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 gets 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 a 2% return 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.

Conclusion

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.