Two Perspectives on Pension Reform: Crisis? What Crisis?

Leading the way on this issue were the governments of Alberta and British Columbia, with their proposal for a broad-based DC plan for all Canadians. Based on this discussion, pensions became a key agenda item at the much-anticipated meeting of provincial and federal finance ministers in Whitehorse on Dec. 8, 2009.

Moving Toward Reform
What happened in Whitehorse? Jack Mintz, research director for the Working Group on Retirement Income Adequacy of Federal-Provincial-Territorial Ministers of Finance, presented his report, which found that the Canadian retirement system is working well and, in fact, is one of the best systems in the world. His conclusion is consistent with the Melbourne Mercer Global Pension Index, which ranked Canada fourth out of 11 countries.

So do we have a pension problem? If so, what is it, and what should we do about it?

The Options
The problem is likely not as dire as it has been portrayed in the headlines, but it still exists. We should be concerned about a decline in pension coverage, as this could set us up for issues down the road.

No retirement system is perfect, nor is any about to become perfect. Bad things can—and do—happen to good retirement systems. However, there are steps that we should take to make the Canadian system more robust and flexible to handle the economic changes that will inevitably occur. The Whitehorse meeting focused on three possibilities:

1. An expanded Canada/Quebec Pension Plan (C/QPP);
2. A voluntary broad-based DC plan sponsored by the government; and
3. A voluntary broad-based DC plan sponsored by the private sector.

While an expanded C/QPP may seem appealing, the financials will likely make it ineffective. Contributions would need to increase dramatically over a short period of time, while pension increases would need to be phased in over 30 to 40 years. Unless this happens, the cost of the expanded C/QPP will lead to intergenerational transfers. In other words, a smaller working population would be paying more than just the cost of its benefits in order to pay for a large number of baby boomers who retired with increased pensions.

Broad-based DC plans have more merit as a potential tool to address pension coverage. Canada already has a DC approach with its RRSPs and tax-free savings accounts (TFSAs). However, many studies have indicated that RRSPs are underutilized. Any proposals to implement a voluntary DC plan must address the key barriers to saving under the current RRSP and TFSA structures, such as cost and flexibility.

Cost Concerns
The issue of cost relates to the fees paid by individual savers to their advisors and investment managers. While low-cost investment vehicles such as index funds, exchange-traded funds and online brokerages are available in Canada, a high proportion of retirement savings still finds its way into higher-cost funds where the difference in fees eats away at the return over time. Even in employer-sponsored DC plans, where fees are typically lower during the employee’s working life, employees are often forced to move their retirement funds into higher-cost vehicles at retirement.

The issue of fees should be addressed through a combination of investor education and low-cost, unbiased advice. Investors need to understand the impact of high fees on their retirement savings and how to manage this cost better. An advisor’s compensation is higher when individuals choose higher-cost funds. It’s crucial that unbiased, non-conflicted advice is available to the individual investor.

A broad-based DC plan that spans a province or the country has the potential to lower costs through economies of scale that could result from larger pension arrangements. If this is combined with an investment structure that directs savings to lower-cost options, it will go a long way toward increasing the retirement savings of people who join the plan voluntarily.

The other issue that will need to be addressed is getting individuals and/or companies to join the arrangement voluntarily. Flexibility in the system will help encourage people to join. An individual’s ability to save for retirement varies greatly over his or her lifetime. In their ’20s, individuals are more likely to be at a lower pay level and have less money to set aside for retirement. Expenses tend to peak in their ’30s and ’40s, with mortgage payments and childcare costs eating up much of their income. Reducing their debt levels is—and should be—their first concern. As they enter their ’50s, disposable cash is available and individuals typically begin to seriously set aside money for retirement.

A Matter of Incentive
In order to create greater incentives to save, thought should be given to creating options for contributing and withdrawing money from the arrangement.

For example, given the typical pattern of savings by individuals, would it be possible to allow individuals to carry forward unused DC contribution room from their ’30s and ’40s to their ’50s? This option is already available for RRSPs, so it will not result in a tax cost and would make the broad-based DC plan more attractive to employees. Similarly attractive would be more flexible options to draw benefits upon retirement, allowing retirees to manage investment risk and longevity risk more cost-effectively.

For pension reform to be effective in increasing retirement savings for all Canadians, it must address the issues and barriers that are preventing Canadians from using all of the retirement savings tools currently available. In Canada, we have a very good retirement system—any reforms must ensure that we make it better. Reducing cost and increasing flexibility will be important elements of meeting this goal. BC

Paul Forestell is a worldwide partner and business leader, retirement, risk and finance, Central Canada, with Mercer.
paul.forestell@mercer.com

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© Copyright 2010 Rogers Publishing Ltd. This article first appeared in the February 2010 edition of BENEFITS CANADA magazine.