The Future of Pensions

Pension promises are like government debts: they are promises to make a stream of future payments. Canadians may be willing to make those promises, but the true costs must be made clear. If pensions are not properly funded, then either:

  • taxes will have to be raised sharply
  • other government services will have to be cut, or
  • pension benefits will have to be reduced, leading to hardship for retirees.

Canada, number of births, 1946-2011

In the first quarter of 2012, Bloomberg reports that US private sector firms have to contribute 67% more to their pension funds than they did two years ago. This is partly because of this decade’s weak asset markets, and partly because of low bond yields, which increases the capital cost of providing a given pension income. Public pension providers are faced with similar challenges: it costs the same to provide a public pension as it does to pay a private one.

Life expectancy is increasing in most countries, including Canada. Canadians reaching the age of 65 in 2007 could expect to live for 5 years longer than 65 year olds in 1967 (to age 83 instead of 78 for men). Greater longevity implies ever-greater pension costs, as well as changes to the employment and retirement patterns of the past.

Old age is also changing and evolving as those baby boomers begin to reach 65. Rather than a homogeneous group of old people, three distinct groups are emerging:

  • the “young old” aged 65 to 74;
  • the “old” aged 75 to 84;
  • the “old old” 85 aged and over.

The needs of each group are different, and require different government policies.

According to York University’s Thomas Klassen, (co-author of a 2010 report on Canada’s pension system):

“For the “young old,” governments need to foster, but not mandate, longer working lives by making it easier for workers to gradually transition from full-time work to full retirement. Creative tax, pension, employment and workplace policies that make it possible to combine work and retirement in any number of ways is required from governments.”

The latest actuarial report on the Old Age Security (OAS) program states that its cost will nearly triple by 2030: from $36.5-billion in 2010 to $108-billion. The Canada Pension Plan (CPP) expects to manage a $275 billion fund by 2020, and $1 trillion by 2050. CPP had a return on invested funds of nearly 12% in 2011, but getting bigger will make it harder to maintain such a high level of investment returns. It may be tempting for the fund to count on equities to keep rising, but with Treasury bonds currently yielding 2%, corporate bonds yielding 3-4%, and an equity risk premium of 4-5% (the 2000-2011 average), then equity portfolios can safely be assumed to earn only about 6%.

Human Resources Minister Diane Finley has suggested the government’s position:

“This is not a short-term problem, nor does it have anything to do with deficits or deficit reduction,” she asserted. “Frankly, the issues with Old Age Security sustainability will come into play long after we’ve achieved balanced budgets. But they are tomorrow’s challenges that need to be addressed today. Any changes that are made will be made prudently and gradually.”

Many of Canada’s fellow G8 countries – the United Kingdom, the United States, Italy, Germany, and France, have already raised their retirement ages:

  • The State Pension age for men and women in the UK will reach 66 in 2020, 67 between 2034 and 2036 and 68 between 2044 and 2046. Even so, the UK government is considering other measures to ensure State Pension age continues to keep pace with increases in life expectancy.
  • Full retirement age in the US for people born in 1938 or later will gradually increase from 65 to 67 for people born after 1959.

Gradually raising the eligibility age for a full Canadian pension from 65 to 67 is a reasonable option for this government to consider. If done right, it will benefit both current and future generations of Canadians.

Sources:
Government web sites
The Economist
The Globe and Mail
The National Post

- Phillip Khaiat


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