Forcing people to save more so they can upgrade their iPhones in retirement - Appeared in the Financial Post

The Institute for Research on Public Policy is the latest organization to publish a study with a proposal to fix Canada’s pension system. However, it’s a proposal akin to using a battering ram to swat a fly.

Like many of the other proposals floated by a variety of groups, the IRPP study suggests expanding mandatory savings by expanding the Canada Pension Plan (CPP). Similar to all the other proposals, this latest one is overkill for a policy issue that has seriously been overblown, and comes with a number of adverse consequences.

According to the study’s author, Keith Horner, the problem is that close to 30% of modest-income and middle income earners are not saving enough to attain an “earnings-replacement rate” equal to 90% of their pre-retirement consumption. Horner notes that those with low earning levels achieve higher rates of earnings replacement through government benefits. Hence the problem is not about senior citizens living in poverty. In fact, OECD rankings show that Canada has the second lowest poverty rate for senior citizens after the Netherlands.

The problem, as seen by Horner, is that some retirees will not be able to maintain their existing lifestyles. In other words, they may not be able to afford premium cable, the latest Apple gadget, or class of car they are used to. They may not be able to spend as much on restaurants meals, vacations, or government lottery tickets. Horner’s solution to save a minority of retirees from having to downgrade to basic cable is to force all working Canadians to contribute more of their earnings to a government sponsored defined benefit plan such as an enrichment of the existing CPP.

Horner argues that increasing mandatory retirement savings is the best option to ensure individuals will have adequate replacement income to maintain their lifestyles in retirement for various reasons including a decline in workplace registered pension plan coverage. However, a 2009 OECD working paper by Pablo Antolin and Edward Whitehouse provides empirical evidence that higher mandatory contributions do not necessarily lead to higher pension income. Based on a cross-country comparison of the pension systems across OECD jurisdictions, the authors of the paper found no link between relative pensioner incomes and the type of pension system, including what component is voluntary.

A 2009 study by Jack Mintz throws additional cold water on Horner’s arguments. The Mintz study noted a Statistics Canada analysis that found, outside the highest income bracket included in the analysis, those with registered pension plans had less retirement income than those without. Mintz suggests that this indicates that declining registered pension coverage may not lead to insufficient retirement savings since Canadians are investing in RRSPs and other assets to fund their retirements.

Increasing mandatory savings is not without costs. The OECD working paper referred to above notes a number of arguments against mandatory savings including the observation that the losses in terms of individual welfare from forcing people to over-save can be as great as the losses from under saving. As examples, the OECD paper notes that the resources diverted to retirement savings might come at the expense of devoting the necessary amounts to raising and educating children, and that some individuals will save for retirement outside formal pension plans such as investment in their own businesses. Despite favouring mandatory retirement savings, Horner acknowledges these issues noting that some individuals might be better off paying down debt or investing in a small business or education.

Horner presents an interesting argument on how tax free savings accounts (TSFAs) add to the need for further mandatory savings. He argues that because income from TFSAs is ignored in determining eligibility for the Guaranteed Income Supplement, a program designed to enhance the retirement income of low-income seniors, middle-income seniors with TFSAs could be eligible to collect benefits from the program. However, if there is an adverse side-effect from the creation of TFSAs, the solution should be to correct the design flaw directly, rather than force everyone, including those who do not even have TFSAs, to save more.

A positive element of Canada’s pension reform debate is that it is turning out to be a long process. For instance, it will not be until December when federal and provincial finance ministers meet to discuss the issue. As the process unfolds, there is a strong possibility that interest rates will move towards their historical norms in which case, Canadians will save more, borrow less, and be able to buy annuities on more favourable terms. This could be enough to alleviate concerns over retirement savings, and ensure that any new policy initiatives are measured and targeted, rather than the drastic solutions proposed by Horner and others.