Recently, Braden Warwick at PWL Capital created an excellent CPP calculator that we can all use.  One of the numbers this calculator reports is the IRR (Internal Rate of Return) you’ll get between your CPP contributions and the CPP pension you’ll collect.  Some financial advisors (but not Braden) decide it makes sense for their clients to take CPP as early as possible (age 60), and invest the proceeds.  Their reasoning is that they believe they can earn a higher return.  Here I explain why this logic compares the wrong returns. The return you’ll get on your CPP contributions depends on the contributions you and your employer have made and the benefits you’ll get.  These amounts depend on many factors about your life as well as some assumptions about the future.  Typically, the return people get on CPP is between inflation+2% and inflation+4%.  (However, it can go higher if you took time off work with a disability or to raise your children.  It al...

Some people have heard that when a spouse dies, the surviving spouse gets a survivor’s pension equal to 60% of the deceased spouse’s CPP pension.  Unfortunately, the actual calculation involves many more steps, and the final amount of the survivor’s pension is often much less.  Here I pull together information from 3 sources to piece together how to calculate the amount of a CPP survivor’s pension. Unfortunately, there is so much bad and incomplete information online about CPP survivor pensions that I can't be certain that I have all the details correct.  I strive for accuracy, but don't rely blindly on my best efforts here. My main source of information is Doug Runchey’s Understanding the CPP Survivor’s Pension .  I used Frederick Vettese’s book Retirement Income for Life (second edition) to corroborate Runchey’s calculations (although they didn’t completely agree), and Kea Koiv’s Shedding Light on the CPP Survivor Benefit added extra detail for young surviving sp...

People without pensions like to call civil servants’ pensions “gold-plated.”  However, when they get a chance to get their own pension, they often turn down half of it. The inflation-indexed pensions common among government workers are extremely valuable.  Government accounting fictions set the value of these pensions lower than they really are, and taxpayers stand ready to make up the difference. Fair or not, it frustrates many private sector workers who have no pension to have to contribute taxes for others’ pensions.  But when these frustrated taxpayers get the chance to collect their own CPP pensions, they often opt for payments less than half of what they could be. The catch here is that to get the largest CPP payments possible, you have to wait until you’re 70 to start collecting CPP.  These payments are more than twice as large as payments are when you take CPP starting at 60. We can’t blame people for taking CPP early if they don’t have any retirement savings...

One valuable part of CPP, OAS, and defined-benefit pensions is that they keep paying you even if you live a long life. In more technical language, these pensions take care of longevity risk. When you have to manage your own investments, you’re forced to spend conservatively in retirement in case you live long. Here we consider example cases to illustrate the cost of longevity risk. Shawna is 65 years old and is entitled to a $1000 per month pension, indexed to inflation, for the rest of her life. She is offered the choice of keeping this pension or withdrawing its commuted value to invest in her locked-in retirement account. To keep this example simple, we’ll assume the pension plan expects Shawna to live 20 more years, and her commuted value is calculated with a discount rate of inflation plus 1.5%. The commuted value of her pension works out to $207,436. We’ll also assume Shawna won’t have to pay any income taxes immediately as she would have to if her commuted value was t...

No. There are some exceptions, but the answer is almost always no. In fact, if a financial advisor is pushing you to pull out the commuted value of your pension, that’s a sign that you’re likely working with a bad advisor. There is almost no chance that your advisor will choose investments that outperform a pension fund, mainly because the total fees you pay with an advisor are so much higher than the fees charged within a pension fund. Some advisors will tell you that you won’t pay any fees because the mutual funds pay the advisor. Don’t believe this. Mutual funds and advisors get paid out of your savings. Further, defined-benefit pensions have the advantage of handling longevity risk. Pension funds can afford to pay you based on your expected life span, and they’ll keep paying if you happen to live long. With an advisor managing your money, you need to hold back on your spending in case you live long. There are some cases where it makes sense to withdraw your pension’s c...

The plight of Sears Canada pensioners has been in the news lately . After reading about the hardships created by pension cuts, it’s natural to think about what we should do to prevent this in the future. Some, like Jen Gerson , question whether pension plans should have higher priority than they do now when divvying up the assets of a bankrupt business like Sears Canada. However, the side effect of doing this is that suppliers would be less willing to extend credit to any business with an underfunded pension, and this would drive struggling businesses into bankruptcy sooner. This is a difficult choice to make when you’re still hoping that a weak business can get back on its feet. However, the Sears Canada case looks far different from a plucky business doing all it can to survive. “While Sears’ shareholders pocketed payouts of $3.5 billion, the chain’s pension plans remained underfunded to the tune of $270 million.” Why are owners allowed to pull assets out of a business that ...

It’s well known that Sears Canada has been having financial trouble for some time. As often happens in these situations, the Sears defined benefit pension plan is underfunded. According to Steven G. Kelman, “Ill-advised government policies” have resulted in former employees getting only “81% of the commuted value of their defined benefit pensions.” What we have here is a tension between trying to keep companies afloat and keeping pension plans fully funded. It’s easy to decide today that Sears should never have been allowed to delay properly funding their pension plan. But, if Sears had been forced to fully fund the plan sooner, they would have gone bankrupt sooner. If we go back to a time when there was still hope to save Sears, few people would have agreed to force Sears into bankruptcy over their pension funding. But allowing sick companies to let their pension obligations slide inevitably leads to some bankrupt companies with underfunded pensions. We can agree that it’s u...

A friend of mine who is collecting a defined-benefit pension had a complaint I’d never heard before. He is convinced he’s being ripped off because his pension benefits only go up by inflation each year, but the plan’s assets go up faster than inflation. I know this isn’t right, but it took a while to think of a good way to explain why. Let’s start with the analogy of a mortgage. Suppose you have a 5-year mortgage with an annual interest rate of 3%. Even though your unpaid balance is supposed to go up by 3% each year, your payments stay the same for the full 5 years. Does this mean the bank is getting ripped off? Not likely. Banks know a thing or two about coming out ahead. The truth is that your flat monthly mortgage payments are calculated to take into account the 3% interest on the declining mortgage balance. If your payments increased by 3% each year, your starting payment would be a lot lower. But banks are smart enough to know that they shouldn’t expect you to be able...

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 ...

At one time I considered taking a job with the federal government. I had a competing offer in the private sector and set about comparing them based on various factors such as how much I’d enjoy the work, the commute, and total pay. A tricky part was placing a value on a public service pension. The value of a pension is very sensitive to the investment return we assume. Let’s look at a simple example of a government worker: – Starts work at age 23 making $40,000 per year – Works for 35 years – Retires at age 58 with an indexed pension of 70% of best 5 years average salary – Pension is reduced by the amount of CPP benefits starting at age 65 – For first 20 years working receives raises of inflation + 4% – For final 15 years working receives raises of just inflation – Lives in retirement for 25 years until age 83 With the details in this example, we can calculate what percentage of this worker’s salary would have to be saved from each pay to cover the pension benefits. Of c...

The C.D. Howe Institute issued a report on Target-Benefit Pension Plans that explains how they differ from traditional Defined-Benefit (DB) and Defined-Contribution (DC) plans. Target-benefit plans solve a number of the problems with DB and DC plans, but they have some serious challenges as well. Defined-Benefit (DB) pension plans push all of the risk onto employers who have to provide predictable benefits. Employers must shoulder the risk that investments may perform poorly, forcing them to make large contributions. One problem with some DB plans is that they use unrealistic assumptions about future returns to reduce today’s contributions. This can lead to chronic under-funding. Another problem with some DB plans is they use unrealistic actuarial information. Effectively, they assume people will die younger than they actually will. This leads more under-funding problems. Defined-Contribution (DC) pension plans push the risk from employers to employees. The employers know...

I’ve read many articles on the debate over whether we need an improved pension system, and I’ve noticed some patterns. The two sides rarely address each other’s issues. Arguments for Change Supporters of change usually point to the alarming number of Canadians who save little and are headed to a dismal retirement where their standard of living will drop significantly. They rightly point out that the only remedy is forced savings. They call for an expansion of CPP or support Ontario’s plans to create a new pension system. Either option leads to higher payroll taxes as a form of forced savings. Status Quo Side Supporters of the status quo say that Canadians are doing just fine with their retirement savings. They say that the average level of retirement savings among Canadians is quite healthy. They observe that few retired Canadians live in poverty. They say that forced saving would just reduce voluntary saving. Who is right? These two arguments seem to contradict each...

Well-respected pension expert Malcolm Hamilton has a new report entitled Evaluating Public-Sector Pensions: How Much do They Really Cost? He shows that public-sector pension costs are "materially understated and, as a consequence: employees in the public sector are paid more than is publicly acknowledged and, in many instances, more than their private-sector counterparts; public sector employees shelter more of their retirement savings from tax than other Canadians are permitted to shelter; and taxpayers bear much of the investment risk taken by public-sector plans while the reward for risk-taking goes to public employees as higher compensation." I approach studies skeptically and am frequently critical of mistakes made by authors of studies, but not here.  It is definitely worth paying attention to Hamilton.

Canada’s pension system is in trouble and we need to do something about it. This is the main message of the book The Third Rail , written by Jim Leech, CEO of the Ontario Teachers’ Pension Plan, and Jacquie McNish, senior writer with the Globe and Mail. The book is a fairly easy read and is worth a look. The authors take a detailed look at pension crises in New Brunswick, Rhode Island, and The Netherlands, and describe how the problems were solved. A common theme is that the pension plans were changed to make benefit levels conditional on the returns on pension assets. On one hand this makes a lot of sense. We can’t expect pension backers (taxpayers or companies) to grow benefits faster than they can grow the savings set aside to pay those benefits. On the other hand, if we make cost-of-living increases conditional on pension asset returns, this automatically takes the pressure off pension administrators to manage the funds well. They can award themselves excessive fees or all...

A recent Family Finance column in the Financial Post showed something strange about the way that financial planners calculate a person’s net worth. Apparently, having a defined-benefit pension plan does not add anything to your net worth. The article profiled Doris, a grandmother with a simple balance sheet. She has a car worth $3000, owes $10,000 on her line of credit, and can begin drawing a $1400 per month pension in two years. For some reason, her pension just doesn’t count and her net worth is listed as -$7000. This isn’t an isolated case; I’ve seen this in many other net worth statements as well. With a negative net worth at age 63, Doris appears to be in dire circumstances. However, a pension of $1400 per month plus CPP and old age security are more than enough to give her a modest but comfortable life. Without the pension, Doris would be far worse off, so why doesn’t the pension count as part of her net worth? To value her pension we would need more details about t...

In a recent article, Rob Carrick suggested increasing the tax clawback for Old Age Security (OAS) as a way to control costs. This would have the effect of lowering benefits without having to increase the retirement age. However, I think we need to have goals other than just cost containment. Life expectancy has risen considerably since 65 was chosen as a retirement age. Instead of increasing the retirement age as life expectancy rises, government workers tend to retire in their late 50s, with many retiring at age 55. Many of these workers will be retired as long as they were working. This is not sustainable. Outside of powerful unions in the public and private sectors, pensions are generally dismal by comparison. Many advocate an improved pension system for all that is as strong as the pensions that government workers enjoy. This will never happen. How could we possibly run a country if nearly half of all adults are retired? Who would mow the lawns on the golf courses? W...

So far I have more questions than answers about the new Pooled Registered Pension Plans (PRPPs) and a big question is what the costs will be like for participants. The Department of Finance has a framework document that lays out the basic idea of PRPPs, but it is the details that will determine if this approach is beneficial for Canadians or not. PRPPs will be administered by “regulated financial institutions that are capable of taking on a fiduciary role in order to act in the best interests of plan members.” The investment choices will allow participants to create portfolios consistent with their “investment objectives and risk preferences including a low cost option.” This seems to imply that high-cost options may be offered as well. Because it will be employers who will decide which financial institution to choose as a PRPP administrator, and we can reasonably believe that employers can evaluate costs better than the typical Canadian, there is some hope that PRPP administrat...

With the Canadian political parties squabbling over the Conservatives’ plans to reform pensions using Pooled Registered Pension Plans (PRPPs) rather than expanding CPP, a key factor that isn’t discussed much is that current retirees aren’t likely to get extra money each month. Many groups have put forth suggestions for pension reform in recent years. Most of these suggestions have not included plans to give more money to current retirees, but usually this fact was not made clear. Those who are retired now or who will retire soon can be forgiven if they thought expanding CPP would mean they’d get more money in retirement. With the Conservatives pushing defined contribution PRPPs, it should now be clear that you won’t get more money out in retirement unless you put more money in while working.

Senator Raymond Lavigne has been in the news lately after resigning to avoid getting kicked out of the senate and losing his $79,000 per year pension. The part of this that struck me was the article writer’s choice to describe the money at stake as a “$79,000 pension” rather than its full value which is clearly more than a million dollars. Similarly, generous pension plans make many government workers pension millionaires. People tend to value spread out payments as less than their total cost. So, a couple spending a day at an amusement park spending a series of small amounts such as $30 each to get in, $25 for snacks, and $15 for parking won’t feel like they spent a total of $100. The Lavigne article would probably have drawn more ire if the pension’s present value of more than $1 million were quoted. Moving to the subject of government workers, a Statistics Canada publication says the following: “In fiscal year 2006/2007, the average age at retirement of the public serva...

The inevitable assault on public service pensions appears to be underway. Many have assumed that the problems of private pension plans would not carry over to public pensions, but this is just wishful thinking. Just because governments can borrow hundreds of billions of dollars to cover promised pension payments doesn’t mean that they are willing to do so. Superficially, the problems of both public and private sector pensions are similar. Too little money has been saved to cover future promises. If that money isn’t made up, then something has to give. If a plate has ten cookies, and ten people have been promised three cookies each, we may not know who will get their cookies, but we can be sure that not everyone will get all three. An important difference between public and private sector pension plans is that the government has greater scope to lie to themselves about the real costs of future pension obligations. As explained in the C.D. Howe Institute’s backgrounder The Star...