Gordon Powers, MSN.ca Money reviews – Pension Ponzi

November 20, 2011
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Gordon Powers, MSN.ca 

November 19, 2011

The current tax rules on retirement savings have created an unfair disparity between members in guaranteed pension plans and those struggling to save on their own.

It seems that some Canadians may be saving a bit too much for retirement, according to a recent report issued by C.D. Howe Institute.

Not all of us, of course — just those lucky enough to still have access to a defined benefit (DB) pension plan, the gold standard for pensions since they guarantee the level of benefits paid out at retirement.

The study, entitled “Legal for Life: Why Canadians Need a Lifetime Retirement Saving Limit,” (pdf) compared contribution and benefit limits in tax-assisted DB plans, defined contribution (DC) plans and RRSPs.

It found that while members of DB plans can accumulate retirement savings worth as much as 60 per cent of their total career incomes, current tax rules prevent RRSP and DC plan members from saving anywhere near that — even if they actually have the money to do so.

And that’s a problem, since fewer Canadians than ever before have access to a DB plan to begin with.

Faced with having to pump more money into such guaranteed plans or decrease the benefits, companies of all sizes are increasingly moving workers away from them into open-ended DC plans.

Fifty one per cent of Canadian companies have already converted to DC plans for current employees or new hires, up from 42 per cent in 2008, according to a recent review by Towers Watson. And a further nine per cent plan to convert this year.

Today, more than 12 million of Canada’s 17.5 million workers don’t participate in a DB plan.

The result is a two-tier system, the study’s authors argue, in which those with DB plans (increasingly mostly public sector workers) have an “unfair” ability to fund their retirement.

To understand the how this has come about, have a look at a new book entitled Pension Ponzi: How Public Sector Unions are Bankrupting Canada’s Health Care, Education and Your Retirement. The book’s authors, Bill Tufts and Lee Fairbanks, document how Canada’s public-sector unions have helped their members negotiate salaries and future benefits that far outstrip anything comparable in the private sector.

What’s worse, Canadian taxpayers now owe hundreds of billions of dollars in public-sector pensions that governments have promised, but never put aside the funds to support, the authors claim.

Tufts, who blogs regularly on these issues at Fair Pensions for All compares the current system to a giant Ponzi scheme that will eventually collapse, as it has started to do in Greece and other EU countries.

The book is a bit shrill in its tone but there’s no question that the discrepancy between pension plans in the public and private sectors will lead to even more friction as the impact of potential liabilities is tallied.

To demonstrate the size of this gap, C.D. Howe developed a model that shows the retirement savings accumulations possible under Canada’s tax rules for retirement saving from 1974 through 2011.

The results highlight that workers saving for retirement using RRSPs can’t reasonably hope to accumulate even half the pension values that routinely accrue to DB plan members with similar income levels.

The solution to such an imbalance is not only to improve the ability of all Canadians to save, but to also limit the amount that DB plan members can put aside in tax-preferred retirement plans, says the report.

“A lifetime accumulation limit will put Canadians who do not enjoy career membership in a defined-benefit pension plan on the same footing as those who do,” the report says.

A lifetime limit would also give newcomers to Canada, the self-employed, or those who started saving later in life, a much better chance of accumulating enough cash for a comfortable retirement, the report says.

In practice, the report recommends scrapping the annual tax-free RRSP contribution limit of 18 per cent of earned income in favour of a lifetime accumulation limit, adjusted to inflation.

To keep things in balance, Canada Revenue Agency would then track the amount individual taxpayers would be allowed to accumulate within their pension or personal tax-deferred account. Any excess accumulations would be subject to a penalty tax until withdrawn, the report suggests.

Does it make sense? Not really. While the current system definitely has its flaws, a lifetime limit like this really addresses the needs of a minority of Canadians — and likely mostly the wealthy.

But the pension envy issue isn’t going away anytime soon.

Tufts feel that government has four choices to shore up future pension costs: Change pension provisions going forward — while still respecting the entitlements that the workers have accrued to date — raise additional revenue through taxes to meet these obligations, cut spending, or increase government borrowing.

Which would you prefer?

 

 

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