sums as well?
• Permitted contributors: include homemakers, caregivers, retirees, etc?
• DC or DB type plan? i.e. investment or insurance/annuity?
• Decumulation: cash value, systematic withdrawal or only lifetime income benefit?
• Improved survivor benefits?
• Does voluntary in ‘voluntary CPP’ come with a ‘nudge’?
• Tax diversification available via TFSA and RRSP wrapper?
• Asset management: CPPIB fund vs. 3^rd party managed passive fund(s)?
• Fund administration: low-cost built on CPP administrative framework?
• Who’s consulted? Who has to agree (aside of 2/3 of provinces)?
• Timeline?
• Impact of financial industry opposition (insurance cos, fund managers…)

Pension reform: Canadian problems and a framework for solutions

When expanded CPP was declared DOA in 2013, my Expanded CPP is dead? Long live pension reform!?! blog post, as well as earlier  Expanded-CPP Plus post and 2007 proposal presented to t the Ontario Expert Commission on Pensions, all outlined the key elements of Canada’s pension crisis and recommended a framework for solutions, essentially as follows:

“The problems are well understood and Canada’s pension system is broken. Some parts work, but most parts need urgent repair and other parts are in systemic failure. The problems in simplest terms are: (1) insufficient savings, (2) the corrosive effects of the high cost of investments during accumulation, (3) lack of simple access to cost-effective decumulation strategies and no access to cost-effective longevity risk mitigation vehicles, and (4) no protection of earned pension benefits (deferred wages) even in trust-funded plans when employer declares bankruptcy with an underfunded pension plan.

The solutions are not complex: (1) payroll-based voluntary and/or mandatory, employer and/or employee contributions, with default “auto-enrolment” and “save more tomorrow” commitment, (2) low-cost default investment vehicles for accumulation, (3) low-cost systematic withdrawal plans with optional pure longevity insurance for longevity risk management, and (4) increased priority for trust-funded pension plan deficiency when employer becomes bankrupt.”

‘Voluntary CPP’ as an enabler of pension reform in Canada?

Let’s imagine how a better retirement might be enabled by an incremental ‘voluntary CPP’ in the solution framework proposed above addressing issues of: (1) contributions, (2) low-cost default investment vehicles, (3) low-cost systematic withdrawals and longevity insurance for longevity risk management. So imagine a ‘voluntary CPP’ world where:

1. Contributions and contributors: ‘auto-enrollment’ with’ save-more-tomorrow’ nudge (e.g. enrol at 6% of salary with commitment to a 1%/year increase until 12%), with an option to change default percentages to other value including 0%. Contributions allowed not just by the employed, but also lump-sum contribution by homemakers/caregivers/retirees. Option to place in TFSA or RRSP wrapper for tax diversification.
2. Investments can be allocated to either of two default investment vehicles: a new low-cost passively managed balanced fund (call it ‘passive fund’) and/or the current CPPIB actively managed CPP fund (let’s call it ‘annuity fund’).  Assets can be transferrable freely from passive fund to annuity fund at any time to buy units of lifetime income at actuarially fair prices. Passive asset management by a 3rd party but administered as an overlay to CPP administrative framework.
3. Decumulation options from ‘passive fund’ can be either a lump-sum or some form of systematic withdrawal mechanism. Distribution mechanisms from the annuity fund are the same as specified by the current CPP plan with lifetime income adjusted for voluntary contributions to this fund, including the option to start the CPP annuity-like payments any time between age 60 to 70 with appropriate reduction or increase if started before or after age 65. However a further flexibility point should be added to allow a portion of the actuarially fair value of the CPP’s annuity-like stream to deliver a “longevity insurance” type of lifetime income starting at age 85 (rather than 65).

Point (4) referred to in the solution framework, pertaining to protection for private sector pensioners when employer becomes bankrupt with a funding deficiency in the trust-funded DB plan, won’t be discussed as it would not be directly addressable by a  ‘voluntary CPP’. However, when such a ‘voluntary CPP’ is in existence it might be a suitable vehicle to deliver an actuarially fair pension using the funds remaining in the trust fund.

Reasons why ‘Voluntary CPP’ together with existing CPP would be even better than existing CPP

-accessibility: allowing the participation of Canadians who by choice are not working for money (e.g. homemakers/caregivers) and retirees who may wish to buy into an inflation indexed annuity or a longevity insurance type annuity (neither of which is currently available in the Canada but could be readily offered in the CPP context)

-cost and risk: including a low-cost passive public equity option (for those unable/unwilling to select appropriate investments) within the administrative framework of the existing CPP would address both the critics of the high cost and active management used by the CPPIB, as well as allay the fears of those who worry about Canadians having too many eggs in the CPP basket

 -decumulation: access to a systematic withdrawal option from the low cost default passive investment retirement vehicle, access to an indexed annuity and/or longevity annuity option both unavailable anywhere in Canada, and allow Canadians choice between investment (save for long-term care or major medical emergencies or just to accumulate assets for retirement) and insurance/annuity (i.e. buy a lifetime income stream) for the incremental voluntary contributions

Bottom line

The devil is in the details, but ‘Voluntary CPP’ can be a powerful addition to existing CPP. This should not be about politics, but what is best for Canadians.  It presents an opportunity to provide access to additional retirement vehicles for Canadians and promises to deliver superior outcomes in concert with existing CPP. A ‘Voluntary CPP’ addition can: overcome exclusion of homemakers/caregivers, nudge level of retirement savings of Canadians without the potential impact on businesses with a mandatory approach, provide opportunity for incremental lump-sum contributions by working with/without pay and retired Canadians, add a (passive) investment with systematic withdrawal option for those who prefer it to the current (actively managed) insurance/annuity only option in existing CPP, offer incremental inflation indexed and longevity annuity access to Canadians. And finally allay the fears of those who are concerned that Canadians have too many eggs in one (existing CPP) basket. Let the consultations begin ASAP, so that implementation can follow swiftly.