Relax. There's no reason to worry about your CPP during these volatile days of wildly fluctuating stock markets and the subprime mortgage crisis. The CPP is in the safe hands – its $121.3 billion carefully vested on behalf of 17 million working and retired Canadians and for generations to come. But that wasn't always the case. Canadians have former prime minister Paul Martin to thank for the restored viability of the country's state-administered pension plan, says Bill Robson, president and CEO of the C.D. Howe Institute. "He's (Martin's) never been properly recognized for this," says Robson. "The reforms have worked very well so far." In 1996, the CPP was headed for certain disaster, taking in only $11 billion in contributions that year, while paying out a whopping $17 billion in benefits. With large numbers of aging baby boomers set to retire by 2011, actuaries projected Canada's pay-as-you-go fund would be unable to fully pay benefits by 2015. It was Martin who had the prescience and political fortitude to launch revolutionary CPP reforms – dramatically increasing contribution rates, reducing some benefits and separating CPP monies away from government assets for investment by an independent board – and who was able to commandeer the necessary co-operation of most provinces. Parliament passed new legislation in late 1997 that took effect in 1998. Quebec has opted to administer its own pension plan, which has not fared as well financially as the CPP. Since 1997, CPP contributions have gradually increased by 80 per cent, from 5.6 per cent of earnings to a maximum 9.9 per cent, shared equally by employees and their employers. In 2008, working Canadians and their employers will pay a shared CPP levy of up to 9.9 per cent on earned income up to $44,900, with employees paying a maximum annual levy of $2,049.30 after a personal exemption of $3,500, an amount matched by their employers. Self-employed Canadians must contribute the full levy to a maximum of $4,098.60. "Canadians have no need to worry," says Ian Dale, a spokesperson for the Canada Pension Plan Investment Board, the Toronto-based arms' length agency set up in 1998 to administer the fund independent of political interference. "The Canada Pension Plan is sustainable for 75 years and beyond, according to the (federal government's) chief actuary. There are all kinds of safeguards in place to make sure these funds are there to pass to pensioners and for investing the fund only for their benefit." The CPP contribution rate has been capped at 9.9 per cent, with no further increases expected for 75 years, says Dale. "(The CPP) is self-sustaining at 9.9 per cent of earned income." In fact, benefits paid out by the CPP are fully funded by incoming contributions, leaving invested funds untouched, until the year 2020. Further amendments introduced by Bill C-36, which came into force on Jan. 1, 2008, assumes steady-state financing, rather than the prior pay-as-you-go funding to build a reserve equivalent to 58 years of benefit payouts. This pre-funding of the plan by soon-to-retire boomers will ease the burden on upcoming generations, says Dale, noting that the legislative amendments require that any new or increased benefits must also be fully funded. More importantly, perhaps, Martin's reforms ensured the CPP monies were separated from government assets and managed by an independent investment board. That means the federal government cannot be tempted to borrow from surplus funds, for instance, as it has done from surplus revenue collected through Employment Insurance premiums or as governments in other countries have done with national pension funds. As of January 2008, the maximum Canada Pension Plan benefit to someone aged 65 is $884.58. The basic Old Age Security, paid to people 65 years of age and over, will remain unchanged at $502.31 per month. Guaranteed income supplement for eligible low-income pensioners is $634.02. While the troubled, stubbornly independent Quebec Pension Plan may well be praying for a financial bailout from the separately managed CPP, as suggested by pundits in recent news reports, the federal reforms mean that is as likely to happen as amending the Constitution – requiring the agreement of two-thirds of 10 provinces, constituting two-thirds of Canada's population. However, Robson says Canadians must remain vigilant to ensure the monies vested with the CPP don't become politicized. One of the reasons the Quebec Pension Plan is now in financial difficulty and may not be sustainable at the 9.9 per cent contribution rate, is the province has unwisely used some pension funds to invest in its industrial policy, So far, the CPPIB has made great strides from 1999, when all extra CPP funds were invested only in federal and provincial bonds, earning a steady, but unexciting rate of return significantly lower than returns of stock market indices. Today, more than half of the fund – 56.5 per cent or $68.5 billion – is invested in stocks of more than 1,900 international and 700 Canadian publicly listed companies, with other investment in private equities, real estate and inflation-linked bonds. For more information on the CPP, go to www.cppib.ca, the website of the Canada Pension Plan Investment Board.
Special to the Star
Sunday, February 17, 2008
Canada Pension Plan sustainable for 75 years
Ensuring your pension won't come up short
In her book, The New Retirement, economist Sherry Cooper delivers bad news to affluent boomers who expect to live well after they leave work.
Her message: You haven't saved enough. You have to save a lot more.
"Roughly 41 per cent of Canadian households earning $75,000 a year or more might not be able to replace two-thirds of earnings," she says.
"And a whopping 55 per cent of Canadian high-income households have not saved enough to replace 80 per cent of their employment income."
She's talking about the fact that government pensions (Canada Pension Plan and Old Age Security) were never intended to maintain your living standards after retirement.
The richer you are, the more you will need to rely on employment pensions or your own savings.
But not all pension plans are the same. The traditional defined benefit (DB) plan, which covers 33 per cent of Canadian workers, is more valuable.
With a DB plan with inflation protection and long service with your employer, you have no reason to worry.
But if you have a defined contribution plan, watch out. You're unlikely to achieve the same level of financial health in your retirement as a DB plan member.
She gives the example of two people, Dick and Jane, starting their careers at age 25 and planning to retire at 65.
Their starting salaries are $40,000 a year, increasing at a rate of 2.5 per cent a year, and their average annual income over their last five working years is $102,290.
Dick is employed by a bank and covered by a DB plan. He contributes 2 per cent of his salary each year and gets an annual retirement benefit of $51,145.
According to financial planners, it would take 20 times the annual payment – or $1.02 million – to generate an annual income of $51,145 for an indefinite period into the future.
Jane works for an investment bank and has a DC plan. She puts 2 per cent of her income, as Dick does, into a registered retirement account to get a 2 per cent matching contribution made by her employer.
For her workplace savings to reach the same imputed value of $1.02 million, Jane would have to get an average annual return of 10 per cent during her working years.
"This is not likely," says Cooper, who's chief economist at BMO Capital Markets.
Assuming a more realistic 5 per cent return, Jane would have to contribute much more each year to bring her DC plan up to $1.02 million at retirement.
In fact, she has to save an extra 9.8 per cent of her income – on top of the 2 per cent contribution she already makes – to get the matching contributions from her company.
"This, too, is very difficult," says Cooper.
"Saving 11.8 per cent of gross income is quite a hefty chunk. Whichever way you look at it, the DB plan is very valuable, far more so than the DC plan."
The prospect of coming up short is even more acute if you go into retirement without having paid off your mortgage.
Owning your own home makes a big difference, since it's assumed that one-half of the home equity is an asset from which you can generate retirement income.
Cooper's book has hit a nerve (for a contrary view, see "An" below). She's on the bestsellers' list and she's speaking across the country.
Her conclusion: If you're a high-income earner without a good pension plan, you have to save more and invest wisely.
Investing wisely means holding 45 to 65 per cent of your portfolio in stocks – both before and during retirement.
This increases the chance of your money lasting as long as you do, which could be 30 years or longer.
Ellen Roseman's column appears Wednesday, Saturday and Sunday.
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