I could not make head nor tail of the unsourced numbers in last week’s National Post editorial on the Canada Pension Plan (CPP):
If workers were able to take the more than $3,000 they and their employers pay into CPP on their behalf each year and invest it in a conservative private fund, at the end of their working lives their private pension income would be nearly $26,000 annually. With CPP, the same $3,600 taken every year yields annual benefits of only around $10,000 at age 65.
These figures have since been reproduced by an anti-CPP letter in The Edmonton Journal. A closer inspection is warranted.
The claim that privately saving $3,600 per year would generate a retirement income of $26,000 is meaningless without knowing how many years the worker saves before retirement or what rate of return the savings generate before and after retirement. The Post provides none of these assumptions.
I will work backward from $26,000. The Globe and Mail reports that it would cost $100,000 for a 65-year-old to buy a life annuity of $400 per month (indexed to inflation, like CPP benefits). So, it would cost $542,000 to buy an indexed life annuity of $26,000 per year.
Accumulating $542,000 by saving $3,600 per year would have taken an 8% return on investment compounded over 34 years. (It would take fewer years given a higher return or more years given a lower return.)
It is indeed conceivable that someone who saved and successfully invested $3,600 each year since 1976 could now privately finance a retirement income of $26,000 annually. But $3,600 was a lot of money in 1976. Certainly, it is way more than anyone was contributing to CPP back then.
In 1976, an employee’s maximum annual CPP contribution was $135. Adding the employer’s matching contribution brings the total to $270.
So, the Post’s argument is that someone who started out saving thirteen times their CPP contribution could enjoy a retirement income far in excess of CPP benefits. While true, that is not a critique of the CPP’s efficacy. If anything, the point that more saving produces more retirement income supports proposals to expand the CPP.
The Post refers to a CPP contribution of $3,600 and benefit of “around $10,000.” As far as I can tell, these figures are the maximums from 2003. Why the Post used 2003 instead of 2010 is beyond me.
In any case, as I pointed out in the following letter, both sets of figures miss the fact that CPP contributions and benefits increase over time with average employment earnings. A contribution of $3,600 in 2003 does not imply a contribution of $3,600 back in 1976. Similarly, a contribution of $3,600 in 2003 corresponds to a benefit of more than $10,000 in the future.
Imagine someone who contributed the maximum to CPP throughout his career and retired today. He and his employer would together have contributed $270 in 1976 and $3,600 in 2003.
However, his CPP benefit would not be the $9,615 maximum from 2003. Instead, he would receive the 2010 maximum of $11,210 per year plus inflation.
CPP: A good investment
National Post - Friday, Jun. 18, 2010
Re: CPP: A Bad Investment, editorial, June 15.
Your editorial complains that “in the recent financial crisis, the Canada Pension Plan (CPP) investment board lost almost as much value as the average among private fund managers.” In other words, the CPP outperformed private funds.
However, your monetary comparison is not based on actual investment performance. Instead, it contrasts current CPP contributions and benefits with a hypothetical retirement income from private savings plus a positive investment return over a period of time.
This approach ignores the fact that, over the same time period, CPP benefits will automatically increase with average employment earnings. A worker contributing to CPP today will retire in the future with benefits well in excess of today’s benefits.
Erin Weir, economist, United Steelworkers, Toronto.