Pooled registered pension plans (PRPPs) are coming, and many will say not a moment too soon given that only one in three private sector worker is currently participating in a registered pension plan or group RRSP. The hope is that PRPPs will dramatically improve pension coverage thus relieving public pressure to expand the Canada/Quebec Pension Plan (C/QPP).
The intent is to make PRPPs easier to join than to leave and to take most of the administrative burden off the shoulders of employers. This would be done by auto-enrolling employees who currently lack coverage and to reduce the employer’s responsibility to making and remitting the necessary payroll deductions, leaving it to a third-party administrator to do the rest. It sounds promising, but will PRPPs succeed?
Success can be measured in two ways: by improving coverage and by lowering asset management costs, which should lead to higher payouts for the same level of contributions.
Early indications are that governments are leaning toward a soft-sell approach, meaning that they will encourage employers to make a PRPP accessible to their employees rather than requiring them to do so.
This is one of the few times that decisive government intervention is probably in order.
If employers are given the choice, it is likely that most employers who currently offer no pension plan will not voluntarily adopt a PRPP. If they haven’t covered their employees in a registered pension plan up until now, it is not clear why they would embrace PRPPs on a voluntary basis.
While bordering on the paternalistic, it would be better if every employee who is not currently participating in a registered pension plan or group RRSP—or completing a reasonable waiting period to join—should be automatically enrolled in a PRPP. Employees would still retain the ability to opt out but inertia will tend to keep the numbers down.
Quebec just announced in its budget that it will indeed be mandatory for Quebec employers to auto-enroll their employees. We’ll need to wait to see if the other provinces follow their lead.
The goal, however, is not to increase pension coverage to 100%. Many workers are better off not participating in a registered pension plan or making contributions to an RRSP. Specifically, younger people should pay down the mortgage first and those earning less than the year’s maximum pensionable earnings (YMPE) are better off putting money (if they have any to spare) into a tax-free savings account (TFSA) rather than an RRSP. Income from a TFSA in retirement will not reduce payments of the Guaranteed Income Supplement whereas income from an RRSP or registered pension plan will. Since PRPPs will not have a TFSA option, low-income earners are therefore better off not participating in a PRPP at all. This suggests that, if the employer imposes a minimum employee contribution under a PRPP, it should only be taken from earnings above a given threshold such as 50% of the YMPE.
The other major advantage, in theory, of PRPPs is access to low-cost investment funds. How low is low? Typical fees on equity-based retail products such as mutual funds can easily exceed 2% (200 basis points). Fees in mid-sized DC pension plans or group RRSPs might be closer to 100 basis points. Given the large pools of assets that are expected to accumulate in a PRPP it therefore seems reasonable that fees should be kept below 100 basis points. For some, this could represent a reduction in annual fees of 150 basis points, which translates into lifetime pensions that are about 25% higher!
The trouble is that fees may not get down to the low levels we would all like to see. Rather than imposing fee levels on PRPP administrators through regulation, it is possible that governments will rely on market forces to keep fees low. While the markets are usually effective, they may not be in this instance, for a number of reasons.
First, fees are nearly invisible to members because they are deducted directly from the returns.
Second, some market players have expensive sales distribution channels, which, if extended to PRPPs, will not allow fees to drop too far.
Third, some investors think that paying more provides a promise of better returns though there is no evidence this is the case.
Fourth, it is the employer who chooses the PRPP while it is the employees who bear the impact of higher fees.
PRPPs might fail to improve coverage or lower management fees, depending on how they are rolled out. If they fail in these two critical ways, it won’t be long before we decide we should really have expanded the C/QPP after all. As details surface in the next few months, we should gain a better idea on which way governments will go.