When is an employment benefit perceived to be a tax? Probably when participation is mandatory and it has the potential to leave the participant worse off than if it had never existed.

The federal government recently released Bill C-25, the Pooled Registered Pension Plans Act. This draft legislation is receiving praise for helping to close the pension gap—the gap between the level of income Canadians will have when they retire versus what they need or want to have. However, it is questionable how effective pooled registered pension plans (PRPPs) will actually be in closing this gap. As PRPPs become better understood, they may end up being considered taxes by some and inferior retirement savings vehicles by many.

Consider, for example, someone who makes approximately $40,000 a year and participates in a PRPP, contributing 3% each year for 30 years. The employer contributes nothing—a key feature of the new legislation. After an entire working life, if the markets behave themselves (a major assumption), and factoring out the effects of inflation and fees, this person might end up with a nest egg of about $54,000 (all amounts in 2011 dollars). Maybe she is able to purchase a single-life annuity with cost-of-living adjustments paying around $300 a month. (It is single-life because most of her disposable income went into the PRPP, so she didn’t get out much.)

This $300 is going to fall short of closing the pension gap, especially when we compare her to her friend who is receiving a pension of $2,000 per month from a 2%-per-year DB plan. This is an unfair comparison because contributions going into the DB plan were much higher, but that is the point. In the absence of employer contributions and/or significantly higher participant contributions—which likely are not affordable—it is doubtful that PRPPs will be much more effective than RRSPs in closing this gap.

To make matters worse, if government benefits (including the CPP) are this person’s only other source of income, the $300 may also serve to reduce the guaranteed income supplement to which she would otherwise be entitled by about $150 per month. So half of her hard-earned 3% per year for 30 years ends up going back to the government. Forcing this person to save in a PRPP, rather than a tax-free savings account, is punitive.

Even if we concede the point that no entity, not even the government, can afford to guarantee all our retirement benefits, it is still not clear that PRPPs represent an improved solution. In fact, measured on the criteria of increasing pension coverage, decreasing complexity and providing flexibility, the PRPP does not represent a clear improvement over existing programs.

In terms of flexibility, the PRPP is a step backwards. The major distinction between an RRSP and a PRPP is that an RRSP is a savings plan, whereas a PRPP is a pension plan. In other words, with a normal RRSP, the participant can gain access to the money if needed. The money will be taxable if withdrawn, but it can still be withdrawn. In a pension plan, including the new PRPP, the money is locked in. If a financial emergency arises, this money may not be available to help. In the event of a rainy day, PRPP participants are likely to get wet.

If your employer implements a PRPP, you are automatically enrolled. You have the ability to opt out only in the first 60 days. Studies in other countries have shown this auto-enrollment feature to be effective in increasing plan participation. Since future financial emergencies are difficult to anticipate, PRPPs may achieve higher participation rates than group RRSPs. But expect push-back in future when the circumstances of some of the participants change and they desperately need the money.

Interestingly, there has been a relaxing of the locking-in rules in much of the other Canadian pension legislation. It is possible in some jurisdictions to unlock pension funds as a result of financial hardship, but this possibility does not exist in the draft PRPP legislation. Of course, the government has its own interests to defend; if the PRPP funds are not locked in, the government may end up paying more in guaranteed income supplements.

To be fair, the draft PRPP legislation is not without merit. As well as attempting to increase pension coverage, the legislation also attempts to lower costs for plan participants. A major disadvantage of current DC arrangements versus DB is their high cost structures. In a world where a greater number of Canadians will be relying on DC arrangements to fund their retirements, it is essential to lower the costs of these plans so that more money ends up being available to fund those retirements.

It was originally stated that PRPPs would achieve cost reductions through higher asset volumes. However, since the greatest economies should come through the investment fees and the major financial institutions already manage tens of billions of dollars in capital accumulation plans, the economies of scale should already be there. So, there is no guarantee that economies alone will translate into low fees for the plan participants.

The draft PRPP legislation now appears to take a more direct approach. It states, The Administrator must provide the pooled registered pension plan to its members at a low cost.

Apparently, the government will mandate the cost through regulation. It remains to be seen how effective this approach will be and what sort of product and cost structure we end up with.

But rather than introducing all the additional regulatory complexity of PRPPs, perhaps a simpler approach would be to try to improve RRSPs, attacking some features such as the cost structures that remain too high, while still allowing Canadians to retain control over their own money. In this way, retirement benefits would continue to appear to be benefits, rather than disguised taxes.

Copyright © 2020 Transcontinental Media G.P. Originally published on benefitscanada.com

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harold gilroy:

re prpps the comment about the govt not being able to cover all pension needs begs question on how it is that plolitians @govt pensions appear to be silver lined if not gold.

Thursday, December 08 at 10:18 pm | Reply

Roto:

Again we wish to make a point by stretching the examples.

Few plans provide a 2% per year benefit, even the rich public sector plans do not, so this individual would likely get a benefit at 65 of not $2,000 but $1,300. Sill more than your other individual but then maybe take 2.5 times the contribution and the other individuals pension amounts to $900 and the employer contributed $0. And I am not sure of the interest assumtion you used. Add an extra 1% return and the benefits get pretty close although no indexing for the individual.

Now the question is would employers join in and contribute, well for those who have DC plans, the answer is yes if the plan does not charge payroll taxes as it will be less expensive to operate. Maybe the reduction in cost may be added to the employer contirbutions.

And who knows, maybe many small employers , who some may say are the future may now be able to jump in and contribute.

Of course, since we wish to give no one any choice, we want to legislate what we think is better for all.

Friday, December 09 at 8:35 am | Reply

Jean-Pierre Laporte:

The irony is that the Govt insists on calling PRPPs a new form of ‘pension plan’. Pensions are mandatory. Employers must contribute. And if of the DB variety, the payments are predictable, often indexed for life. As far as I can tell, PRPPs do not meet a single of these criteria. Let’s be frank, the PRPP is an attempt to avoid expanding the Canada Pension Plan, not a genuine attempt to close the pension gap.

Friday, December 09 at 11:04 am | Reply

maiden:

The public-private diidve will never be broken down until the public sector and private sector have the same pensions provisions available to them .Only when everyone is in the same boat will there be any chance for decent pensions for all .All pensions should be fully funded and the recipient should bear the majority of the risk of shortfall , not someone else . I just don’t see how that is possible with any defined benefits system .What is being put forward by John Hutton is a stop gap .

Friday, July 20 at 2:19 am

J.-P. Morency:

I would agree with M. Laporte’s comments. Furthermore, I would add that the Govt want to please the private financial institutions since they will manage ‘IT’ and then increase their earnings. Silmilarly, I would say that it is some form of disguise taxes as the writer put it.
Finally, I doubt very much that the employers would join the bandwagon since they were, through their national representatives, against the extension of the CPP in which they must contribute.
As far as I am concerned this is a new fancy scheme to save the ‘façade’ and not to help the workers…

Sunday, December 11 at 12:09 pm | Reply

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