Monday, June 10, 2019

Should CPP Exist?

When Canada Pension Plan (CPP) expansion was first being discussed, businesses didn’t like the prospect of making larger CPP contributions on behalf of their employees. Money managers and financial advisors weren’t happy either because of the likelihood of it reducing their assets under management. This led to many negative articles about CPP. Here I look at some criticisms of CPP.

CPP is a Ponzi scheme.

No, it isn’t. Detractors only call it a Ponzi scheme to try to make it seem fraudulent and likely to collapse. CPP did begin as a scheme where worker contributions were used to pay retired workers, but it is moving away from that model as it builds assets from new contributions. CPP is on very solid footing now and is set to make its promised payments for decades to come.

We should have more individual responsibility.

That sounds good in theory, but let’s look at how that would play out in practice. Suppose we eliminated CPP, OAS, GIS, and other programs that direct money to low-income retirees. This would likely prompt a few people still working to save more, but we’d still have a very large number of people who would spend all the money that gets into their hands. Once these people become unable to work for physical or mental reasons, they’d have no money for food, clothing, or shelter.

It might be tempting to say “too bad” at this point, but there’s no way we’d want to live in a world with hundreds of thousands of starving old people begging for food on the streets across Canada. A majority of us would demand that the government step in to help these people. This would soak up massive amounts of tax money. A much better idea is forced savings in the form of CPP contributions to reduce the burden on taxpayers.

CPP should be optional.

It’s true that not everyone needs to be forced to save money for their retirement. If we could identify just those who don’t need CPP and let them opt out, then making CPP optional would work well. But that’s not what would happen. Huge numbers of people who need CPP would opt out, and we’d be left with the same problem of massive numbers of starving old people. CPP only does its job properly when it’s mandatory.

CPP management is too costly.

I have some sympathy for this one. Those who actively manage CPP investments are soaking up billions of dollars. I’m skeptical that they will outperform by enough to justify their costs over the long run. One thing is certain, though; they will be able to produce reports that paint their performance in a positive light.

Now let’s compare CPP management to the alternative: allowing people to manage more of their own savings. The returns that we get collectively on our retirement accounts are dismal. Huge fees and poor market-timing decisions are widespread. The current costs of running CPP are a bargain by comparison. Any time we talk about running CPP more efficiently, it’s important to remember how badly most people manage their own investments.

CPP returns are too low.

CPP returns are higher than most people would get managing their own money. The usual analyses that show low CPP returns are quite biased. First, they usually take the example of someone who makes the maximum contribution every year and doesn’t need any of the dropout provisions. These dropouts mean that some of one worker’s CPP contributions become benefits for another worker. A slice of contributions get redistributed. That’s the way the system works. Those who don’t use dropouts get a somewhat lower return so that others get a higher return. I think of it as most of my CPP contributions are for me, and the rest are essentially a tax.

Another misleading part of many analyses is that they don’t mention that the investment returns they calculate are real, meaning they are above inflation. There is a big difference between 2% and inflation plus 2%. Canadians whose long-term returns are inflation plus 2% are doing quite well.

CPP will be bankrupt by the time Millennials retire.

No, it won’t. This is mostly used as a scare tactic to get people to save more for their retirement so that money managers and financial advisors can have more assets under management. The increases in CPP contribution rates from 1987 to 2003 have put CPP on a stable trajectory.


Canadians are far better off with CPP than without it. There is room to improve how CPP is run, but eliminating this program without a similar replacement would be a disaster.


  1. The CPP has a lot of advantages.

    There is one current structural disadvantage, because some of the payments being made now are going to people who contributed much less. The need to do this reduces returns.

    There is also a future risk if the quality of the management declines. It's hard to predict this and it would be even harder to do something about it if it happens.

    Some people will think they could do better. A few may even be right. Unfortunately it's hard to see the country as a whole doing better.

    1. @Richard: There is definitely room to improve CPP, but the gap between CPP and how the average person manages his or her own investments is so wide that there is little hope of it dropping to zero.

  2. Michael, I agree with all your points.

    An additional thought is as follows. As a whole, our nation will likely die very closely to what actuarial tables predict. But, individually, this isn't the case. Thus, if one had to replace CPP with their own savings, each and everyone one of us, if we were being prudent, would likely have to contribute more than they are now to CPP, in order to take care of both market risk, as well as longevity risk. CPP takes care of this risk for us as a whole.

    10 to 20 years ago, I would have been one of those arguing against CPP. Not anymore. I think it's a relatively fair system that benefits the country as a whole. Many people don't realize the benefit to their financial plan by having a fixed annuity, especially one that is indexed. Reading Fred Vettese's book goes a long way in defending this.


    1. @Lance: Good points. Longevity risk is expensive to handle on your own, and CPP gives it to you for free.

    2. @Lance: The closest equivalent to replace CPP with your own savings is to buy an annuity with your savings in retirement. This doesn't require saving substantially more since everyone pools their money with everyone else. Of course, the insurance money takes a cut, and perhaps the lifetime guarantee of income isn't as ironclad as what the Canadian Government can provide, but I think it is nearly equivalent.

      But I'm not arguing against CPP. I agree with the general premise that people wouldn't save enough money on their own. Although CPP may not be perfect, I think we are far better off with it than without it.

  3. Hi Michael,
    "free" ? I don't look at contributing a portion of a paycheck into a program for 39 years as being free? Maybe i misread your thought here? :)

    As for Annuities, not a big fan of most of them for a variety of reasons. High fees, low payouts, early death - 0 payout to siblings, unscrupulous advisors pushing the wrong style annuity product on clients for personal gain, to name a few of them. However losing cognitive thoughts managing your own money in your +80's a well designed, fairly priced one could become more suitable.

    As for a possible alternative, I think I have had this discussion with you a few years ago. The Singapore CPF pension model seems to be an interesting concept. (minus the corruption claims that that clouded it) It makes people more responsible for themselves. It's a forced savings plan that can be utilized for other necessities while still giving you a pension later in life. Just to add some content to your discussion here.

    1. @Paul: CPP payouts are based on your expected lifetime, so the longevity protection part is free. I don't know much about the Singapore model, but one of the virtues of CPP is that it protects taxpayers from having to save people who won't show any responsibility for themselves.

    2. @Paul: When it comes to annuities, the only one I'd advocate is an immediate annuity. These simply exchange cash now for an income stream starting now. While nearly every other form of annuities has the problem of high fees, I believe immediate annuities are a sensible insurance product to deal with longevity risk.

      I don't believe dying tomorrow and leaving no money behind should be a concern. The alternative is running out of money and living your final years at a drastically lower standard of living. A sensible approach (it seems to me) combines saving an appropriate amount prior to retirement, then exchanging a portion of those savings for an income stream to cover your basic necessities, and keep the rest of your savings for discretionary spending and to leave to your estate. This is almost exactly what CPP is except that CPP controls the investments prior to the purchasing of the annuity and it is the Canadian government that provides the annuity rather than an insurance company. If I were to paint my own perfect picture, I'd personally prefer to control the investments and have the government provide the annuity. But what we have isn't bad, and it forces people to save.

      I'd agree unscrupulous advisers push bad products onto people with high fees. This is more of an argument against unscrupulous advisers rather than a portion of products available to them. I'd say unscrupulous advisers typically aren't intentionally unscrupulous.
      They lack education and their interests aren't aligned with their clients. Therefore they sell products with high fees in order to earn money.

    3. @ Returns Reaper

      Why not simply take your $100,000.00 and buy XEI.TO that has a steady monthly distribution. (or mix it up with a few quality Reits for a boost of income) It will give you almost $5000.00 per year, very close to an annuities return of the same amount. Your expense ratio is 0.22%. If the market drops 25% they still pay the same distributions. I just don't get the need for annuities at all when there are so many simple low volatility ways to create a steady income stream and hang on to your principle.

      I do totally agree with your last paragraph by the way.

    4. @Paul: Annuities have their problems, but dividend ETFs aren't perfect either. There's no guarantee that dividends won't be cut in a market downturn. Further, an 80-year old could get about $9000 per year with that $100,000. To match that, the ETF holder would have to sell $4000 worth or units per year (initially), which would be painful if the market had dropped 25%. At its core, you either are willing to accept some risk or you're not.

  4. @Michael: I just wanted to say thank you for the great arguments against the naysayers and “water cooler experts”.

    Often in life, what we have is not perfect, but it’s way better than the alternatives.

    1. @Bob: Thanks. It's easy for people to repeat a quote like "CPP is a Ponzi scheme," but harder to spread reasonable discussion.

  5. I'd prefer a system where CCP forces deduction only on people who don't contribute to another system for similar benefits. The other system could be managed along the lines of CPP and could even have a higher contribution cap with defined benefits based on contribution. I don't like the current idea of putting gun to people's head and extorting money.

    1. @Ram: I agree in principle, except for the part about "putting gun to people's head and extorting money." However, I don't know of any system with similar benefits. Everything else I'm aware of has ways of accessing the money early. Even a DB pension gives you the possibility of quitting your job, taking the commuted value into a LIRA, using LIRA provisions for accessing some of the money early, and begging for money from the government when you're old and hungry.