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Home » General
CPP is not ‘money for nothing’: Why you shouldn’t rely on big government for your retirement
Category :- General

Author :- Ted Rechtshaffen 
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Posted on May 14, 2014, 1:44 am
(6 Ratings)

The rock band Dire Straits had a big hit in the 80s with a song called “Money for Nothing.”

Sometimes I think we really believe that government pensions are money for nothing. This is never the case. When it comes to the Canada Pension Plan, how much does it really cost us, and should we even want a higher CPP payout in retirement?

When it comes to your RRSP you regularly look at returns, but why not the CPP? In many ways the CPP and your RRSP are closer than you think, and they are both simply parts of your retirement savings plan. So let’s take a closer look at the CPP as part of your retirement plan.

Recently, there has been a big push on to try and boost CPP benefit payouts. These currently max out at $12,460 if taken at age 65.  There is a belief among some that this number is not high enough because a retiree can’t live on this amount and another $6,600 of Old Age Security. Of course this belief assumes that we have no responsibility or capability of creating any meaningful personal savings in our lifetime.

Don’t get me wrong. Money for nothing is wonderful. I would love it if the politicians would vote in increases to CPP payouts, then miraculously, the government would create more money and we would cash a higher monthly cheque in retirement. Unfortunately, this is only true in the land of buttercups and lollipops.

In the real world, the Canada Pension Plan is fully funded by two groups. The first is the employer, and the second is the employee.

Not surprisingly, retirees and their lobby groups love the idea of an expanded Canada Pension Plan. They represent those that are neither the employee nor the employer, but represent the cheque casher. In case anyone cares, I support all programs that will be of benefit to me, and paid for entirely by others.

One group that isn’t a fan of expanded CPP is employers. The reason is that expanded CPP payments represent a pure cost with no direct benefit to employers. If this expansion is forced on employers, at some level this leaves less money for wages since CPP contributions are usually thought of as a payroll cost. This can either come from fewer hires, letting go some employees, slowing down any wage increases or a combination of the above.  Most companies with a mandate for growing profits can’t afford to simply suck up a meaningful extra cost, with no steps taken to recover the cost increase.

The one sizable group that is potentially a contributor and beneficiary of CPP expansion is the Canadian worker. On the one hand, a larger amount of your earnings will be put into the CPP, and it is possible that your employment situation will be a bit tougher, but on the other hand you will have a larger pension payment in retirement.

For some workers, this is a good tradeoff. The CPP represents a forced savings plan. For many this money that is going to be part of their retirement income would otherwise be spent on something that is not really needed today and would leave them at financial risk in retirement. In fact, if you want a larger government pension, you actually have the option of putting up to $2,500 a year into the Saskatchewan Pension Plan. It may not make sense for all Canadians, but it is available to you.

For other workers, this forced government savings makes little sense. They have some financial discipline. They are adults who do not need to be forced to ‘take their medicine.’ They would rather control their own retirement savings decisions. But this goes beyond simply personal freedoms. Among the benefits of funding your own retirement plan over expanded CPP contributions include:

-CPP ends at death (or death of surviving spouse).  With savings, if funds are left over they go to your heirs – not back to the pension plan.

-CPP program has a major flaw in that you can only receive maximum pension even if you are the survivor collecting for two people. This means that if two spouses have contributed and have maximum pension, when the first spouse dies, other than a small one time benefit of $2,500, the surviving spouse effectively gets nothing. The rationale being that they can’t receive more than their maximum personal pension. This is a terrible deal for Canadians where both spouses work. This two-income scenario is one that is much more likely for many Canadian families today, even though it was fairly rare when this rule was put in place.

-Retirement is no different than other parts of your life. Sometimes you need or want more cash and sometimes less. This flexibility on income can also help lower your taxes by being able to manage this cash flow better. With the CPP you have no flexibility other than what year it starts (between age 60 and 70).

Besides the pro and con list above, one of the biggest questions about CPP is whether it is even a good investment for us? What is the return on investment with your CPP contributions?

Interestingly enough, the rate of return on CPP contributions is quite poor when looking at the total amount going in to CPP from the employer and employee compared to what the employee will receive – this return is in the 2% to 3% range. The good news is that as an employee, your contributions are being fully matched, so you only pay 50 cents on the dollar. It is quite tricky to determine your rate of return on CPP contributions because of many variables. One personal variable is how long you will likely live? The longer you live, the better deal expanded CPP becomes. The shorter you live, the worse the deal on CPP.

My current analysis shows that a male employee’s rate of return on CPP contributions is 5.9% while a female employee’s rate of return is 6.3%. This assumes that you are contributing the maximum CPP each year for 40 years, assumes a 2% indexation/inflation for life, and is based on the current cost of an annuity that would provide the same lifetime payout as CPP.

Of particular interest is that this 5.9% and 6.3% is likely at the high end of the range. The reason is that the cost of an annuity today is very high because interest rates are very low. If we did this scenario at a time when interest rates were a couple of percentage points higher, the rate of return needed on the CPP contributions to pay for a lower priced annuity would likely be more like 4% to 4.5%.

So is this 4% to 6% a good return? Long-term stock market returns are between 10% and 11%. Long-term bond returns are around 9%. Even in a lower inflation environment and after fees, it is reasonable to assume a long-term return of at least 6.5% if you were in control of the money. As a point of comparison, the Ontario Teachers Pension Plan has averaged over 10% return since 1990.

I would argue that the rate of return for an employee is not terrible on the CPP, but it isn’t especially good. In fact, for people without a company pension, it is quite possible to build or have a professional build an investment portfolio that is pension style in terms of income, dividend growth, and lower volatility.

When you look at all of the factors, I believe that for most people, it is much better for individuals to control more of their retirement savings and planning rather than being forced to save more by big government. It is certainly better for employers, and quite frankly, a smaller CPP reduces the pension liability risk of the government (also known as you and me).

Let the government focus on the many other priorities that they face, and leave the building of a personal retirement pension to us. After all, we are funding it anyway, we might as well have some freedom and flexibility on this important part of our retirement.

Reproduced from the National Post newspaper article 20th January 2014.


Source: http://tridelta.ca/The-Canadian-Financial-Planner/2014/01/21/cpp-is-not-money-for-nothing-why-you-shouldnt-rely-on-big-government-for-your-retirement/

Comments : Ted can be reached at tedr(at)tridelta.ca or by phone at 416-733-3292 x221 or 1-888-816-8927 x221
Rate this article   
Thanks for the great read
Couldn't agree more. It's a great idea for those who do not pay into a pension scheme but does not make any sense for others. As a contract worker, I'm used to fending for myself and continue to save as much as I can without relying on government support in the future.

Great article!

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Posted by : Chris  
Posted on : October 15, 2015, 9:33 pm
Thanks for Sharing
I agree wholeheartedly that one should not be forced to pay into CPP and simply putting the burden on employers is not the answer either. Individuals, not government, should be in control of one's financial future. Governments, like referees in a game, should simply provide a level playing field.

I agree that CPP may be a great idea on those who don't have a company pension. But I do hope those in that situation, including those in relatively lower income brackets, would be able to afford paying the required amount to get a decent payout. As we know, there is no free lunch.
Posted by : Srikanth (Sri) Amudhan  
Posted on : February 15, 2015, 12:25 am

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