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The Path to Pension Freedom
The Path to Pension Freedom…
This article will help illustrate the issues surrounding pensions for the Canadian worker. I will first answer the necessary questions that have been given to me. This will allow me to form a foundation for my argument. Once I have answered the necessary questions, I will be able to build conclusions on the effect of the recent macro-economic recession on pensions, labour force participation and labour supply in Canada. This will help me conclude about the kind of challenges retirees and canadian workers face in the future.
“The impact of the recession has exacerbated the straining pensions of many companies with aging work forces and growing numbers of retirees, and has left private-sector pensions under-funded by an estimated $50-billion.” After fully understanding the issue I will be led to find solutions on the pension dilemma. The kind of options that are available and what can be done to fix the issue. What experts have concluded to help solve the pension problems behind the recent recession.
A retirement decision involves an older person choosing not to participate in the labour force anymore. This means the person is willing to collect a benefit to compensate for the retirement. This benefit is referred to as a pension. The structure of Canadian pensions involves 3 types. These types are Universal Old Age Security Pension Plan, Canada/Quebec Pension Plan, and the Employer-Sponsored Occupational Pension Plans. The Universal Old Age Pension Plan (OAS) is considered to be a grant given to citizens above the age of 65 years old. Typically the pension comes with an income supplement, which depends on various factors. The guaranteed income supplement (GIS) is different for each person. The government looks at whether the spouse receives the OAS benefit as well. This factor determines how much GIS should be given. According to the July 1st 2009 figures, the recipient with a spouse that also receives OAS will receive a GIS from the government of $430.90 per month, on top of the $516.96 for the OAS. For a recipient that has a spouse not receiving OAS, the GIS benefit will be $652.51.
The Social Insurance Pensions include both the Canada Pension Plan and the Quebec Pension Plan. These publicly funded plans are dependant on contributions made by workers from the payroll tax. Each worker over the age of 18 is expected to contribute, the worker is allowed to contribute until he or she reaches the age of 70. Contributions can only be made between the minimum and a given maximum. The minimum level is always set to be at $3500, the maximum adjusts every year based on average wage. The recipients’ entitlement is determined by the amount contributed and the length of time contributions were made for. The amount of contributed results from the earnings made by the worker. “Pension credits” are accumulated based on the participants’ earnings and contributions made. Higher credits generally result in bigger pension benefits.
Sponsored Occupational Pensions involve contributions made by the employees and the employer. In the past 30 years there has been tremendous improvement in the popularity of these plans. This growth is sourced from women. This is due to the dramatic increase in labour force participation rate, and pension laws changed in the late 1980s which favoured part-time workers. There are 2 types of occupational pensions. With defined benefit, most or all the coverage comes from the employers. Defined contribution plans focusses on employee contributions. The responsibility of finding return is left up to the employee. The employees can mould their pension accounts towards their own preferences. This saves time and money for the employers.
The government maintains pensions through policies. This is to help satisfy all pension holders. Age credits are given out to those that make less than the adjusted amount. In 2002, if anyone made less that C$27,749 then a credit of 16% (C$3778) would be given. When the person exceeds the average, then the credit is reduced by 15% on income that is in excess. The minimum frozen level has remained at C$3500, where anyone making less than that amount per year does not have to contribute to the CPP. Public policies regarding pensions have found to be changing consistently. This holds true for ceilings that restrict contribution and benefits. Price ceilings that were C$39,100 in 2002 are now standing at C$44,900 for 2009. These price ceilings are adjusted according to the annual averages in wage and salaries. A person making more than the ceiling is not expected, nor allowed to make any contributions to the public pension.
A major predicament caused by the macro-economic recession was the impact on the stock market. The Dow-Jones Industrial Average fell by of 18.1% in October 2008. There were plenty of companies with pensions plans that were hit hard. Along with the stock market crash, interest rates decreased. This effected the returns on borrowing in the long run. The combination of the stock market crash and low interest rates left companies with a decrease in value of pensions holding stocks, mutual funds, bonds etc. Assets fell to 80% of liabilities, the private sector of the economy was left with a deficit of about C$50 billion.
The impact on labour supply was negative because Companies were in a position to lay-off workers. Since the manufacturing sector was not doing well, companies based in Ontario were in a position to cut down labour. Jobs based in Alberta were also lost because of the impact the recession had on the oil industry. This hurts the confidence of people looking for jobs, which negatively effected the labour force participation rate.
We have understood that the implications on the labour force are not good, and there is a big problem for retirees. It is known that about three quarters of canadians working in the private sector have no plan at all, and the canadians that have defined benefit plans have pensions declining in value. Many canadians are left in a situation where they haven’t saved enough funds for their retirement. These people are facing harsh circumstances because the job market recently suffered a decline. This leaves many people with insecurities about the future. The CPP/QPP has offered some support, but not enough. Only 25% of preretirement income is contributed from the CPP/QPP.
Credible solutions are needed to assist retirees and future pension plan holders. Senior citizens need better cushioning towards retirement. One solution suggested by experts is the concept of having hybrid pension Plans. These plans involve some aspects of defined contribution, yet the pensions are regulated and insured similarly to the way defined benefits would be. This plan would lead companies towards the eventual, gradual shift towards defined contribution plans. Most companies use defined benefit plans at this point. Hybrid plans are shown to have better returns in the short-run. The plan is built to be more appealing to the young worker that may switch jobs in the near future. The loyal worker won’t reap benefits because as time proceeds he will find less pension benefits than the defined benefit plan. The defined benefit plan is structured so that workers will receive low returns if the pension if growth is disrupted before the age of 55. However, as soon as the 55 age mark hits, the returns are much greater compared to hybrid plans. Since pension is a part of the package, companies would become competitive when offering lucrative salary deals to potential hires.
Hybrid plans uses different elements of both defined benefit and contribution. Defined benefit involves companies contributing more heavily. Many companies are beginning to insist on the shift towards direct contribution, where companies start to contribute less towards retirement. The pension experts and provincial financial ministers meeting in Whitehorse (Yukon) in December 2009 will have to consider the effects of moving away from defined benefit plans. The benefits retirees anticipating at the end of their careers would be lessened by moving way from defined benefit plans. This could lead to workers extending employment, which in many cases is beneficial to companies. Workers are being retained. Also, offering defined contribution pension packages will attract young workers. These young workers want to accumulate benefits as early as possible, so switching companies is never an issue. Hybrid plans are looked at as short term solutions, the middle ground between defined benefits and defined contribution. Once the shift to hybrid plans have been made, companies could start considering the movement towards defined contribution. Where most of the responsibility and risks will be faced by the worker.
The paper began with a general introduction on pensions, which then led to the basic structure of pensions. This structure involved 3 basic type of pensions, Old Age Security with Guaranteed Income Supplements, the basic implications of the CPP/QPP, and sponsored occupational plans. Once the structure was established, some of the policies regarding the public pensions were considered. How these policies changed over time. The paper then analysed the impact of the recent recession on pensions. What was it that made pension holders unhappy. This also lead to implications the recession had on the labour force participation rate and labour supply.
Not only were people losing jobs, but they were also losing the value in their pensions. Less money is available to support the retirement dreams of many. Much of the loss was suffered in the defined benefit plans. Companies are left in a position where they are not able to support the decline. Companies and pension holders are looking for a change. Pension plans that are simple, reliable and affordable. Experts are pushing for reform in the pension system. A system that involves a progressive move towards defined contribution plans. Where much of the risks are being shifted away from the company. Finding middle ground means supporting hybrid pension Plans. Where risks and contributions are shared between the employer and employees.
One can say moving away from defined benefit plans is needed. The issue behind this is that changes can’t be made too drastically. There are many workers who are still dependant on this type of pension. The changes have to be gradual and have to be consistent with the goals of current pension holders. This is a matter of solving the problems of senior citizens close to retiring, and those who are in the labour force right now. Sensitive situations such as this require a smooth transition.
Written by Basim Mirza
Sources Used:
Ambachtsheer, K. “Looking across the Abyss: Pension Design and Management in the Twenty-First Century”, The Finance Crisis and Rescue, p.139-148.
Chase, S., McFarland, J., McNish, Jacquie. “Jim Flaherty unveils pension reform” from http://www.cawlocal200retirees.ca/blog/?p=733.
“Canada lost 129000 jobs in January: Statscan” from
http://www.cbc.ca/money/story/2009/02/06/januaryjobs.html
Gale, W., Shoven, J., Warshawsky, M. (2004), “The transition to hybrid plans in the United States: an empirical analysis.”, Private pensions and public policies, p.11-21.
“General Information About The Canada Pension Plan”, Service Canada.
http://servicecanada.gc.ca/eng/isp/cpp/cppinfo.shtml#a1
Keenan, G. “Bankrupt companies, pension promises destroyed”, The Globe and Mail.
Kirby, J. “Downsized Dreams”, Maclean’s, p.39-40.
McFarland, Janet. “Hybrid pension plans: a hard sell”, The Globe and Mail
McNish, J. “Retirement dreams under siege”, The Globe and Mail.
“Old age security benefit rates effective July 1, 2009″ from
http://news.gc.ca/web/article-eng.do?nid=456449
“Pensions at a glance: public policies across OECD countries”, Organization for Economic Co- operation and Development, p.103-104.
Price ceilings for 2008 from http://www.taxes.ca
Price ceilings for 2009 from http://www.canadiantaxresource.ca
Russell, I. “A flexible RRSP to give boomers room to recover”, The Globe and Mail.
“Stock Market Crash of 2008″, from
http://www.money-zine.com/Investing/Stocks/Stock-Market-Crash-of-2008/
Tamagno, E. “Occupational Pension Plans in Canada: Trends in Coverage”, The Caledon Institute of Social Policy, p.1-5.
Wills, Andrew. “No pension safety net for self-employed”, The Globe and Mail.
Yakabuski, C. “Canada’s gathering pension storm”, The Globe and Mail.
About the Author
Basim Mirza
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