Canadians will receive meagre rate of return on CPP contributions

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Appeared in the Financial Post, April 4, 2018

Misperceptions plague the public’s view of the Canada Pension Plan (or CPP). Mark Machin, CEO of the Canada Pension Plan Investment Board (CPPIB)—the organization tasked with investing CPP contributions—recently hit the 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 CPP is a much better deal for Canadians than it actually is.

For example, Machin told Canadians that the CPP is financially sustainable. This wasn’t always the case. The CPP was overhauled in 1997; reforms included the creation of Machin’s CPPIB to invest CPP contributions made by working Canadians that are 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 investment arm. But its existence gives the impression that the money Canadians pay into the CPP will eventually fund their individual retirement, just like private pension plans. But CPP premiums paid today are still largely used to pay benefits to already-retired Canadian workers (this is referred to as a “pay-as-you-go” plan). Again, in reality, the CPPIB only invests a portion of our contributions—the rest goes to current recipients of CPP benefits.

Still, the CPPIB has 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 investments 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 does not directly translate into higher benefits for Canadian retirees. And 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, a formula—based on how many years you work, your annual contributions, and the age you retire—determine your benefit amounts when you retire. This formula has nothing to do with the CPPIB’s investment performance. So what is the actual rate of return on CPP contributions for individual Canadians?

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). This is a meagre rate of return for Canadian contributors. 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 on death (spouses get only partial benefits if one passes away but only if they are not eligible for benefits on their own). Indeed, the program is designed so Canadians who die early in life subsidize those who live longer.

Moreover, the CPP lacks the flexibility of other retirement vehicles. Unlike RRSP contributions, CPP payments cannot be withdrawn in cases of hardship (financial or health-related), to fund a down payment on a home, or to help support the costs of education upgrading.

So while we agree with Machin that it’s important Canadians understand the CPP and how it works, he should be careful not to add to the confusion.

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