Friday, April 2, 2010

Pension Reform: Liberal Delusions vs Common Sense

Let's say you have a choice between two pension plans. One is flexible - you can choose how much to invest - up to a certain limit. The other one is mandatory - the contributions are deducted from your paycheck and your employer must remit the same amount. (If you're self-employed, you have to pay for both.) The first one is directed by you and your financial adviser. It's up to you to decide the security level and the anticipated rate of return on your investments. The other plan is directed by the government. Their appointed investment board chooses where to invest the money without asking for your permission and is known to have made bad investment decisions at least twice in the past decade.

Plan one has a tax advantage: all contributions to it could be deducted at your marginal tax rate (up to 29% federally). Contributions to the second plan can only be credited at the lowest tax rate (15% federally). The first plan allows you to withdraw some (or all) of your savings if you need the money that bad - as long as you pay income tax on your withdrawals. The other plan allows no withdrawals until you turn sixty and even then - you better wait at least 5 more years unless you want your benefits to be prorated.

Finally, if you choose to increase your contributions to the first plan - you can look forward for higher benefits when you retire. If however you are mandated to contribute more to the other plan - your benefits won't increase. Moreover, you can look forward for your benefits to go down, (despite the near threefold increase in mandatory contributions since 1986,) because too many contributors are expected to start drawing for the plan all at once.

Now, imagine someone gives you the right to contribute more - not to the first plan, but to the second one; promising you that this time you could (probably) expect higher benefits when you retire. Will you be eager to invest your hard-earned money there? Will you consider this to be a good idea? Well, that's exactly what has been proposed at the Liberal 150 conference:
Former Bank of Canada Governor David Dodge is adding his voice to the debate over pension reform, calling today for a voluntary component to the Canada Pension Plan.
...
Nortel workers and others workers who have lost pension savings as their companies went “bust” during the recession, Mr. Dodge said reforms will not likely help them.

But there is still time to help other workers.

“Much really can be done to improve the policy framework for these plans going forward,” he said, “possibly we could have a voluntary component for the Canada Pension Plan and the Quebec Pension Plan.”
If anything, Mr. Dodge's example speaks in favor of letting each individual manage his own retirement fund, rather encouraging people to expect someone else to do the job for them. After all, let's not forget that the CPP Investment board too used to be among those investing in Nortel - and they too ended up losing money. So, if instead of contributing directly to Nortel-managed pension plan, the employees were allowed to make voluntary contributions to the CPP, which would then invest the money in Nortel - what difference would it make?

If however, employees had been allowed to direct the very same funds that their employer was investing on their behalf to their own personal retirement plans or, if they had been allowed to opt-out of the plan altogether, so that at least their RRSP contribution room wouldn't be reduced by the "pension adjustment" factor - that would have made a difference. That would have prevented at least those who knew that they shouldn't trust someone else to take care of their pension for them, from losing their retirement savings.

So if we want to help the people put some money aside for their retirement, then, instead of trying to siphon more cash into the one-size-fits-all (-delivers-pennies) retirement plan, we better implement some real solutions that would encourage people to take control over their own retirement savings. Among them:
  1. Increase the RRSP contribution room for middle income earners by raising the percentage limit from 18% of an earned income, to 20%-22% or even higher.
  2. Allow people to opt-out of their employer's pension plan so that at least their RRSP contribution room wouldn't be reduced by the "pension adjustment" factor. Ideally it would be better if the employees were simply allowed to redirect the funds invested on their behalf to their own RRSP accounts - which would then count as a standard contribution.
  3. Instead of the bureaucracy-breeding TFSAs, implement a a full-scale tax reform, that would turn every single saving account into a TFSA by taxing dividends, interest and other investment income at business level, making those sources of income 100% tax free for individual taxpayers.
  4. Reform the CPP, gradually transforming it from a "pay as you go" plan to a set of Personal Security Accounts.
The government is launching cross-country consultations on pension reform. This is our opportunity to voice our support for the real solutions to the pension crisis and for the real alternatives to the "voluntary" increase in mandatory payroll deductions, proposed by the Liberals.

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