Ontario’s Liberal government is proposing to introduce the Ontario Retirement Pension Plan (ORPP) to solve a looming retirement crisis if they’re re-elected in the provincial election on June 12. However, this strategy is ill conceived and timed.
Canada’s retirement system is based on three pillars:
- Old-age security (OAS) and the guaranteed income supplement (GIS), which are monthly government payments to senior Canadians and lower-income seniors, respectively.
- The Canada Pension Plan (CPP), which makes fixed, monthly payments to seniors based on their contributions — and matched by their employers — over their working lives.
- Workplace pensions and people’s own savings from investment vehicles such as RRSPs, savings accounts, investments and home equity.
Although this is simplistic, the main point is that these pillars need to work in balance — and a change in one may potentially affect the others. No one can argue against the need for enhanced retirement savings, but do we have a crisis that dictates Ontario needs to work outside the current system? Should we not look at the pillars and enhance each one so that the system is in balance for the risk management of people’s retirement security?
These considerations lead to the conclusion that the Ontario Liberals’ ORPP is ill conceived and timed — and that financial planners need to take note so that their clients are not distracted from their personal savings goals.
The rationale for the crisis that needs to be solved is, in summary, that Canadians have fewer pensions and lower savings. This is proven by Statistics Canada, which provides the following findings:
- The number of people enrolled in employee-sponsored pension plans decreased to 25% in 2008 from 35% in 1977.
- RRSP contributions deepened but did not widen, meaning that for 2011-12, contributions increased by 3.8% but the number of RRSP contributors remained virtually unchanged.
- Participation rates in defined-benefit pension plans are declining while the participation rates in defined-contribution pension plans are up by 3.5% for the 2011-12 period.
- The Canadian household savings rate has been declining over the past 30 years: from 18.8% in 1981 to 1.5% in 2006 and recovering to 5.2% in 2013.
It appears that from this data that the last pillar — workplace pensions and personal savings — needs enhancement. As we all know, the CPP and OAS will not be enough to maintain the standard of living of future retirees, especially those in the middle class, given that life expectancy is increasing.
Moreover, young people will foot the bill for these seniors either through higher taxes or direct family support, and governmental expenditures will be restricted in the future because of increased social transfers to seniors.
On a good note, Canadian seniors have a low poverty rate by global standards, and CPP is solid on an actuary basis. Compare this to the European model in which a majority of pension plans are unfunded liabilities of governments. This highlights that the Canadian system is a sound system to enhance vs a crisis.
What do the Ontario Liberals propose? Basically, it’s a target plan vs a fixed payment plan like the CPP. Your return is based on the performance of the plan. It aims to replace 15% of an individual’s working income upon retirement by having employees contribute 1.9% of their income up to $90,000 of earnings; these contributions are to be matched by employers, save for the self-employed and federal workers. This new system will create a $3.5-billion savings pool each year and be managed by a board that is arm’s-length from the government.
This highlights the idea that the ORPP is ill conceived because this is exactly what the CPP Investment Board does with a 7.4% annual rate of return — and it took years to build it and its track record. Ontario is better off working with its confederation partners and enhancing the CPP as this is more efficient than building another bureaucracy.
Further analyzing this plan reveals that it’s also ill timed. Ontario is struggling to regain its economic form and is deeply in debt. These payroll taxes will hurt small companies and reduce growth, which is required to increase disposable incomes so people spend more as well as save more for retirement.
This creates a vicious circle as taking from one area from the retirement system just transfers it to another area. Although it’s true that there are some economies realized from pooled funds vs individual investing, economic growth trumps these savings.
This is why financial planners need to take note of the ORPP as these diverted funds will turn clients’ focus away from their personal savings — either in monetary terms or a perception that they don’t need to save. And personal savings is the surest retirement planning strategy that people can do vs relying on others.