Tag: Saving

Is the CPP a good deal? – A napkin-alysis

Over lunch with a colleague on a recent road trip he posed to me a simple, but ultimately very complex question, “Is the Canada Pension Plan a good deal?”

He wasn’t trying to debate social policy, public finance or macro-economic principles – we’d already chewed that fat during our advisor meetings while canvassing potential future OAS changes and actual current CPP retirement provision changes.  No, his focus was now squarely on the baseline CPP retirement pension itself, and whether it is a good financial proposition for a retiree. 

Putting on my lawyer’s cap I prefaced my comments with the standard ‘it depends on circumstances’, before reaching across the table for a napkin to scribble down my own 2 cents.

Quantum of the pension

To begin, what dollar amount of pension might one expect to receive?  

The 2012 maximum CPP retirement pension is about $11,840 annually, though the actual average pension as at October 2011 was about $6,512.  Using the maximum figure for argument’s sake, I asked, “To produce that income, how much do you think it would cost to purchase a single premium immediate annuity on a 65 year old?”  

As I look into this from time to time (verified once more in drafting this article), I offered that presently $100,000 would buy about $7,000 of annual income with zero years guaranteed.  Men would get a few hundred more, women a couple hundred less.  Grossing that up, it might cost our androgynous retiree about $170,000 to acquire the max CPP pension.  

Put another way, $170,000 is a rough proxy for the present value of the anticipated future pension payments, actuarially speaking.  Of course that’s understating the matter as it is based on a non-indexed annuity, but it will serve for the time being.

The quid pro quo: Past paid premiums

Continuing the case, we turn to an estimate of the present value of all past CPP premiums paid.  

To be entitled to the maximum pension, our increasingly theoretical retiree will need to have contributed maximum premiums for the maximum entitled years.  For simplicity, that would be the period from 18 to 65, less the low earnings dropout years, which just increased from 7 to 7.5 this year, and will settle at 8 in 2014.  So, that’s 47 minus 7.5, or 39.5 years.

The 2012 maximum employee-side premium is about $2,301, with the employer responsible for an equivalent figure.  While the premium rate is presently fixed at 4.95% (I will come back to this shortly), the annual cost is effectively indexed, so for these purposes we will use current premium as a stand-in for the present value of each previous year’s premium paid. 

Applying further rough math, the product of multiplying max years times current premium is about $90,000. 

Deal or no deal?

Thus in this simplistic sketch, a maximum pension retiree’s fortunes would appear to have almost doubled.  Proportionately that should apply at lesser pension levels, perhaps even more favourably at the lowest income levels as premiums are not due on the first $3,500 of income.

Returning to that premium cost, the actual rate was 1.8% from 1966-1986, rose 0.1% per year until 1997 when it was 3.0%, then stepped up from then until 2003 when it reached the current 4.95%.  So for a current retiree with premium cost having often been less than the current rate and future pension payments being indexed, further credence is lent to the CPP value proposition.

Add to that the availability of other features like the death benefit (modest though it may be), disability pension, children’s benefit and survivor benefits (both before and after retirement).  Beyond the inherent worth of each of these features, in combination they suggest that the zero guarantee assumption used in my annuity example is more than fair in most situations.

Still, conceding on the downside, people are not statistics and those of us with known lower life expectancies will have correspondingly lower pension receipt expectations.  And for those self-employed who paid both employer and employee premiums, the net result is unclear at best. 

As for my colleague I don’t know if he left the restaurant heartened or heartburned, but at least it gave him something to digest, other than lunch that is.

The HST and its impact upon savings

As July 1 approaches, our thoughts turn to Canada Day parades, backyard barbecues and, oh, the launch of the Harmonized Sales Tax (HST) era in Ontario and British Columbia. 

In the financial services field, there has been much hand wringing about the HST applying to mutual fund management fees and other investment services previously not subject to such provincial taxes.

While the HST launch may be imminent, it is not necessarily an immutable change. Let’s put it in context.

Taxes are innately good

It is true. Taxes are the primary means by which we finance our society, particularly in providing the infrastructure and public goods and services that otherwise would be left undelivered or unsupported. 

So the issue is not really “if” tax revenue must be raised, but rather “how” to do so. 

The impending HST

A broad-based consumption tax aligns the cost of producing goods and services with taxpayers who are currently consuming them. Combined with a tax credit for those at low income, it can be an effective and equitable way to spread tax need across a population.

Being broad-based is critical as exceptions and exemptions – whether attributable to the pursuit of social policy or due to industry lobbying – lead to a higher tax rate being applied to remaining taxable units.

How then can we reconcile the concept and practicality of personal savings within such a tax regime?

Savings as consumption

Savings is not as simple a concept as one might expect. There is a large body of tax and economic literature on the issue, and it is an ongoing debate. To the person on the street, a reasonable definition of savings might be that which is not consumed, or that which is set aside to be consumed later.

So, is the HST a tax on savings? No, but it is a tax that is borne by those savings. The best illustration may be the case of mutual funds held in registered plans, where it causes a direct decline in savings and a permanent loss of future tax-sheltering opportunities.

In that light, and knowing already that there will be exceptions and exemptions to the HST, would it make sense to exempt services that support savings? If saving is consumption-in-waiting, then arguably this is no more than a deferral of tax revenue.

Toward retirement

As our federal and provincial Ministers of Finance continue public consultations on retirement income adequacy, perhaps some explicit consideration may be given to coordinating income taxation and consumption taxation – one of those “left hand/right hand” things.

And as the HST comes into place in July, here’s hoping that future amendments to the GST and HST consider the practical impact these taxes have on savings, retirement and the broader economy.