Thursday, November 14, 2013

Expanded CPP and Debt

The push to expand CPP has been strong lately. The idea is that too many Canadians won’t save for their retirements and must be forced to save more money. Setting aside the argument over whether it is a good idea to force Canadians to save more money, I wonder if it is even possible because of debts.

For various reasons, many Canadians simply won’t save for their retirements. Some have good reasons, but most don’t. If we expand CPP, we can force people to save more through increased payroll deductions. Those who already save for their retirements can afford to save a little less because they can expect higher CPP benefits. So, by expanding CPP, we’re mostly affecting those who don’t save now.

But how can we stop people from simply building larger debts as they head into retirement?

When Canadians carry debt into retirement, it’s as though they have pre-spent part of their CPP benefits. If CPP expands, they can borrow even more and pre-spend the increase in CPP benefits.

You might object that people aren’t this calculating. That’s generally true, but lenders are definitely that calculating. Lenders have been wildly successful at marketing debt to Canadians in recent decades. Sadly, many people just keep borrowing until lenders say no. If a borrower has higher CPP benefits coming, then lenders will delay saying no for a little longer allowing borrowers to pre-spend their increase in CPP benefits.

According to Douglas Hoyes, “it is very difficult, if not impossible, for a creditor to garnishee a pension,” but if the debts are backed against seniors’ homes, then the threat of losing one’s home will keep seniors making interest payments out of their expanded CPP benefits.

You might think that I’m offering this line of thought as an argument against expanding CPP, but that’s not where I’m headed. I’m actually a supporter of a modest expansion of CPP as long as the higher benefits go to those who make the higher payroll contributions. What I’m looking for is some sort of solution to the debt problem I described.

If we were to expand CPP, how would we stop Canadians from building up larger debts that eliminate some of the upside of higher CPP benefits?

14 comments:

  1. Problem with debts is in the bankruptcy laws. Many irresponsible people pile debt and when they go under the rest of population effectively pays these debts through various taxes and charges.
    "Shift your debt to somebody else" trick is being performed at different levels nowadays, governments included.

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    1. @AnatoliN: Those who can't handle credit aren't likely to change unless it's forced on them somehow. I don't think the answer is to stiffen bankruptcy laws. Only a scheming few plan to exploit bankruptcy. Most of those who become buried in debt never planned to get that way and will never pay their debts off no matter how strict bankruptcy laws become. The real answer is to put the brakes on debt before it becomes unmanageable. The question is how can we do this? Doing this essentially takes away some people's freedom of choice.

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    2. Having worked with a few people who were in governmental roles where they dealt with bankruptcy, I suspect people actually planning on going bankrupt are more frequent than we realize.

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  2. I think the rise in debt has had a lot to do with low interest rates in recent history. Once interest rates rise (they have to eventually, right?), debt will reduce.

    Regarding "I’m actually a supporter of a modest expansion of CPP as long as the higher benefits go to those who make the higher payroll contributions. " I would also be a supporter if I believed that the benefits would go to the contributors. But CPP hasn't worked that way so far, CPP was made sustainable in the backs of the younger generation. CPP is too susceptible to politics and changes that appeal to current voters at the expense of those too young to vote.

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    1. @Greg: The real problem is payments on debts. These won't go down if interest rates rise. I think we still need to find some way to stop people from pre-spending their increased CPP benefits or else expanding CPP won't be as effective as people hope it will be.

      You're right that any pot of money sitting around (like CPP investments) is susceptible to political forces to divert it one way or another. In my opinion, CPP hasn't been perfect, but it hasn't been too bad either. Who knows what will happen in the future, though.

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  3. If the CPP is expanded, I would like to see it done as a "CPP 2", a new plan that only accounts for actual contributions people have made to it. There is still a risk of returns being unsustainable as the CPP becomes one of the largest investment funds in the world. Not sure where it ranks now but most mutual fund managers can't keep up their outperformance with 1/10 or 1/20 of the current assets.

    Regarding the debt, I don't know if an expansion of the CPP would have a significant effect either way. It depends whether the majority of new debt is for people near retirement or young people who expect to earn their way out of it (from what I can see, the later is a big part). In some areas such as mortgages the government could regulate limits a bit more. But if there is any unregulated area, the debt will still flow from there.

    Rising interest rates, reading to higher payments and bankruptcies, might make the point. Hopefully we don't have to wait so long that that is forgotten as a policy tool.

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    1. @Richard: In this post, I'm specifically interested in the debt levels of the subset of Canadians who are about to reach retirement age. Without any intervention, we can expect an expansion of CPP to lead to their debt levels rising simply because they will have more future income. Unfortunately, this will make the expansion of CPP ineffective as a way to force people to save enough for better retirement years.

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  4. I can can imagine some people building up largers debts, but would the practice be widespread? Don't know.

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    1. @Blitzer68: Good question. I guess what it comes down to is whether there will be a net increase in saving. If banks have anything to say about it (and they usually do), pre-retirees will take on more debt.

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  5. Why are we concerned with people who refuse to take responsibility for their lives?
    Personally, I would rather help people who are unable to help themselves rather than people who choose not to help themselves.
    I also wish the government would operate this way as well. Help those who can’t, not those who won’t.
    The more we help the people who won’t help themselves, the more people we will have not helping themselves.

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    1. @Anonymous: I guess the most direct answer to your question is that people who mange their money poorly can still vote, so their needs get factored into public policy.

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    2. yes, they do vote but I think there are far more people voting for a nanny state that are doing it out of misplaced altruism than there are people voting themselves raises. All the hip and cool people will shock you with behavioural and economic ignorance imploring government solutions for all of life's ills.

      This needs to stop.

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  6. My biggest complaint about expanded CPP contributions is the lack of cash value it has upon death.

    Example, I save in my RRSP and die at age 65, then my family will get the RRSP (minus a lot of taxes). If I die at 65 with no RRSP, but a larger CPP income, what does my family get? Next to nothing. So the money "I" have been saving through CPP is wiped out. Money "I" save in RRSP can go to my family.

    Maybe some system where if you're making RRSP contributions, you can opt out of expanded CPP ????

    Sorry to go off topic, but expanded CPP isn't the magic bullet everyone thinks it is. And no, I'm not totally against expanded CPP. Unfortunately if we don't do it, then the responsible savers (with RRSPs) will end up picking up the tab for the tab for the irresponsible ones.

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    1. @Anonymous: The fact that CPP offers no lump sum of the remaining cash value upon death is what gives us some protection from longevity risk. CPP payments would have to be lower for everyone if those who died early got a lump sum for their estates.

      I don't like the idea of a big expansion of CPP, but a modest expansion probably makes sense if we can find a way to stop people from pre-spending it (by building debt) before they hit retirement age.

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