It’s time we had a workplace pension plan for all Canadians. Here’s how that could look

Canada’s retirement income system is seriously flawed. To explain the problem, it is helpful to understand how the system currently works.

It is made up of three tiers, as set out in the table below. Tier 1 includes three government-sponsored programs, Tier 2 holds workplace pension plans and Tier 3 is where individuals can save on their own, primarily using RRSPs and TFSAs.

Nearly everyone is eligible for Tiers 1 and 3, but not Tier 2. That’s because employers can choose whether to sponsor a workplace pension plan and decide how generous it should be.

The voluntary nature of Tier 2 might have seemed like a good idea at one time, but it has not turned out well. Only 35 per cent of workers in the Canadian labour force are covered in a Tier 2 plan and few new plans are being created.

What is worse, the benefit levels in the plans that do exist are uneven, with some mid-level workers (especially in the public sector) receiving pensions worth up to $1.5-million while others (in the private sector) earn a small fraction of that.

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This state of affairs raises several questions. First, why do so many employers choose not to offer a plan? It’s because setting up a pension plan is a major hassle and, frankly, many companies have discovered they don’t need to offer one to attract workers.

Second, why not simply scrap Tier 2 and beef up the Canada and Quebec Pension Plans instead? My answer is I believe we would lose something in the process. Having three tiers is a strength of our system: It minimizes the “contagion” issue should a fiscal problem arise with one of the remaining two tiers.

Finally, there is the even more fundamental question: Is the low coverage rate in Tier 2 truly a problem? We can answer that by asking whether it would be a problem if only 35 per cent of the workforce was covered by Canada’s health care system.

This is not the Canadian way, and what is unacceptable when it comes to health care should be equally unacceptable for retirement coverage.

Tier 2 is the Achilles heel of the retirement income system, providing pensions that are much higher than necessary for some and but nothing for the majority. This needs to change dramatically if we are to achieve the twin goals of fairness and ensuring that all Canadians can retire in dignity. The remedy is simple but not easy to implement, since resistance to change from some of the stakeholders would no doubt be formidable.

I propose that we transform Tier 2 into one large workplace pension plan that covers virtually all Canadian workers on a consistent basis. This new plan should be a defined contribution plan because such plans are transparent and equitable. You know what you are getting and no one is subsidizing anyone else.

For now, let’s call this new plan the Universal Canadian Superannuation Plan, or the UCSP. I believe the role of the UCSP should be to provide a substantial enough benefit so that no one suffers a dramatic drop in their standard of living after retirement, but not so great a one as to render Tiers 1 and 3 unnecessary.

Basic features of the UCSP

Under the UCSP, all workers would contribute 4 per cent of their pay, and employers would make a matching 4 per cent contribution. These contributions would be deducted from paycheques and go into a pension fund that cannot be touched by the employer or any creditor.

All contributions would be tax-deductible up to a fairly high dollar limit. Unlike with the current Tier 2, the same tax-deductible limit would apply to everyone.

Each participant would be able to choose the investment funds that best match their own appetite for risk. There would also be a smart “default” option for employees who can’t or won’t choose their own investment options, perhaps in the form of target date funds. Each member would be able to view their account balance online any time and to switch between investment funds.

There would be no need to create much new infrastructure. Canada’s existing investment community, including investment managers, investment advisers and financial planners, would be mobilized to provide the investment choices and help advise members, with some regulatory oversight.

At the point of retirement, each participant would have several options for converting their DC balance into regular retirement income, perhaps along the lines described in a recent paper published by the National Institute on Ageing.

Sufficiency

A total contribution rate of 8 per cent may sound low to some, but the chart shows that it provides about the right level of income. In the chart, I assume that investments will earn a return of 5.5 per cent before retirement and 4.5 per cent after retirement, which I believe is modestly conservative. I compare four scenarios for a couple, now age 26, who plan to retire at age 62.

The chart shows the couple’s expected retirement income at age 62 from all sources as a percentage of their pretax final pay before retirement. The right retirement income target is normally be between 50 per cent and 70 per cent of final pay, depending on one’s circumstances (single or married, mortgage payments, child-raising costs et cetera).

In this scenario, the UCSP is projected to produce incomes in this target range and even potentially exceed the target when combined with a Tier 3 RRSP. Note in the chart that the current federal public service plan produces an income that translates into a standard of living in retirement that is higher than the couple enjoyed while still working. It totally eliminates the need for Tiers 1 and 3.

Looking at what other countries have done, the most relevant example is perhaps Australia, which adopted a universal DC pension plan nearly 20 years ago. Employers there contribute 12 per cent of pay to the Superannuation fund; employees are not required to contribute. The rate needs to so high because Australia has no separate arrangement akin to the CPP or QPP.

Britain also established a national DC plan when it rolled out the National Employment Savings Trust in 2012. Employees must contribute a minimum of 4 per cent of pay to NEST, while the government contributes another 1 per cent of pay on their behalf in the form of tax relief. But other workplace plans still exist in Britain so, once again, it is not directly comparable with our system.

The biggest lesson we can glean from both the Australia Superannuation fund and NEST is that mature countries with established pension systems can make dramatic changes to their retirement systems if they want.

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This next point will be contentious: If the UCSP is launched, all existing workplace pension plans would have to be phased out, so that everyone could participate on an equal footing. Supplemental Tier 2 plans would not be permitted, since allowing them would create a real danger of gravitating back to the current system.

How long should workers who are pension plan members at the time of the UCSP launch be grandfathered? At one extreme, everyone goes into the UCSP immediately. At the other, existing pension plan members stay in their current plans until retirement, but those plans do not accept new hires.

Before we worry about transition, though, we need to get buy-in. Clearly, MPs or civil servants who now have better pensions will dislike this proposal. We need to find ways to ensure that their total compensation remains competitive. Having the same DC workplace plan will actually make this job easier since it improves transparency.

The UCSP will not solve Canada’s retirement readiness problems overnight. A long transition period cannot be avoided but that is all the more reason to get started early. The first step is to engage all stakeholders in a dialogue.

Frederick Vettese is former chief actuary of Morneau Shepell (now Telus Health) and author of Retirement Income for Life.