Very few Canadians wait until 70 to claim their benefits, despite many financial experts advocating for this exact strategy.designer491/Getty Images
This article is part of a new Globe Advisor series, Pensions Unpacked, exploring how workplace pensions fit into retirement strategies, and the technical details and decisions that come with the plans.
As we’re being encouraged to turn inward and buy more Canadian goods and services, why not allow Canadians to buy more of something that’s manufactured in Canada, is envied around the world, and supports many Canadians already: the Canada Pension Plan (CPP).
The national pension program sees Canadians contribute approximately 6 per cent of their wages over their working life in exchange for a pension annuity of approximately 30 per cent of their best year’s wages when they retire. This is an idealized description of a rather complicated plan (all those government actuaries need employment). Employers also have to contribute their own 6 per cent to the pot.
But the end result is that when Canadians retire, they gain a real inflation-adjusted life annuity that pays an income for as long as they live. Money from CPP is on autopilot, without having to worry about decumulation at an advanced age.
The design, management and governance of the CPP have been lauded by pension observers around the world. When U.K. Chancellor of the Exchequer Rachel Reeves visited Canada last year, she made a point to chat with the managers of our largest pension plans, including the CPP.
The CPP is so good that those who hold off until the biblical “three-score-and-ten” (i.e., age 70) to start their benefits see their annuity increase by approximately 40 per cent; instead of $1,000 a month at age 65, they would get around $1,400 monthly if they wait until they turn 70.
And yet, here’s the annuity puzzle: very few Canadians wait until 70 to claim their benefits, despite many financial experts advocating for this exact strategy. So, how do we get more Canadians to wait? Perhaps, counterintuitively, we should allow them to buy more.
Here’s how this would work: starting at the age of 60, any Canadian could voluntarily purchase three-score-and-ten “income units” of the CPP that would only spring to life when they’re 70 years old.
For example, the CPP might announce on Jan. 1 that “income units” could be purchased for $10 each, entitling the holder to $1 of annual inflation-adjusted income for life starting at age 70. Someone who wanted to supplement their CPP pension by $1,200 a year, or $100 a month, would have to pay the CPP $12,000. For someone who wanted $200 more a month, it would cost $24,000.
The CPP actuaries would waive their magic models and update the price of the income units periodically to ensure they’re financially fair to everyone, but the deferred income would always begin at 70. Those still working could also purchase the income units.
To make this as simple as possible for tax-filing, the units could only be purchased in a tax-free savings account (TFSA), placing a limit on the total amount, but the extra income would be tax-free and wouldn’t result in the clawback of a retiree’s precious Old Age Security benefits.
There are additional economic and psychological benefits to making these “income units” available. As some Canadians buy more CPP, it will signal to those who take their benefits too early that they’re making a financial mistake. After all, if some people are buying more of this good deal, then why are you selling?
Second, and more importantly, buying these income units will offer Canadians a genuine way to guarantee a lifetime of inflation-adjusted income that isn’t subject to the vagaries of the stock market. They will use their TFSAs to purchase what is effectively longevity insurance against living longer than expected.
Third, it will give everybody a true sense of what their CPP benefits are worth in present value terms. Multiply your benefit by the price of the “income unit” and, voila, you will see that you are truly richer than you thought.
For example, if someone is told that (A) waiting until age 70 to collect their CPP will generate $2,000 a month, and (B) they can purchase three-score-and-ten “income units” at a price of $10, then the market value of their pension is 12 x A x B, or $240,000.
Now, the great free-market economist Adam Smith may be turning in his Edinburgh grave at the suggestion that the government should get involved in yet another business that has been the domain of insurance companies for centuries.
But most Canadian insurance companies haven’t shown much interest in designing or marketing true longevity annuities. This absence is for a variety of supply and demand reasons Mr. Smith would recognize, but is a type of market failure. This proposal is more likely to threaten investment fund manufacturers who would rather retirees ride the stock market roller coaster.
Another concern is that if the actuaries haven’t learned to price the “income units” correctly, it could ruin the viability of the CPP. But then again, market discipline isn’t a bad idea.
In sum, allowing Canadians to purchase more CPP benefits when they retire would boost retirement income at a time when fewer retirees benefit from workplace pensions. We could even allow our American neighbours to buy some, which would help them diversify their own retirement portfolio – subject to a small fee or tariff, of course.
Moshe A. Milevsky is the CIT chair in financial services and professor of finance at York University’s Schulich School of Business in Toronto.