Wednesday, December 9, 2015

Pension Ponzi

Canadian baby boomers don’t have to look very far in their circle of friends to find people retiring in their 50s on very generous life-long public service pensions. In their book Pension Ponzi, Bill Tufts and Lee Fairbanks try to persuade readers that “public sector unions are bankrupting Canada’s health care, education and your retirement.” Of course, unions argue differently. As with most debates between sides with polarized views, there is lots of room for both sides to be wrong.

While the authors make a number of excellent points, they hardly give a balanced view. This book is written to outrage you more than it is written to inform you. I’ll go through some of the book’s good and bad points before offering my own thoughts on public service pensions.

The Good Parts

Mounting public debt is a sign that governments at all levels in Canada have been overspending for decades. “There is really only one place that meaningful cutbacks can occur, and that is the size and cost of the government workforce and its salaries, benefits, and pensions.” When companies face tough times, they are forced to cut jobs. The same is true for governments if they plan to balance their books.

“The age for regular retirement in the public sector needs to be raised to 65 for full benefits, with penalties for early retirement.” I don’t like the use of the word “penalties” here because pension reductions should not be seen as a punishment. If you start collecting a pension in your 50s, you’ll collect money longer than if you start at age 65. The pension payments must be reduced to make the total payout the same.

To remain competitive, companies must routinely evaluate their workers and lay off workers who don’t perform well. However, “neither incompetence nor lack of achievement is cause for anyone to lose their job in the public sector.” This point is somewhat overstated, but it is largely true. Few bad public sector employees lose their jobs.

The “oft-touted idea that public sector employees would all receive more money were they working in the private sector is totally unfounded.” There is a very wide range of talent within the public sector. The most talented government employees in technical positions could do well in private industry, but many of the others could not get and hold a comparable private sector job. If public sector workers could easily make more money in the private sector, more of them would do so.

The Not-So Good Parts

Much of the book is devoted to describing specific pension-related abuses by top bureaucrats. These problems should be fixed, but I doubt they are representative of the typical public sector retiree. The authors use these examples to boil readers’ blood rather than inform them.

The authors give many dollar amounts in their examples of waste and abuse. Unfortunately, they adjust for inflation and investment returns only when it suits them. The pension abuses are bad enough without overstating them by adding up nominal dollars to be spent in future decades without adjusting for inflation.

The authors point to a report showing that a family with 2 children only needs 43% of their pre-retirement income to have the same disposable income in retirement. They arrive at this figure by deducting child costs, employment costs, mortgage payments, and retirement saving, and accounting for the reduction in income taxes. It is not fair to compare this 43% figure to a 70% pension. If we’re going to say that public service workers actually make much more than they appear to earn because of their pensions, then the actual percentage of their true incomes they receive as a pension is well below 70%. Put another way, we cannot count the retirement savings for the example family as part of income unless we’re prepared to count employer pension contributions as part of income for public sector workers.

My Take

Among the many people I’ve dealt with professionally in government as well as friends working in the public sector there is a strong feeling of entitlement to their pensions. On one level, this makes sense: they expect to receive what they were promised.

But there is more to this feeling of entitlement. I would say that almost everyone I know who has been in government for at least 25 years doesn’t like their jobs. They tough out as many years as they can to get to a pension they’ve earned through suffering.

The most common complaints I hear are bad coworkers, bad managers, and insufficient meaningful work. It’s normal for workers to complain a certain amount in the private sector, but things seem much worse in the public sector. No doubt there are parts of the public sector with good working conditions, but this seems to be more an exception than the rule.

The problem is that Canadians derive no benefit from the suffering of public servants. We can’t afford to pay people for enduring poor coworkers and a dysfunctional work environment. I would love to see a more efficient public sector where workers feel that their efforts have real meaning. This can only happen if the public service does a better job of identifying poor performers at all levels and laying them off.

Steve Jobs famously declared that he wanted only A-players working at Apple, no B-players. The public service doesn’t have to get rid of B-players; they just have to stop employing the obvious F-players.

On the specific pension issues raised in this book, here are my thoughts:

Pension Accrual: For the most part, pensions accrue at 2% per year for a 70% pension after 35 years. For some occupations, a 70% pension is reached after only 30 years. People should not be able to have a standard retirement before age 65. An accrual rate of 1.5% so that workers reach a 60% pension after 40 years makes more sense. For occupations with physical demands, it should be standard practice to shift workers to less demanding roles in their later years.

Retirement Age: The standard retirement age should not be earlier than 65. Like CPP benefits, anyone collecting a pension sooner than age 65 should get a reduced pension, even if they’ve reached the 40-year mark. This is not a punishment; it simply reflects the fact that pensions that start early will be paid longer. There should not be bridge benefits for those retiring early unless there is a corresponding reduction in pension benefits. Anyone who wishes to retire early should save up to make up the difference for a reduced pension.

Retirement Salary: Currently, pensions are based on an average of the best few years of income. This encourages “spiking” to artificially inflate earnings at the end of a worker’s career. The pension should be based on lifetime average earnings, but with appropriate adjustments for inflation and investment returns. CPP is a good model here. If you earned half the maximum pensionable earnings 30 years ago, this counts the same as earning half the pensionable earnings today, even though the dollar amounts are higher today.

Employee Contributions: It makes sense for employees to contribute half the value of a pension and for the government employer to contribute the other half. However, this can’t be based on unrealistic return expectations in defined-benefit plans. If you assume high investment returns, then you’ll conclude that very little needs to be saved today to cover pension payments in the future. Using realistic returns means employees would make a fair contribution to their own pensions. But it doesn’t make sense to use low bond returns either. The correct return to use is somewhere between bond rates and historical real stock returns.

Overall, I found this book useful for learning the important issues in the public service pension debate, but it is far from balanced. I encourage readers to seek out other points of view before drawing any conclusions.


  1. I'm a member of the federal public service pension plan, and appreciate your review of the book. A couple of notes about changes that have happened since the book was published:

    -In 2013, the federal public service plan was changed. Contributions for employees were increased for all plan members, and any member joining the plan after 2013 now has an eligibility date of age 65 (it was, and remains, age 60 for members in the plan prior to 2013).

    -Contribution rates now differ for pre-2013 and 2013-onwards plan members. For members under the 'old' rules (eligible for retirement at 60), the employee contributes 8.15% of salary up to YMPE, and 10.4% above YMPE. For new entrants to the plan, the contribution rates are 7.05% up to YMPE and 8.54% above. These contributions are in addition to the CPP contribution of 4.95% up to YMPE. This means that public servants are now paying roughly 13% of salary toward their pension.

    -This plan is integrated with the CPP/QPP, and as a result pension benefits are automatically reduced at age 65 according to a formula designed to approximate CPP payments.

    1. @George: Yes, some positive changes were made since this book came out. It's tricky to determine if the rules surrounding retiring before the eligibility date fully take into account the increased value of a pension when it starts early. If you know the details of these rules, I'm interested.

      As I illustrated in an earlier post (, the value of a pension is extremely sensitive to assumptions about investment returns. So, the debate about how much of their pension public servants pay remains.

      However, in my opinion, debate over public service pensions is a smaller issue than being ineffective at eliminating obviously poor employees.

    2. @MichaelJames I agree that it's tricky to determine whether the early retirement rules are truly 'just'. The early retirement provisions for the federal public service plan are detailed here:

      For this comment I'll focus on the rules that apply to members of the plan prior to the 2013 changes - they're what I'm familiar with. There are a lot of examples here - I'm not a pension expert, just a money geek who has read the rules pretty closely!

      The "immediate annuity" is a regular, unreduced pension, payable at age 60 in most cases, but also payable between 55 and 60 if the plan member has at least 30 years of service. The payment is 2% per year of service - for somebody at age 60 with 30 years of service whose salary basis is $50000 before retiring, the pension would be $30000 ($50000 x 0.02 x 30). This amount would be reduced at age 65 to account for CPP (see below).

      The "annual allowance" is the term used for the reduced early pension. It is payable as early as age 50. There are a few formulas used to determine the reduction, based on age and years of service. For members with fewer than 25 years of service, the reduction is 5% for each year prior to 60. So somebody who retires at age 55 with 24 years of service, this allowance would be the average salary over the best 5 years, multiplied by 48% (24 years x 2%), and then that amount would be reduced by 25% (60-55 is 5 years, multiplied by 5%). If the salary basis is $50000, then the pension in this case would be $18000/year. This would get reduced at age 65 to account for the CPP also (see below).

      For members with more than 25 years of service, the reduction is the lesser of 5%/year under 30 years of service, or 5%/year under 55 years of age. So somebody with a salary basis of $50000, 27 years of service and age 52 would receive a pension of $23800 ($50000 x 28 x .02 = $28000 full pension, minus 15%). The reduction at age 65 for CPP also applies here.

      The above examples incorporate the "bridge benefit" which applies if the person retires before age 65. It is calculated as (0.625% x salary basis up to AMPE x years of service). In the immediate annuity example above, the $30000 pension would be reduced by $9375 ($50000 x .00625 x 30) at age 65.

      All of the above calculations are for the pension payable at the time of retirement. These amounts are indexed to inflation, and typically increase annually in line with the CPI.

    3. There is a web-based calculator for the pension plan that automates some of these calculations here:

    4. @George: Thanks very much for the detailed information. The biggest problem I see with these rules is the ability of a 55-year old with 25+ years of service to retire with no reduction in pension. That's 10 extra years of payments with no reduction.

  2. Few things in random order:

    Not all public sector positions are unionized (my dept, for example). Government jobs shouldn't be unionized, anyway. I've worked private, private unionized, and govt non-union jobs, the latter two both have a lot of bizarre problems.

    Union job paid 30% more than a strictly private sector equivalent; govt job pays 60% more (straight wage only, no bennies).

    Did the authors give a figure(s) as to what percentage of taxes go to paying public sector -- that is, straight govt as opposed to unionized govt like health care, police, fire etc. -- wages, benefits, and pensions?

    1. @SST: I certainly understand the argument that well-paid people with other employment options don't need to have a union. We're a long way from the days of workers losing limbs on the job and getting fired.

      I see conflicting figures, but government paying workers much more than the private sector is consistent with my experience.

      I think I remember the figure you're asking for being in the book, but I don't recall exactly what it was.

  3. The solid gold deals that upper Civil Servants, MPs and the like receive are amazing, and make me want to be one of them, but as a tax-payer I hope the system changes soon.

    As a member of the Public Service Pension Plan, I am always interested in hearing the opinions of other folks about this benefit (that was negotiated with many different governments over time (in terms of changes and updates and such)). We shall see how this all pays out.

    1. @Big Cajun Man: I never blame individuals for accepting a good deal when they see it, but I'm hoping for change as well. What I'd most like to see is laying off workers who are just terrible at their jobs.

  4. I'm a member of a provincial public service pension plan. Important to point out that, according to our pension investment board, 80% of the pension benefits paid out to retired public servants are investment returns earned by the pension fund, 20% are employee and employer contributions. I think sometimes there is an impression that public service pension payments come out of general revenue (like OAS).

    Also, if changes are deemed necessary, they will very likely have to be grandfathered in some way. Not so much because of what the promised benefit is to current employees, but because of the fact that being in a registered pension plan consumes so much RRSP contribution room. Seems fair that if the pension benefit is to be reduced, an impacted employee should have the opportunity to compensate through their own savings/investments. It won't surprise me if before my career is done they introduce new rules for new employees, likely along the lines of a defined contribution plan.

    All that said, I certainly feel grateful to be a member of a public service pension plan and acknowledge what a valuable benefit it really is.

    1. @Juan: The same is true of my own retirement savings. The bulk of my savings will ultimately be investment returns rather than my original contributions. But this doesn't mean much. These returns were derived from my contributions. The same is true for a public service pension plan. Some benefits are paid from money originating with the employee and some of it with money originating with the employer, with any shortfalls made up by taxpayers.

      As I pointed out, this book plays fast and loose with dollar amounts at times. What is reasonable, though, is to fairly determine the present value of public service pensions, subtract employee contributions, and treat the difference as added pay. Similarly, in private sector DC plans, any company match should be treated as extra pay. This allows us to make better comparisons.

  5. It depends on your context of entitlement. If that's entitlement as in "guaranteeing access to a certain benefit" then yes, in part, I do feel that way. Just like my money and the government's money are in my RRSP, I feel "entitled" to that pool of money but mostly entitled to my own money invested.

    If you mean by entitlement as "the employee deserves" this or that, then no, I certainly don't feel this way. I believe that mindset comes from an older generation although I don't want to generalize. Nobody I know in my cohort feels they are "owed" a pension. It's a benefit as part of total compensation package. There are other forms of compensation when it comes to employment, a pension is just one part of it.

    I would go beyond your statement that most organizations cannot afford to pay people to support a dysfunctional work environment - it doesn't matter if that's in the public or private sector. Just my take though.


    1. @Mark: It's true that no organization can afford to keep poor or unnecessary employees. The difference between the public and private sector is that the private sector does a better job of eliminating poor and unnecessary employees. If they don't they risk going under entirely which indirectly eliminates poor and unnecessary employees as well.

    2. "The difference between the public and private sector is that the private sector does a better job of eliminating poor and unnecessary employees."

      Agreed :)

  6. I think one major stumbling block is that almost all govt & public positions are non-profit service jobs (including politicians), thus, unlike private sector profit, there is no quantifiable means of measuring how successful a worker or department truly is beyond completing tasks in a set timeframe.

    (That's a big drawback, for me personally, I have no control over my wage; time and title are the most determinant factors. Perhaps I'm trading that control for future "guaranteed" income.)

    What metrics are used to determine fair market public service wages and pension levels?

    Beyond that, public pensions are merely quasi-closet index funds with extraordinarily expensive management costs.

    1. @SST: I agree that there can be challenges with measuring an employee's effectiveness or a group's effectiveness. However, I'm advocating starting with low-hanging fruit. Every public servant I talk with at length has a story of some employee who makes no real contribution at all. There are also some jobs that could be trivially automated away.

      One thing I would add to you last line is "with guaranteed returns."

  7. "With guaranteed returns" only because it's a perpetual fund (maybe). There will always be govt workers and a taxable public which to fund them.

    A more realistic view of pension funds would be the fall and demise of private sector funds. They couldn't hold up under unrealistic assumptions (8-10% rtn/yr). The public pensions don't seem to be bothered with this problem -- yet.

  8. While I agree that public service employees who work in a typical office setting could and should work until age 65, I don't think that is appropriate for some government employees. Expecting a police officer, prison guard or school teacher to work that long is probably not a good idea for the worker or the public.
    Bob in T.O.

    1. @Anonymous: As I said in the article, for occupations with physical demands, "it should be standard practice to shift workers to less demanding roles in their later years." Currently, police officers are often able to get full pensions in their early fifties. This is unreasonable. Expecting them to do something useful is better. And at least it would be more humane than the typical practice in the private sector where people just get fired when they're deemed too old to contribute.