What can Canada learn from pension reform Down Under?

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Appeared in the Financial Post

As Canada's finance ministers meet to discuss the Canada Pension Plan, the debate has thus far been insulated from international pension models and limited to whether or not we should expand the CPP.

Canadians, however, would benefit from a broader debate and one that looks beyond our borders to see what other countries are doing on employment-based pension policy. Australia’s 1992 reform is particularly worth looking at. This reform has led to extensive pension coverage and high replacement rates, while offering more individual flexibility than typical government-mandated pension plans. Put simply: the Aussies offer a useful lesson.

A recent study published by the Fraser Institute examined Australia’s employment-based pension reform—a reform intended to address a gap in the country’s retirement savings and an overreliance on Australia's public pension system. The Australian system now rests on three pillars.

Australia has a mean-tested public pension program that provides a basic source of retirement income to all Australians aged 65 years or older (set to rise to 67 years by 2020) regardless of employment history. It also encourages voluntary private savings through the tax system.

But the lynchpin of the Australian model and where the lesson for Canada may lie is its individual retirement savings accounts with mandatory employer contributions.

In 1992, rather than go the CPP route, the Australia government chose an employment-based pension reform that made individual retirement savings mandatory. Prior to the reform, Australia’s pension system consisted only of the means-tested public pension program and private savings.

Now these employment-based savings accounts cover approximately 90% of the country's workers. Employers must contribute a minimum of 9% of an employee's gross earnings up to a maximum income threshold (rising to 12% by 2019-20) into an individual account that is privately managed.

There are limited rules around asset allocation and investment strategy for these accounts. This affords considerable flexibility to account holders—particularly when compared to the CPP—as an individual may choose a different investment strategy based on his or her risk profile.

There is also flexibility to withdraw funds from the accounts prior to retirement for medical emergencies or financial hardship. And any balance in the accounts can be fully transferred in a lump-sum to a dependent tax-free upon death. These important benefits are not available through the CPP.

While investment income earned in the accounts is taxable, the withdrawals are tax-free starting at the age of 60 and can be taken as a lump sum or converted to an annuity to provide a guaranteed stream of retirement income. These accounts can achieve income replacement rates of 90% for a median wage earner entering the workforce today and retiring at age 67.

Australians can begin withdrawing from their retirement savings account at age 55, though the income is subject to tax. The option to withdraw from the accounts early has contributed to low levels of post-retirement participation in the labour force, so the government is now transitioning to a minimum retirement age of 60 by 2025.

Australia’s 1992 reform is estimated to have raised its national savings by 1.5% of GDP.

To be clear: all this does not suggest that Canada should adopt compulsory individual retirement savings accounts in addition to the existing pension system. But Australia’s system of compulsory personalized retirement savings has features that would certainly appeal to many Canadians if given the decision versus the CPP.

There are, however, important distinctions between the two government-mandated savings models.

For instance, Australia's individual retirement savings accounts are defined contribution plans—not defined benefit plans—which means the level of retirement benefits is less certain. But the Australian accounts have their own benefits not found in the CPP like the ability to personalize one's investment strategy, to fully transfer assets upon death, and to withdraw funds in the case of an emergency. Perhaps most importantly, all of what you contribute and earn in the Australian-style accounts go to the individual, which contrasts sharply with the collective CPP model.

Looking at the retirement system of both countries more broadly, the opportunity for lessons works both ways. In particular, Australia may look to Canada's pension income support programs and its record on achieving a relatively low rate of senior poverty.

But this is distinct from what Canada can learn from Australia's 1992 reform. As the debate about the CPP charges forward, Canada's finance ministers should broaden their horizon and look Down Under. There’s something to learn.

Sean Speer is associate director of fiscal studies and Charles Lammam is resident scholar in economic policy at the Fraser Institute. Click for study Policy reforms in Australia and what they mean for Canada.

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