Australia’s system of individual retirement saving accounts vs. the collective CPP model
Ottawa and the provinces have announced an “agreement in principle” to expand the Canada Pension Plan (CPP), requiring increased mandatory contributions from workers starting in 2019 in exchange for higher CPP retirement benefits in the future.
This is a wrong-headed policy for several reasons, not the least of which is that evidence shows most Canadians are adequately prepared for retirement, making CPP expansion largely unnecessary. Moreover, past experience in Canada indicates that higher mandatory CPP contributions will not actually boost overall savings; Canadians will simply respond by reducing the amount they save privately, offsetting the increase in government-mandated savings.
But governments have nonetheless insisted on increasing government-mandated retirement savings. Rather than use the existing collective CPP model for the additional mandatory contributions, they should have looked beyond our borders and considered pension models from other countries requiring their citizens to save for retirement. We made this recommendation in the past and it’s one that National Post columnist Andrew Coyne recently wrote about.
For example, Australia’s system of mandatory individual retirement saving accounts, with its greater choice and flexibility, deserves a close look.
In Australia, the mandatory employment-based pension approach more closely resembles Canada’s RRSPs. Australian employers are required to contribute 9.5 per cent of an eligible employee’s ordinary earnings to individual retirement accounts.
The Australian model has several distinct advantages over the CPP model.
For starters, the Australian accounts have limited rules around asset allocation and investment strategy, offering considerable flexibility to account holders. Individuals can choose an investment strategy based on their preferences and circumstances.
The Australian plan is also flexible enough to allow withdrawals from the accounts prior to retirement for medical emergencies or during times of financial hardship.
Crucially, any balance in the accounts can be fully transferred in a lump sum to a dependent tax-free upon death.
And all contributions and earnings in the Australian accounts accrue directly to the individual.
These important benefits are unavailable in the collective CPP model. Indeed, the CPP lacks the flexibility and choice that Canadians enjoy from private saving vehicles such as RRSPs, TSFAs, and other investments. This is particularly relevant in light of the fact that higher mandatory CPP contributions will be offset by lower private savings. Employing the Australian model could at least minimize such drawbacks.
There are other significant differences between the collective CPP model and Australia’s individual retirement saving accounts. Most notably, Australia’s scheme is a defined contribution plan, meaning the level of retirement benefits depends on how investments perform.
Defined benefit plans like the CPP—where beneficiaries receive a specified monthly benefit—are subject to a different set of risks. For example, under-funding of the plan or changes in the rules by government could lead to increased contribution rates or reduced benefit payments—something that has happened in the recent past.
Moreover, as Andrew Coyne correctly notes: “The CPPIB’s selling point was supposed to be that it could invest at much lower cost than private investment funds, on account of its larger scale. And at one time that might have been true. But even as costs have been plunging on the private side, thanks to the index-investing revolution, the CPPIB’s have been exploding.” Indeed, as a share of assets, a common measure of the relative cost of pensions, the CPP’s cost has more than doubled over the past 10 years as the CPP Investment Board, which manages CPP assets, has become more active and aggressive in its investment strategy.
If Canadian governments are determined to increase government-mandated retirement savings, the Australian model of privately held individual retirement accounts is worthy of serious consideration.