Think you’ve got a pension? Well, you’d better think again
Published On Mon Mar 15 2010
The majority of working Canadians – about 67 per cent of today’s workforce – are currently pensionless: that is, they are not part of a registered pension plan (RPP).
It is no surprise then that one of the public policy questions du jour is what to do about this segment of the workforce that isn’t fortunate enough – or savvy enough – to participate in an RPP. Proposals abound and much ink has been spilled. Should we increase the Canada Pension Plan from its current maximum benefit of $10,600 per year? Shall we allow for greater tax-sheltered savings? Do we mandate universal pensions for all employees?
Now, the assumption underlying all of these discussions is that the population about whom we are concerned is the majority of Canadians who do not belong to an RPP – and not about the “lucky third” with workplace pensions.
But allow us to be contrarians for a moment. We are actually quite concerned for a large proportion of the so-called lucky third: those who think they will retire to a guaranteed pension income, when in fact they have nothing of the sort.
To understand our concern, we need to step back and carefully review the meaning of the word pension. A quarter of a century ago, the vast majority of the largest and most prestigious employers in North America offered defined benefit (DB) pensions to their new employees. This form of pension promises a lifetime of income to each retiree when he or she stops working, with potentially a survivor pension for the employee’s spouse.
However, over the last few decades, the proportion of North American companies offering DB pensions to new employees has dropped to less than 20 per cent of large employers. The remaining 80 per cent of companies that still offer pensions have switched to what are called defined contribution (DC) plans. DC pensions are still considered “registered pension plans” for Statistics Canada purposes – even though they are essentially tax-sheltered investment plans with zero guarantees and no promises. In a DC (a.k.a. “money purchase”) world, money flows into the pension plan pot, it gets invested by professional (hopefully) portfolio managers in the volatile stock and inflation-sensitive bond market, and any gains are tax-deferred until the income is received – but nowhere is anything mentioned about a guarantee.
Our concern is that many people who think they have a pension really are members of a collective saving and investment plan. An RRSP is not a pension: it is a tax-favoured portfolio. Worse still, because workers in this fragment – perhaps with six-digit RRSPs – believe they are in the lucky cohort, we suspect they are relating to their DC pension entitlements more like DB entitlements, and they won’t wake up to the difference until it’s too late. And most importantly, getting more of the 67 per cent of pensionless Canadians to save and contribute more into tax-sheltered savings plans won’t necessarily solve their retirement income problems.
So let’s make sure everyone involved understands exactly what a pension really is. A true pension requires two parties: you, the prospective retiree, and the entity standing behind the promise. The counterparty to the pension promise can be an insurance company, government entity or corporate pension plan. But for it to be called an honest pension there must be somebody guaranteeing something. No guarantee? No pension. Telling people that they are on track to replace an average of 70 per cent of their pre-retirement income when the standard deviation (partially due to volatility of the stock market) is plus or minus 30 per cent is misleading at best – and deceiving at worst.
As the current debate about securing the retirement incomes of Canadians rages, we have a modest proposal for framing the discussion: No more confusing guaranteed DB pensions and DC investment plans – and no more assuming DC pensioners are in the same boat as their DB counterparts.
Beyond this first principle, we believe it’s important to stay focused on three core discussion points:
First, pensions are about providing a lifetime of income by pooling risk across different groups using the principles of insurance. Pensions are not about creating financial legacies and “rainy day funds” for family and loved ones. Any focus on financial legacies is misplaced.
Second, a true pension guarantees predictable income, starting at some advanced age, which matches the increasing cost of living for retirees. Hope, expectations and estimates “in all probability” aren’t enough. Canadians need certainty. Pensioners need guarantees.
Third, pensions must be paid for by someone. The key to the future workability of the Canadian pension system is to create a framework that allows them to be offered at the lowest possible cost in today’s dollars.
The dictionary tells us that the first written use of the word “pension” to mean a “regular payment in consideration of past services” dates back nearly 500 years. We urge all Canadians to think carefully and clearly about what we mean when we are talking about pensions – as the discussions we are having may not only impact you in your lifetime, but may stretch an astonishing half-century into the future!
Moshe A. Milevsky and Alexandra C. Macqueen are the authors of “What Is A Pension, Exactly? (And Why Should You Care?)” published in the March 2010 issue of Policy Options (www.irpp.org). Milevsky is an associate professor of finance at York University and executive director of the non-profit IFID Centre at the Fields Institute for Research in Mathematical Science. Macqueen is a special project manager at the QWeMA Group, which specializes in the business of retirement income planning.
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