The debate about the merits of the proposed Ontario Retirement Pension Plan (ORPP) and a mandatory CPP expansion versus private pensions continues. But proposal opponents have failed to take into account key data about the costs of the public and private models. If you do the math, it turns out the public pension model has an advantage.
A recent study by the pro-free markets Fraser Institute has found the almost tripling of the CPP contribution rate over the 1986–2004 period coincided with a nearly equivalent drop in Canadian private savings. Authors Charles Lammam and Ian Herzog warn “the benefits of mandatory CPP expansion should be weighed against its costs.” By extension, that same warning could hold for mandatory participation in the ORPP.
And what kind of costs do the authors have in mind? They mention the lack of flexibility and choice in the CPP and, presumably, in the ORPP, which will be modelled after the CPP. But, surprisingly, they ignore the biggest cost factor of all: the actual monetary cost of the CPP (and the ORPP) on one hand, and the cost of individual retirement saving through vehicles such as RRSPs and tax-free savings accounts (TFSAs).
The Costs
These expenses can be considerable. For example, an estimated 40% of the $1 trillion in Canadian mutual fund assets is retirement savings-related (e.g., RRSPs and TFSAs). If the holders of this $400 billion pay the reported average mutual fund fee of 2%, their annual expenses amount to $8 billion.
This compares with a combined annual cost to run the CPP of about $3 billion (roughly $2 billion for the CPP Investment Board, including external investment fees, and $1 billion for the administration of the CPP).
Based on these assumptions, the CPP runs about 38% cheaper than Canada’s mutual fund sector.
And, what about expenses on a per capita basis? About five million Canadian households invest in mutual funds. If we assume they’re also the collective owners of the $400 billion in mutual fund assets held for retirement purposes, their average per household expense for management and administration of their private retirement plans works out to about $1,600 per year.
We know roughly 17 million Canadians participate in the CPP. Their average per capita expenses work out to about $180 per year. So under these assumptions, on a per capita basis, the CPP delivers its retirement program at about 11% of the average out-of-pocket expenses Canadians incur to have their retirement savings invested and administered through the mutual fund sector.
It Matters
Does this material difference in the expense structures of the two retirement funding options matter? It does. Monies paid out to financial intermediaries now cannot compound into future pension payments decades from now. I agree with Lammam and Herzog that the value of mandatory CPP or ORPP expansion versus the value of private pensions through alternative approaches should be weighed against respective costs.
But surely the actual expense of CPP or ORPP expansion versus that of alternative approaches should be one of those considerations. In broad strokes, an annual fee reduction from 2% to around 0.5% compounded over a 40-year period will increase someone’s ultimate pension by as much as 30% a year. This expense differential gives the collective, low-cost pension model a major advantage over the individualized, high-cost model.
A few final words: the most important challenge is to ensure that any CPP expansion, or the ORPP, will be sustainable tomorrow. This means any future expansion in Canada’s collective models can no longer involve ironclad guarantees. We can’t make new pension promises that become cost burdens on future generations of Canadians.
Keith Ambachtsheer is president of KPA Advisory Services and a member of the technical advisory group to the Ontario government on retirement income security.
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