How prosperous will your retirement be? That depends on how generous and dependable public pensions and government services will be. Many lucky folks will have private investments and prosperous farms and will, therefore, be relatively less dependent on the Canada Pension Plan and Old Age Security. But those services will be the great levelers of society. Indeed, what separates societies where the elderly mostly live in comfort from those where old age means poverty is the dependability and prosperity of government retirement programs.
We are living in a golden age of pensions with enough people working to support the most generous pensions in Canadian history. For the record, American Social Security, which allows people to cash in at age 62 and a half, is more generous than the Canada Pension Plan. But the American system is running out of money and is due to be broke in a few decades if it is not fixed by higher contributions or reduced draws by benefit recipients. The broad Canadian system, based on the Canada and Quebec Pension Plans, Old Age Security, the Guaranteed Income Supplement, RRSPs and company pensions, is intact. By comparison, the U. S. Pension Guarantee Corporation, which picks up the pieces of pension obligations after corporate insolvencies, is bankrupt with liabilities far in excess of assets.
Canada’s public pension system is okay. Although the number of people of working age available to support federal programs, which was eight in 1971, 5.1 in 2008 and due to be just 2.5 persons in 2033, is declining, more people are staying on the job. Data shows that 90 per cent of baby boomers are still in the labour force.
The new fashion is to continue to work past age 60 or 65. Freedom 55, the London Life slogan, is history. Populations often do sensible things and the continuation of work is one of those smart moves.
People are working longer because they have to. Defined benefit pension plans are no longer as available as they were 30 or 40 years ago. Nor are jobs for life.
There is also a recognition that many government programs have had a perverse effect. For example, Greece, with an official retirement age of 63, has government debt equal to 200 per cent of its gross domestic product. Why? Because people have taken advantage of the chance to retire. Greek pensions replace 96 per cent of income during working years. Greece has flirted with insolvency, because its policies pulled people out of the labour force with a velvet glove.
In Germany, which may have to bail out Greece’s debt, the retirement age is 67 and the income replacement ratio is just 60 per cent. German workers, who see themselves as the underdogs (though they have far higher disposable income than Greek workers) have taken to the streets to protest what they see as pension injustice.
In the U. K., the problem of a looming inability of their treasury to pay for entitlements is forcing the government to raise the retirement age and qualification for the state pension to 66 in 2024, then to 67 in 2034, then to 68 in 2044.
Canada is facing an expected tripling of persons over 65 from 3.9 million today to 9 million in 2041. It is trying to solve the problem by raising the penalty for early application for CPP benefits from 30 per cent today — that’s six per cent per year for each year before age 65 at which benefits begin, to 36 per cent and raising the bonus for staying at work to age 70 from 30 per cent today to 36 per cent — that’s six per cent for each additional year the person stays on the job.
CPP is also removing the work cessation test for early application for benefits so that people can work and receive CPP pensions. The new style of quasi-retirement may well become “take your pension and stay on the job.”
A MORAL QUESTION
We come to a moral question embedded in the numbers. When pension schemes became part of national budgets, few people made it to age 65. Now many do and 85 is the new 65. Is it right for younger workers to have to support older people who have decided to spend the final third of their lives golfing, curling or whatever? Legally, our system has to provide that right. But there is a deeper question — should those who can do productive work not do it? Moreover, given that families continue to shrink, the state has to stand in as a sort of foster family, supplying services that real families used to provide.
It comes down to asking how much we want the state to do. And that, in turn, has been left by the Government of Canada to individual choice.
A few decades ago, the defined benefit pension plan was common. Workers would be provided for in retirement by a fixed flow of money, professionally and efficiently managed. In the 1980s, capital markets turned very volatile and companies, often facing requirements that they beef up their pension plans, converted to defined contribution plans in which it’s every worker for himself.
WHO WILL RESCUE PENSIONS?
The mutual fund industry arrived just in the nick of time with what has become 13,000 mutual funds available for sale in Canada. There are hundreds of bond funds, thousands of stock funds, massive duplication of offerings all sustained by the highest management fees in the world. The average fees on a Canadian equity mutual fund are 2.4 per cent of total fund assets per year. After 10 years, you’ll have given a quarter of your initial contribution to the management company. After 20 years, you will have forked over half of your initial contributions. If you buy funds with deferred sales commissions, you will be punished for taking your money out after just a few years. This is a system of forced savings or at least forced asset retention by managers.
You can beat the system by investing outside of RRSPs and company pensions plans, but the tax benefit of RRSPs — postponement of tax until plan assets are paid out — is a strong incentive not to fight the system.
The policy of government and pension fund mangers has been to offload investment risk onto the shoulders of future retirees who manage their own RRSPs.
That risk is exacerbated by those high management fees. Compared to the 2.4 per cent management fee of retail RRSPs, pension funds charge about 0.2 per cent for management. That’s less than a tenth of the retail fee for what is usually better performance. Professional portfolio managers seldom go for fad stocks and park their emotions when dealing with other people’s money. That’s why they outperform retail investors managing their own retirement funds.
Facing the end of the golden age of pensions, individuals who have been forced and who will be forced to take over management of their retirement assets should try to invest on a cost-efficient basis. Mutual funds with good managers can beat their markets or sectors for a few years, but the huge fees they charge make it almost impossible for them to match low fee index funds and exchange traded funds for periods of ten or more years. “Almost” is the word here, for there can be exceptions that very lucky or very gifted investors will find.
Invest in fundamentals. That is what professional pension fund managers, including those who run the Canada Pension Plan do. Banks, railroads, big real estate owners and managers, telecoms, and public utilities are what they buy.
Buy some bonds or bond exchange traded funds. The older you are, the more you need dependable income. High grade bonds provide more dependable income than stocks. They tend to go up when stocks go down, providing a cushion for portfolio returns.
If you want to buy venture stocks of tiny companies, junk bonds, European pharmaceuticals, Asian steel makers, and so on, by all means do it, but keep the amount of money you commit to five per cent or less of the portfolio. Remember, it is better not to lose a dollar than not to make a dollar. That is both good economics and good psychology. Betting on small companies is like putting money on a 30 to one nag at the track. It may work, but the odds are not encouraging.
In the new age of pensions, we will all have to be more self-reliant. It is inevitable that government, faced with an elder boom, will have to do less for retirees. There is no alternative to doing more for yourself.
Andrew Allentuck’s latest book, When Can I Retire? Planning Your Financial Life After Work, was published in 2009 by Viking Canada.