Expanding the CPP will increase forced contributions, unlikely to boost retirement savings

Speaking to reporters on the newly minted “agreement in principle” to expand the Canada Pension Plan, federal Finance Minister Bill Morneau said “we are going to improve the retirement security of Canadians.”

The agreement, however, will do nothing to substantially achieve this goal.

Starting in 2019, working Canadians will be forced to contribute more to the CPP—though the details on exactly how much more have been sparse thus far. 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. The range of earnings subject to the contribution rate will also increase to $82,700 from the current maximum of $54,900.

The proposed changes could result in thousands of dollars in extra contributions from working Canadians every year—that’s on top of their current annual maximum contributions of approximately $5,000.

While the proposed changes to the CPP 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.

With reduced private savings come a loss of choice and flexibility. For example, money saved in an RRSP can be used for a down payment on a home, to pay for education upgrading, or withdrawn in case of an emergency. And all the money can be transferred to a beneficiary in the event of death. 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 the federal government is most concerned about: those without a workplace pension.

When faced with increased mandatory CPP contributions, this group may be more likely to reduce their private savings since they generally have more flexibility than Canadians locked in a workplace pension.

Nonetheless, the concern that Canadians without a workplace pension do not save enough for retirement is misplaced. Statistics Canada research shows that relative to their pre-retirement income, retirees without a workplace pension have a higher average retirement income than those who do not (although the median is slightly lower). Simply put, lack of a workplace pension does not doom someone to a financially insecure retirement.

Despite the rhetoric, the agreement to expand CPP is unlikely to boost overall retirement savings yet will undoubtedly take more money from working Canadians on payday.