Writing in the Financial Post, Macdonald-Laurier Institute senior fellow Philip Cross addresses calls for expanding the Canada Pension Plan. Cross points out that the “crisis publicized by the pension ‘industry’ of academics and financial institutions lies in the future, and as such relies on assumptions and projections in models which are questionable”. Cross argues that Canadian seniors can defy predictions by, for example, accepting a lower level of income in retirement or working longer, receiving assistance from family members, or taking advantage of the equity in their homes. Cross writes: “The fundamental flaw in using models to simulate the future of retirement is the underlying assumption that prospective retirees don’t understand their financial circumstances”.
Philip Cross, April 23, 2014
With talks to expand the Canada Pension Plan having stalled, the Ontario government has promised to roll out its own provincial version next week. The impulse for a “big CPP” is based on the fundamental assumption that the public is too ignorant or misguided to plan for retirement themselves and that the meddling hand of government bureaucrats can help guide them. In a study published today by the Fraser Institute, I question many of the assumptions behind the drive for “big CPP” in Ontario and elsewhere.
The first important point is that no crisis exists in Canada’s current retirement system. People are living longer, healthier and wealthier lives in retirement, largely the result of their own actions. The few pockets of poverty among seniors, such as single or widowed elderly women who have never worked, are best addressed by better targeting government benefits, not by a wholesale expansion of the CPP.
The crisis publicized by the pension “industry” of academics and financial institutions lies in the future, and as such relies on assumptions and projections in models which are questionable. The model results are based on the traditional three pillars of Canada’s pension system — social security payments from government, the mandatory CPP, and voluntary pensions like RRSPs. This downplays the role of assets people hold in a fourth pillar outside the pension system, which total $8.6-trillion including real estate and various saving and investments, compared with $2.6-trillion held within the pension system. And it completely ignores a largely undocumented but vital fifth pillar of support to retirees from family and friends; for example, 10% of seniors live with their families, with unknown amounts of money and in-kind support flowing back and forth across generations, including inheritances.
There are many problems with model-based extrapolations of pension incomes years in the future. For example, models assume that the replacement rate of working income with pension income is fixed over time, when it more likely declines as older age curtails spending on travel and entertainment, just as government provides more assistance. Banks routinely exhort retirees to replace 70% or more of their working income, when some experts find 50% would be adequate for most.
But the fundamental problem with targeting replacement rates is that they are an opinion, not an observable fact, which depends on individual circumstances and preferences. A prospective retiree can rationally choose to retire early, accepting a lower standard of living to spend more time pursuing leisure activities or with his family.
However, a growing number of older Canadians are staying in the labour force. Nearly half of Canadians over the age of 55 are still in the labour force, including one quarter aged 65 to 69 (near doubling in a few years). Canadians are increasingly working past what used to be the traditional (and often mandatory) age of retirement and this shift is playing havoc with forecasts of the labour force. In 2007, Statistics Canada projected the labour force could be as low as 18.1 million for the year 2031; by the end of last year, the labour force already had grown to 19.2 million. This should give pause to anyone basing policy prescriptions that increase payroll taxes for virtually all working Canadians today on model simulations of the distant future. Every extra year working produces a double benefit of generating more income and reducing the years saving are withdrawn for retirement.
Meanwhile, Canadians show a savvy willingness to adopt new financial strategies. One-third opened Tax Free Savings Accounts in the three years since their creation. This ignores the trillions stored in the value of their homes, which effectively is an unlimited tax free saving account for the principal residence.
The fundamental flaw in using models to simulate the future of retirement is the underlying assumption that prospective retirees don’t understand their financial circumstances. In models, Canadians march towards retirement either blissfully unaware of the lower standard of living waiting for them or utterly incapable of altering their behaviour by saving more or working longer in response to that knowledge.
In real life, there’s ample evidence that Canadians alter their behaviour in response to a keen awareness of their circumstances and act decisively and rationally to control them. Some accept lower incomes in order to retire early, others work longer when circumstances dictate, they save less voluntarily when government increases mandatory saving, they save more in their own pension accounts when employer-based pension plan benefits erode, they elect to receive C/QPP benefits earlier or later than the traditional 65 years as they see fit, they shift consumption between the early and later stages of retirement, they save more in their later years to leave an inheritance, and they understand government will intervene more as their health deteriorates in their final years.
Canadians are anything but the robotic automatons portrayed in models, doomed to endlessly repeat past patterns of behaviour, incapable of learning and adapting their lifestyle to the changing world around them. They are actively involved in making the myriad of decisions that affect their pensions and their retirement. The improved quality of these decisions is reflected in the better outcomes for people after they retire.If there is an expanded role for government to play in the future retirement system, it’s filling in the few cracks through which pensioners can fall into poverty.
Philip Cross is the former Chief Economic Analyst at Statistics Canada and author of “The Reality of Retirement in Canada.”