Uglier truths about the CPP
Misperceptions plague t he publ i c’s view of the Canada Pension Plan. Mark Machin, CEO of the Canada Pension Plan Investment Board ( CPPIB) — the organization tasked with investing Canada Pension Plan contributions — recently hit t he road in a cross- country effort to clear up the confusion. Unfortunately, Machin’s lack of clarity on key issues may have muddied the waters even more, giving the impression the Canada Pension Plan ( CPP) is a much better deal for Canadians than it actually is.
Machin told Canadians that the CPP is financially sustainable. But this wasn’t always the case. The CPP was overhauled in 1997; reforms included the creation of the CPPIB to i nvest pension contributions. That money, taken from working Canadians, is well in excess of the benefits paid to retirees in a given year.
As Machin himself admits, most Canadians don’t know much about the CPP’s i nvestment arm. But i ts existence gives the impression that the money Canadians pay i nto the CPP will eventually fund their individual retirements, the way things work with private pension plans. But that’s not how it is. CPP premiums paid today are still largely used to pay benefits to already- retired Canadian workers ( referred to as a “pay- as- you- go” plan). So, in reality, the CPPIB only invests a portion of our contributions. The rest is income redistributed to existing retirees currently receiving CPP benefits.
The CPPIB has seemingly done well in recent years. According to the last annual report, the five- year inflation adjusted rate of return earned by the CPPIB is 11.8 per cent. Does this mean the CPP is a great deal for Canadians? Simply put: no. The benefits Canadians receive from the CPP do not directly depend on the CPPIB’s investment performance.
For the CPP to remain sustainable, CPPIB invest- ments must deliver inflation-adjusted rates of return of 3.9 per cent each year. Beating that target puts the CPP on a sound financial footing. But that does not directly translate into higher benefits for retirees. Yet, in his recent comments, Machin failed to differentiate between the CPPIB’s rate of return and the rate of return individual contributors receive.
In fact, there is simply a formula — based on how many years you work, your annual contributions, and the age you retire — that determines your benefit amounts when you retire. This formula has nothing to do with the CPPIB’s investment performance. So, then, what is the actual rate of return on CPP contributions for individual Canadians?
It’s not great. Canadians born after 1970 can expect to receive a rate of return from their CPP contributions of between 2.3 per cent and 2.5 per cent ( depending on their specific year of birth). That’s pretty meagre. But the CPP is also a not- so- great deal for Canadians in other ways.
Unlike most pension plans, CPP benefits cannot be fully bequeathed upon death: spouses get only partial benefits if their partner passes away but only if they are not eligible for benefits on their own. Indeed, the program is designed so that the contributions made by Canadians who die early in life are used to subsidize those who live longer.
The CPP also lacks the other kinds of flexibility offered by privately managed retirement vehicles. Unlike RRSP contributions, CPP payments cannot be withdrawn early in an emergency or in case of hardship ( financial or health- related), to fund a down payment on a home, or to help support the costs of education upgrading.
Machin is right that it’s important Canadians understand the CPP and how it works. But he should be careful not to add to the confusion.