Expanding the CPP unlikely to increase overall retirement savings
Earlier this week, Canada’s finance ministers reached an “agreement in principle” on expanding the Canada Pension Plan (CPP), which starting in 2019, will require Canadian workers to contribute more to the CPP. In speaking at the joint press conference, federal Finance Minister Bill Morneau said “We have come to a conclusion that we are going to improve the retirement security of Canadians.”
The agreement, however, will do nothing to substantially achieve this goal.
The agreement does not specify exactly how much more Canadians will be required to contribute to the CPP. News reports suggest that, once fully implemented in 2025, the total CPP contribution rate will increase from 9.9 per cent to 11.9 per cent (split notionally between employees and employers) for earnings between $3,500 and $54,900. An extra 8.0 per cent total contribution rate will apply to earnings between $54,900 and $82,700, which represents an increase to the range of earnings subject to the CPP contribution rate.
The proposed changes will result in thousands of dollars in extra contributions from working Canadians every year. Based on the limited information available at the time of writing, we estimate that working Canadians could contribute up to an extra $3,250 more to the CPP each year—that’s on top of their current annual maximum contributions of approximately $5,000.
While the proposed changes are intended to boost the retirement savings of Canadians, the reality is that an increase in mandatory CPP contributions will be offset by lower private savings. Why?
Because Canadians choose how much they save and spend based on their income and preferred lifestyle. If their income and preferences do not change, and the government mandates higher contributions to the CPP, Canadians will simply reduce private savings.
In the end, overall savings won’t change but there will be a reshuffling, with more money going to the CPP and less to more flexible private savings such as RRSPs, TFSAs and other investments. A recent study that examined past increases in mandatory CPP contributions found that for every $1 increase in contributions, the average Canadian household reduced its private savings by roughly $1.
Among the implications associated with reduced private savings are loss of choice and flexibility. For example, money saved in an RRSP allows Canadians to pull a portion of their funds out for a down payment on a home or to upgrade their education, transfer money to a beneficiary in the event of death, or withdraw money in the case of an emergency. These benefits are not available through the CPP.
Somewhat ironically, the reduction in private voluntary savings is more likely to occur among the group of Canadians that the federal government appears most concerned about: those without a workplace pension. This group was highlighted as part of the motivation for expanding the CPP in both the press conference announcing the agreement and in the recent federal budget.
When faced with increased mandatory CPP contributions, Canadians without a workplace pension may be more likely to reduce their private savings since they generally have more flexibility to do so than those locked in a workplace pension. Consequently, expanding the CPP is unlikely to achieve the goal of increasing the overall retirement savings of Canadian workers who do not have a workplace pension.
However, the concern about Canadians without a workplace pension not saving enough for retirement is overblown anyway. It assumes that they will not adjust and save adequately in other ways. This assumption is contradicted by Statistics Canada research, which shows, relative to their pre-retirement income, retirees without a workplace pension have a higher average retirement income than those who do (although the median is slightly lower). Simply put, lack of a workplace pension does not doom someone to a financially insecure retirement.
By making the additional CPP contributions tax deductible, the finance ministers seem to implicitly recognize that CPP contributions are a substitute for saving through tax-deferred saving vehicles such as RRSPs. Without this change, many Canadians would have paid more income taxes as CPP contributions increased and savings in RRSPs fell.
Despite the rhetoric, the agreement to expand CPP will not substantially improve the retirement income system.
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