Inconsistent Pension Envy
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 to spend during their 60s, or if their health is so poor that they’re certain to die in their 70s or earlier. Or maybe they’re so rich it doesn’t matter.
However, huge numbers of Canadians who don’t fall into these exceptions fail to maximize their CPP payments by waiting until they’re 70. In effect, they’re turning down most of their own gold-plated pension. This is a strange way of showing their pension envy.
Hi Michael,
ReplyDeleteI always enjoy your posts and perspectives! This is a take on CPP that I had not considered!
While I can't speak to other pension plans, the federal plans are currently structured with a 50/50 funding model where the cost of the plan is shared equally between employees and the employer: https://lop.parl.ca/sites/PublicWebsite/default/en_CA/ResearchPublications/2015110E#a15
For public servants who will potentially be eligible to start their workplace pension at age 60, would you also recommend deferral to age 70 (assuming that RRSP/TFSA savings combined with the employer pension is adequate)?
Anonymous,
DeleteThe 50/50 funding model is based on accounting fiction. Because the pension is more valuable than the government lets on, civil servants pay less than half the cost. Some people take this to mean that I'm knocking civil servants; that's not my intent. You can't blame someone for taking a good deal when it's offered.
It only makes sense to delay CPP to 70 if you have savings you can spend to make up the difference in your 60s. So, healthy civil servants retiring at 60, who have net savings (after accounting for all debts, including a mortgage) greater than 10 years of the large CPP payments that would come at 70, should consider delaying CPP. Run the numbers to be sure.
Can you elaborate on the "accounting fiction"? The current contributions range from 8.69% to 11.72% of salary (https://www.canada.ca/en/treasury-board-secretariat/services/pension-plan/active-members/pension-contribution-rates-major-public-sector-pension-plans.html) - and that's on top of the CPP contributions.
DeleteBecause of CPP integration, public service employees are currently paying ~15% of their salary toward their pension and the employer is paying another ~15% - yes, the pension is extremely valuable but it is also extremely expensive for the employees paying for it.
Anonymous,
DeleteThe discount rate is too high. There is room for disagreement over what discount rate to use, but the rate they do use is unreasonably high.
Somewhat related question: Do you think the Pension Adjustment formula for a defined benefit plan does a good job of estimating the value of the pension? Obviously the PA doesn't take into account whether a pension benefit is indexed to inflation or not, although I suppose the formula could become more complicated if there was an attempt to account for various pension features.
ReplyDeleteAnonymous,
DeleteThe key input to any pension adjustment formula is the rate used to discount future payments. If you're referring to the pension adjustment formula used to reduce available RRSP room, I'm afraid I've never examined it in detail.
The actuaries at CPP probably do not care whether we start payments at age 60 or age 70 as they expect to pay out about the same total amount on an average lifespan. I think you would agree that we should view the two choices in the same way...probably about of equal present value. The real advantage to deferring is being able to safely spend more of your nest egg early on in your retirement. This is a difficult concept to understand...I know it took me quite a while. Perhaps you could do a post using some examples to illustrate?
ReplyDeleteThe fact that the government, on average, pays the same regardless of when you start taking it is why this is a key part of the solution. I think of using savings in my 60's to get a higher, indexed inflation-adjusted payout beginning in my 70's as purchasing an inflation-indexed annuity from the Canadian government.
DeleteThe annuity can be thought of as "longevity insurance". It ensures that regardless of how long you live, you will be able to afford to continue to live at a certain standard of living. As with most forms of insurance, it doesn't make sense to purchase more than you need. I think it makes sense to ensure
Why "buy" this annuity from the government? Insurance companies also offer annuity products. In my mind there are 3 reasons:
1. It is very difficult to find an inflation-indexed annuities in Canada. If the annuity isn't inflation-indexed, it isn't a great fit for longevity insurance.
2. Due to the lack of suitable insurance products, it is difficult to comparison shop and get a good deal. I think if you do the math, you would probably find the "increased CPP" annuity is a fairly good deal, especially in low-interest rate environments where annuities are typically very expensive.
3. Any concerns over complexities of what might happen if an insurer goes defunct are certainly minimized if your insurer is the Gov't of Canada.
Hi Garth and Returns Reaper,
DeleteWell said. The critical difference between how the government views CPP and individuals view it is the different views on how long we'll live. The government gets to average out life expectancy over all Canadians, and can base all their plans on life expectancy. However, I need to consider what will happen if I live a long life. So, if the government sets the rules so they're indifferent to whether I take CPP at 60 or 70, I prefer taking it at 70 as some longevity insurance.
Not just inconsistent on when to take CPP, but whether to pay into it at all! So many independent contractors tie themselves in knots to set up corporations and pay themselves dividends just to avoid having to pay into CPP.
ReplyDeleteHi Potato,
DeleteGood point. Not too many years ago, before I ever really looked into CPP, I might have been among these CPP avoiders. When I was younger, I just thought of CPP as another tax. Now I better understand its value.