In autumn 2014, I wrote about the CPP operating expenses and thought they seemed excessive.
In view of the proposed changes to the benefits under the plan, and the proposed higher contributions, roughly 12% of qualifying income when mature, I thought it might be useful to think about an alternative to that increase.
I am aware that the CPP provides many benefits. Disability, survivor before 65, survivor after 65, child survivor and a tiny death benefit. I have chosen to focus solely on the retirement benefit. Partly because that is the only thing presently being feted by the government and their acolytes, and partly because there are hidden funding methods they don’t talk about.
The hidden funding includes at least these.
- Death before retirement for anyone with no survivor returns $2,500 only. Less than 6 months of contributions at today’s maximum
- No survivorship pension in some circumstances
- Survivorship pensions are tied to an individual’s personal retirement pension. The plan has a cumulative maximum that deletes the survivor pension for anyone at maximum on their own.
- Over-contributions are refundable only to an individual. The employer share remains with the plan custodian.
- Contributions in the 15% of years not used to calculate the pension are not refunded.
These other funding methods may not pay all the expenses of the other benefits, but that does not change the gist of the story. They do not earn enough on their assets.
I decided that an investment plan that returns 2% over inflation before taxes and after management fees was minimal. Most balanced funds do that and more.
So what happens if CPP did that?
Assume inflation at 2%, a couple for retirement purposes, a person who contributes maximum once they are 25 years old and every year thereafter. Assume retirement at 65, death of the contributor at 85, and death of his spouse at 92.
The required internal rate of return net of expenses to pay that is roughly 3.5%. 1.5% over inflation.
At 4% rate of return, (2% over inflation) the contribution rate could remain the same as it is now. If they could make 3% over inflation, then the contribution rate could be nearly one third less than now.
Your future pension results from more than what you pay in. Rate of return is crucial. The time invested matters, expenses to earn the income matters. The duration of life after retirement matters. It is not a simple calculation, but investment yield is a very important factor.
The managers of the CPP fund must be held to a higher performance standard. The Ontario Teachers Pension plan is a bit over half as big as CPP and has earned 10.3% on assets over the past 25 years. I have not looked for the net return but I would be astounded if it is less than 9.5%.
I wonder why projecting CPP at 4% or even 5% is such a stretch goal.
A quick look indicates that one could outperform the CPP Investment Board by using Index tied, ETFs. That will never happen because you don’t need the CPPIB to do that. No government department ever gets smaller.
How much should we pay for managing these funds and who is accountable for keeping that cost as low as possible? The goal ishould be to give fewer assets to those least able to use them well. For more, see this recent Fraser Institute Paper. Myth—the CPP is a low-cost pension plan.
Most people just complain about the payroll deduction and look no further. Knowing little about the details is not an excuse for missing the inefficiencies. The contributions the government proposes to take from you would amount to more than $1,000,000 by age 65, even if invested ineptly. I don’t know about you, but I think people should manage a million dollar asset with more care and attention.
Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario. In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.
Please be in touch if I can help you. firstname.lastname@example.org 866-285-7772