By Charles Lammam
and Hugh MacIntyre
The Fraser Institute
Misperceptions plague the public’s view of the Canada Pension Plan (CPP), despite efforts to provide some clarity.
Mark Machin, chief executive officer 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 CPP is a much better deal for Canadians than it actually is.
For example, Machin told Canadians that CPP is financially sustainable. This wasn’t always the case. CPP was overhauled in 1997; reforms included the creation of 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 admits, most Canadians don’t know much about the CPP investment arm. But its existence gives the impression that the money Canadians pay into 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. In reality, CPPIB only invests a portion of our contributions – the rest goes to current recipients of CPP benefits.
Still, CPPIB has done well in recent years. According to the last annual report, the five-year inflation-adjusted rate of return earned by CPPIB is 11.8 percent. Does this mean CPP is a great deal for Canadians?
No. The benefits Canadians receive from CPP don’t directly depend on CPPIB’s investment performance.
For CPP to remain sustainable, CPPIB investments must deliver inflation-adjusted annual rates of return of 3.9 percent. Beating that target puts CPP on a sound financial footing but doesn’t directly translate into higher benefits for Canadian retirees.
And yet, in his recent comments, Machin failed to differentiate between 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 – determines your benefit amounts when you retire. This formula has nothing to do with CPPIB’s investment performance.
So what’s 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 2.3 to 2.5 percent (depending on their specific year of birth). This is a meagre rate of return for Canadian contributors.
But CPP is also a not-so-great deal for Canadians in other ways.
Unlike most pension plans, CPP benefits can’t be fully bequeathed on death (spouses get only partial benefits if one passes away but only if they’re not eligible for benefits on their own). The program is designed so Canadians who die early in life subsidize those who live longer.
Moreover, CPP lacks the flexibility of other retirement vehicles. Unlike registered retirement savings plan (RRSP) contributions, CPP payments can’t be withdrawn in cases of hardship (financial or health-related), to fund a down payment on a home or to help pay for education upgrading.
So while we agree with Machin that it’s important Canadians understand CPP and how it works, he should be careful not to add to the confusion.
Charles Lammam is director of fiscal studies and Hugh MacIntyre is senior policy analyst at the Fraser Institute.