Pensions Still Leave People Mystified

back

Pensions Still Leave People Mystified

By Michael Kane, The Vancouver Sun

March 8, 2004

Pension tension is in the air. Surveys show Canadians don't understand how their plans work and they are worried employers will break their pension promises.

They also continue to doubt that the Canada Pension Plan will be there for them when they need it, and they increasingly expect their homes to be a primary source of retirement income.

Far from anticipating "Freedom 55," we're hearing more and more talk about working beyond age 65, or at least having that option.

While many Canadians are building up substantial equity in today's red-hot housing market -- and that's a tax-free gain when they sell a principal residence -- they may be over-estimating how much will be left over by the time they have downsized and how much pension their real estate profit will buy.

In the absence of serious health concerns, most financial advisers suggest individuals should plan for about 30 years of retirement beyond age 65.
Advisers will also tell you that many of today's seniors view their home as an insurance policy against another bout of runaway inflation, or the time when they may need to fund long-term care. It is a last-resort source of income that many would prefer to leave to their kids.

Indeed, some seniors are borrowing against their equity not for income but to help their children get on the first rung of the real estate ladder.
"I would typically think that your home wouldn't be your major source of retirement income," says Enzo DeLuca, a principal and retirement specialist with Mercer Human Resource Consulting in Vancouver.

"I would still go back to the three pillars which are government pension schemes, primarily the CPP; company pension plans if you have one; and then personal savings. If you own a home, I would view that as part of your personal savings."

So how are pensions faring after the double whammy of a prolonged bear market coupled with declining interest rates?

First the Canada Pension Plan to which every worker is compelled to contribute. Those who suggest we can't count on CPP usually neglect to mention that the plan does not cost Ottawa or the provincial governments one red cent.

The plan is financed entirely by employee and employer contributions, and investment earnings. Even administration costs are deducted from the CPP account rather than the public purse.

Indeed, it is only a government program in that government came up with the idea and government makes the rules under which it operates.
Moreover, when you collect your pension, it is taxable and it pushes many recipients into higher income levels where they may lose some or all of the age tax credit and the tax-funded Old Age Security pension and Guaranteed Income Supplement.

In other words, CPP is a cash cow for the government. OAS is vulnerable to government whim and, like GIS, may one day be reserved for only the neediest seniors, but it is highly unlikely Ottawa would choose to dismantle CPP when it not only finances itself but generates tax revenue and reduces government costs.

For its first three decades, CPP was a glorified Ponzi scheme with the contributions of many workers paid out to relatively few pensioners. However, it was massively overhauled in 1997 to address concerns about the aging population.

As a result of those changes, which included building up and investing reserve funds while increasing contributions to nearly 10 per cent of every salary up to $40,000, the chief actuary for the CPP, who reviews the health of the plan every three years, has said that it is sound for at least 75 years.

DeLuca agrees that concerns about CPP are overblown and that it would be difficult for government to attack money held in trust by an independent board and segregated from government funds.

He says CPP could be "tweaked" in the years to come to address concerns that younger contributors are paying more into the plan than they will receive. "That is the kind of thing that could sway through the political arena, but I think as a program it will be around."

Last week, the Canadian Taxpayers Federation suggested it would improve inter-generational equity if the age of eligibility for the full CPP was raised from 65 to 69 and the earliest age to receive a reduced pension was raised from 60 to 64. That idea is unlikely to win votes from the aging baby boomer generation, but stay tuned.

Of more immediate concern is the state of employer pension plans, particularly defined contribution plans where employers simply contribute a defined amount of money each year while the pension that the member ultimately receives is at the mercy of the markets.

DeLuca and others in the pension industry expect employers with defined contribution plans may be hit with some high-profile lawsuits in the coming years from employees who now realize they may not be getting the kind of pension they were expecting as a result of the bear market and declining interest rates.

A recent survey by SEI Investments Canada found that nearly one-quarter of employers sponsoring defined contribution plans expect to get sued over the course of the next two years, and 40 per cent expect to lose their court battles.

Fuelling these concerns are regulatory guidelines, expected to come into effect this year, which make it clear that plan sponsors must be significantly involved in the oversight of defined contribution plans. Employers can't simply match an employee's contribution and then leave it up to the employee to manage the money so that it generates a reasonable pension.
Employees in defined benefit pension plans -- where the plan sponsor is on the hook to deliver a promised pension regardless of investment returns -- are less vulnerable but not immune to changing times.

While contributions to pension plans are held in trust and can't be taken back or "borrowed" in tough times, employers may go broke before periodic plan shortfalls have been corrected -- that's what the fuss at Air Canada and Stelco is all about -- and they can back off from optional benefits like pension indexing, or generous early retirement benefits.

Employers may also cite the need to fund a pension plan shortfall as an excuse to hold the line on pay increases. One way or another, employees tend to share the pain when a defined benefit plan gets into trouble.

Experts like DeLuca are calling for reforms to the structure of defined benefit plans that would balance risk between employees and plan sponsors, thereby easing the burden on employers who are increasingly avoiding the schemes because of their cost and complexity.

He says one concept may be to share future deficits and surpluses in the same proportion that costs are shared.

Some companies may also wish to reduce future defined benefit plan benefits and costs and complement the plans with fixed costs through a supplementary defined contribution plan. The defined contribution element would allow employees to participate directly in the markets, something many were clamouring to do when markets were booming.

The good news is that last year's stock market recovery has restored the fortunes of many defined benefit plans. According to the Mercer Pension Health Index, a barometer for the health of a typical employer-sponsored pension, these plans were almost 90 per cent fully funded at the end of 2003.

DeLuca said, however, low interest rates remain a concern because every one per cent decline in interest rates translates into a 10-15 per cent increase in pension liabilities.

The bottom line is that Canada's pension system is far from broke, but it is going to be fixed to ensure greater transparency for investors and plan members, to improve plan portability for younger workers, and to encourage employers to remain involved.

When it comes to your own retirement, those in best shape are counting on a pension plan, government programs, and personal savings, including a home. They also have a debt repayment plan so that, even if they choose not to retire at 65, they won't have to continue working to pay the bills.