Abstract
This paper explores the factors that have led to a Canada-U.S. productivity gap using a sectoral growth accounting approach. Both fiscal and monetary policies have had significant effects on the saving rate. The Canadian dollar’s appreciation was followed by a protracted period of exchange rate weakness. This paper reviews the institutional aspects of Canada’s real return bond program. The Canadian system provides a successful model for pension reform. Free trade has helped promote the integration of U.S. and Canadian economies, but significant differences remain.
V. Canada’s Pension System: Status and Reform Options1
1. Canada has a comprehensive three-pillared pension system (Box 1). The public pillars consist of an old-age security benefit, financed through the federal budget, and the Canada Pension Plan, which is funded partly by employer/employee contributions, and partly by the returns on accumulated trust fund assets.2 The private pillar of the system consists of corporate pension plans and individual savings plans.
2. The Canadian system provides a successful model for pension reform, but challenges remain. As a result of a series of reforms introduced since the mid-1980s, most elderly Canadians at the low- to middle-income level are provided with the means to broadly maintain living standards in retirement. At the same time, public pension benefits remain relatively modest, providing an incentive for middle- to high-income households to accumulate sufficient assets to fund their retirement. With the retirement of the baby boom generation expected to begin at the end of the decade (Figure 1), this paper discusses the state of the Canadian pension system and explores the scope for further policy action. Among other issues, the paper touches on the role of private saving vehicles, governance of corporate pension plans, incentives for labor market participation of elderly workers, and trends in public pension benefit levels.
Old-Age Dependency Ratios in Selected G7 Countries
Citation: IMF Staff Country Reports 2004, 060; 10.5089/9781451806908.002.A005
Sources: World Bank; and OECD.A. The Public Pension System and Issues
Old-Age Security
3. The Old-Age Security (OAS) system is targeted mainly at lower-income seniors. The OAS was initially provided as an universal retirement benefit, with additional benefits provided through the attached Guaranteed Income Supplement (GIS) from 1967 and Spouse’s Allowance (SPA) from 1975 (see Box 1). However, fiscal pressures prompted some cutbacks in the mid-1980s, including through the partial deindexation of income tax brackets, exemptions, and deductions that increasingly brought lower-income seniors into the tax net (but have since been reversed). Moreover, maximum pension levels have remained frozen in real terms since 1984, and means-tests (or “clawbacks”) for OAS benefits were introduced for higher-income retirees in 1989, which effectively ended the universality of public pension benefits. These measures caused benefits to drop in real terms for all but the poorest seniors, and placed government spending on old-age security on a downward trend relative to GDP since 1994 (Figure 2).3
Government Spending on Old-Age Pensions
Citation: IMF Staff Country Reports 2004, 060; 10.5089/9781451806908.002.A005
Source: Haver Analytics.Canada’s Three-Tiered Pension System
The first tier consists of universal basic pension benefits financed through the federal budget. They include Old-age Security (OAS); the Guaranteed Income Supplement (GIS); and Spouse’s Allowance (SPA) for 60-64 year old spouses (the term OAS is also often used to refer to the three benefits together). In total, these benefits provide a maximum income of about C$12,000 per year, which is indexed every three months to the consumer price index. These benefits are taxable, but retirees also receive an age-related tax credit. GIS and SPA benefits are tax-free, but are reduced (“clawed back”) by 50 cents and 75 cents for every dollar of other income, respectively, which makes the benefit structure highly progressive. Finally, retirees receive a tax credit worth around C$1,000, which is reduced for higher-income seniors, and half of all provinces provide additional income supplements to seniors with low incomes.
The second tier is formed by the Canada Pension Plan (CPP), a compulsory pension plan covering all employed and self-employed Canadians. Premiums are split equally between employers and employees (self-employed pay both parts). The maximum CPP benefit roughly equals one quarter of the past five years’ average industrial wage; survivor, disability, and death benefits are also provided. Benefits are indexed to the CPI and fully taxable. The CPP is a joint federal-provincial program, with changes requiring the agreement of two-thirds of the provinces carrying two-thirds of the population.
The third tier comprises the private pension system, much of which receives favorable tax treatment. These include corporate pension plans (Registered Pension Plans; or RPPs) and individual retirement savings vehicles (Registered Retirement Savings Plans, or RRSPs). The income tax system provides tax deductions for contributions to RPPs and RRSPs, and although only about a third of the workforce are covered by RPPs, survey results suggest that some 71 percent of households had either RPP or RRSP assets in 1999. Benefits are fully taxable, except for a C$1,000 private pension exemption.
4. However, the means tests have come under criticism. In particular, OAS benefits are tested against personal income only, which raises questions about horizontal equity, given the advantage the system provides to retirees with working spouses. The sharp clawback rate of GIS and SPA benefits and the progressive nature of the old-age income tax credit imply relatively large marginal disincentives to work. Finally, the existence of a large number of tax credits and benefits, with different clawback rates, has been viewed as unnecessarily cumbersome and complex.
5. The last attempt at reforming the OAS system in 1996 failed in the face of widespread political opposition. In 1995 and 1996, the government proposed a “Seniors Benefit” that would combine OAS, GIS, and age and pension income tax credits. This benefit would have been tested against full family income and clawback rates would have been even more progressive than for existing benefits. Taking into account changes in the tax system that were also envisaged, the plan was not expected to have had a significant immediate impact on retirement incomes, but would have produced considerable savings over time. However, as a result of strong political opposition, a lessening of fiscal pressures owing to improving government finances, and a successful CPP reform, the proposal was withdrawn in 1998 (Battle, 2003).
Canada Pension Plan
6. Successful implementation of a 1998 reform plan has put the Canada Pension Plan (CPP) on a sound actuarial footing. Prior to the reforms, it was expected that the combined employer/employee contribution rate would need to rise from 5.6 percent of pensionable earnings in 1996 to more than 14.2 percent by 2030 to preserve the system’s long-term actuarial balance. In order to avoid this sharp increase in contribution rates and the associated intergenerational inequities, the reform package contained the following elements (Battle, 2003):
Benefit cuts. A number of modest changes to the way benefits are calculated (including with regard to pensionable earnings, eligibility for disability benefits, and the amount of death benefits) were estimated to reduce annual benefit payments by 2 percent initially.4 However, these measures were expected to reduce total benefit payments—already low by international standards—by almost 10 percent by 2030.
Base broadening. For the purpose of calculating pension contributions, the yearly basic exemption (YBE) was frozen at C$3,500. However, with the maximum amount of yearly maximum pensionable earnings (YMPE) continuing to rise with average wages, the amount of earnings subject to premium payments was gradually increased.
Contribution hike. The CPP contribution rate was gradually raised to a “steady-state” level of 9.9 percent, with the increase completed in January 2003. At this level, the CPP was deemed to be in actuarial balance, and no further rate increases were expected pending regular actuarial reviews.
Market investments. The reforms have resulted in a significant buildup of CPP assets, expected to reach around five years’ worth of benefits by 2010 (Figure 3). In addition prior to 1998, surpluses had been lent to the provinces at a subsidized rate—the market rate paid by the federal government. With the reforms, provinces are now required to pay their own market rates of interest when borrowing from the CPP. Additionally, the provinces’ access to surplus CPP funds is gradually being eliminated. The CPP Investment Board (CPPIB) was established with a mandate to invest future surpluses in a diversified portfolio of market investments, including equity and real estate. By 2005, management of the CPP’s fixed-income portfolio will also have shifted from the Finance Department to the CPPIB, allowing public pension assets to be managed in a manner consistent with employer pension funds in Canada and elsewhere.5
Projected CPP Contribution Rates and Pension Reserves
Citation: IMF Staff Country Reports 2004, 060; 10.5089/9781451806908.002.A005
Source: OSFI, 2001.7. The 2002 Actuarial Report has confirmed the long-term viability of the CPP through 2075 (OSFI, 2002). The report found that the steady-state contribution rate required to achieve long-term balance was only 9.8 percent as of end-2000, and that the legislated rate of 9.9 percent would result in a larger-than-anticipated buildup of surpluses. Consequently, CPP assets are projected to reach six times annual plan expenditures by 2075 (see Figure 3). These results appear to be relatively insensitive to changes in underlying assumptions.6
8. CPP assets have grown rapidly, notwithstanding investment losses in recent years. As of September 2003, CPP assets amounted to C$64.4 billion (5 percent of GDP), of which the CPPIB held C$27.4 billion in stocks and real estate (Table 1). Since beginning operations in October 1999, the CPPIB has registered a cumulative loss of C$1.2 billion in its active portfolio—mostly a result of heavy stock losses between mid-2002 and early 2003 (Table 1). For the most part, stock losses were offset by gains in the CPP’s bond portfolio, but the CPP as a whole also registered a loss of C$1.1 billion in FY2003. Results improved between March and September 2003, with the CPPIB achieving a 14½ percent rate of return and the CPP’s bond portfolio also gaining 5 percent in value.
CPPIB Operations
CPPIB Operations
| Net investment income | Net assets (C$ bn) |
|||
|---|---|---|---|---|
| Fiscal year | C$ billion | Rate of return (In percent) |
CPP | Of which: CPPIB |
| 1999H2 | 0.0 | 5.0 | 39.1 | 0.0 |
| 2000 | 0.5 | 40.1 | 41.3 | 2.4 |
| 2001 | -0.9 | -9.4 | 45.7 | 7.2 |
| 2002 | 0.3 | 3.4 | 51.9 | 14.3 |
| 2003 | -4.2 | -21.1 | 55.6 | 17.5 |
| 2004H1 | 3.1 | 14.5 | 64.4 | 27.4 |
CPPIB Operations
| Net investment income | Net assets (C$ bn) |
|||
|---|---|---|---|---|
| Fiscal year | C$ billion | Rate of return (In percent) |
CPP | Of which: CPPIB |
| 1999H2 | 0.0 | 5.0 | 39.1 | 0.0 |
| 2000 | 0.5 | 40.1 | 41.3 | 2.4 |
| 2001 | -0.9 | -9.4 | 45.7 | 7.2 |
| 2002 | 0.3 | 3.4 | 51.9 | 14.3 |
| 2003 | -4.2 | -21.1 | 55.6 | 17.5 |
| 2004H1 | 3.1 | 14.5 | 64.4 | 27.4 |
B. Private Pension Schemes
Employer pension plans
9. Accounting for about a third of total household assets, private pension assets are the second most important source of private wealth next to primary residences. As of 1999, households held an estimated C$604 billion (50 percent of GDP) worth of assets in corporate registered pension plans (RPPs) and C$408 billion in individual retirement plans (Statistics Canada, 2001). As of 2003, there were some 15,400 RPPs, covering 5.4 million workers, about a third of the workforce.7 Included in this number are pension plans for employees of the federal, provincial, and municipal governments, which account for almost half of all workers covered by RPPs. Indeed, some 89 percent of public sector employees are members of an RPP, compared to only 30 percent of workers from the private sector.
10. The scope of employer-sponsored pension plans has increased in recent years. In most provinces, vesting in RPPs must now occur after only two years of employment, after which plan members become entitled to employer contributions made on their behalf. Employers also have to offer coverage for part-time workers, subject to certain conditions, and must allow early retirement at actuarially-reduced pensions. Indeed, half of all plans are thought to offer unreduced benefits in the case of early retirement once minimum service requirements are met (OECD, 2001). Portability provisions were also improved, and plans also have to provide survivor benefits. The FY2004 budget also raised ceilings for tax-deductible employer contributions in real terms for the first time in 25 years.8 However, less than half of RPP members are in plans that provide some form of benefit indexation, and only one in seven plan members enjoys full CPI indexation of pension benefits (Battle, 2003).
11. Recent years have also seen an increase in the importance of defined contribution (DC) plans, which shift investment risks to employees (Table 2). DC plans remain the preferred choice of small companies, in part because individual accounts are easily transferable to individual or group retirement accounts.9 By contrast, defined benefit (DB) plans are generally sponsored by large companies such as banks, railroads, and telecommunication organizations. While the majority of private pension plan members still belong to DB plans, employers are increasingly offering members the option of accruing future benefits on a DC basis and, in some cases, of converting accrued benefits to cash for transfer into a DC account. However, almost all public pension plans have remained on a DB basis, typically offering 2 percent of salary for each year of service up to a maximum of 35 years.
Membership in Registered Pension Plans
(In percent of all employees)
Membership in Registered Pension Plans
(In percent of all employees)
| 1989 | 1991 | 1993 | 1995 | 1997 | 1999 | 2001 | ||
|---|---|---|---|---|---|---|---|---|
| Total | 45.7 | 48.5 | 48.1 | 45.7 | 44.6 | 43.6 | 43.5 | |
| Defined contributions | 3.8 | 4.3 | 4.7 | 4.8 | 5.6 | 5.9 | … | |
| Defined benefits | 41.4 | 43.6 | 42.9 | 40.3 | 38.3 | 36.9 | … | |
| Mixed | 0.4 | 0.7 | 0.6 | 0.7 | 0.7 | 0.8 | … | |
| Public sector | 83.5 | 89.4 | 87.4 | 84.6 | 83.9 | 82.2 | … | |
| Private sector | 33.6 | 34.1 | 33.6 | 32.1 | 31.4 | 31.1 | … | |
Membership in Registered Pension Plans
(In percent of all employees)
| 1989 | 1991 | 1993 | 1995 | 1997 | 1999 | 2001 | ||
|---|---|---|---|---|---|---|---|---|
| Total | 45.7 | 48.5 | 48.1 | 45.7 | 44.6 | 43.6 | 43.5 | |
| Defined contributions | 3.8 | 4.3 | 4.7 | 4.8 | 5.6 | 5.9 | … | |
| Defined benefits | 41.4 | 43.6 | 42.9 | 40.3 | 38.3 | 36.9 | … | |
| Mixed | 0.4 | 0.7 | 0.6 | 0.7 | 0.7 | 0.8 | … | |
| Public sector | 83.5 | 89.4 | 87.4 | 84.6 | 83.9 | 82.2 | … | |
| Private sector | 33.6 | 34.1 | 33.6 | 32.1 | 31.4 | 31.1 | … | |
12. The financial position of many DB pension plans has deteriorated as a result of market losses. Comprehensive information is not available, owing to the fragmented nature of pension fund supervision, but several reports suggest that among larger companies with DB pension plans, the degree of underfunding is similar or slightly worse than in the United States.10 For those plans supervised by OSFI, a solvency test in June 2003 found that about 210 plans (more than half of all DB plans under OSFI supervision) were not fully funded on a solvency basis—i.e., the net present value of future pension obligations exceeded the market value of plan assets—compared with about 180 plans in December 2002. When assessing pension assets at liquidation value—a more stringent criterion—the aggregate solvency ratio remained around one, reflecting plan surpluses of some large pension plans. Nevertheless, the number of companies on OSFI’s watch list increased from 50 to around 90 through the first half of 2003. Since then, pension plans are likely to have benefited from the recovery in equity markets, but relatively low long-term interest rates continue to keep the discounted value of future liabilities at a high level.11
13. OSFI has responded to recent developments by strengthening its regulatory oversight. OSFI has tightened regulations on contribution holidays, refined its supervisory tools, and taken a more proactive stance in dealing with severely underfunded pension plans. For example, corporate plans are now subjected to semiannual stress tests, and actuarial reports are requested on an annual basis (instead of every three years) as long as plans are underfunded. Moreover, regulatory changes are currently being considered which would have the effect of limiting benefit improvements that would unduly affect the solvency ratio of a plan. This proposed change is currently under development and will be subject to industry consultation through the early part of 2004. A proposed regulatory change that would require full funding of a pension plan deficit on plan termination will also be subject to further consultation through 2004.
Private retirement accounts
14. Registered Retirement Savings Plans (RRSPs) were introduced in 1957 to provide nonparticipants in employer pension plans, such as the self-employed, with a tax-preferred vehicle for retirement savings. RRSP contributions are deductible from taxable income, and income earned within RRSPs is tax exempt. Cash withdrawals, however, are treated as ordinary income and are taxable in the year of withdrawal. Contributions to a spouse’s RRSP are also tax deductible and since 1991 any unused contribution room can be accumulated and carried forward indefinitely. Workers covered by corporate pension plans are also allowed to contribute to RRSPs, but in recent years the contribution limit was set at C$14,500 per year (including contributions to RPPs), somewhat lower than for corporate plans. The 2004 budget increased the annual cap to C$18,000 by 2006 (equal to the RPP limit), and also provided for the cap’s annual indexation in line with average wage growth.
15. RRSP contributions have dropped in recent years. The participation rate in the RRSP (defined as the percentage of eligible tax filers making a contribution in a given year) steadily increased from the system’s inception to reach close to 50 percent in the late 1990s, and the amount of RRSP contributions reached 6V2 percent of total wages and salaries in 1998. However, both participation levels and average contribution size have declined since about 1997 (OECD, 2003). In 2002, close to six million workers contributed about C$27 billion to an RRSP, down 7 percent from the peak of C$29.3 billion in 2000. Tax statistics also indicate that only one third of all tax filers contributed to an RRSP in 2002, out of about 80 percent of filers that were eligible.
16. RRSPs are most heavily utilized by high-income groups. Marginal incentives to save for retirement are highest at the very low and middle-to-high ends of the income scale, owing to the sharp reduction of public pension benefits above the low-income threshold. This is confirmed by a recent Statistics Canada study that found relatively high contribution rates both among low and high-income wage earners (Palameta, 2003). Nevertheless, a Statistics Canada (2001) survey found that 80 percent of those families without any private pension assets earned less than C$30,000 per year, and households with more than C$100,000 in accumulated retirement savings account for 84 percent of all private pension savings.
C. Pension Incomes and Retirement Trends
Pension income levels and distribution
17. Canada’s old-age security system has achieved considerable success in reducing poverty among the elderly. Although public expenditures on income security for seniors have remained modest by international standards—and are projected to peak at levels well below those anticipated by other industrialized countries in the next century—low-income rates among elderly Canadians are now among the lowest in the OECD (Smeeding and Sullivan, 1998; Table 3).12 The success in raising retirement incomes for poorer Canadians has also been reflected in a reduction in domestic inequalities, with virtually all of the relative income gains since the early 1980s taking place at the lower end of the income distribution (Table 4).
Old-Age Income and Labor Market Participation
Old-Age Income and Labor Market Participation
| Low-income rate of elderly (Percent of the elderly with income less than 50 percent of median disposable income) | Relative disposable income of the elderly (Percent of the disposable income of all individuals) | Participation rate, 2001, percent | ||||
|---|---|---|---|---|---|---|
| Private pension funds, 1999 (Percent of GDP) | Aged 55-64 | |||||
| Aged over 65 | Male | Female | ||||
| Australia | 16.1 | 67.6 | 63.8 | 6.0 | 60.0 | 36.9 |
| Canada | 2.5 | 97.4 | 45.7 | 6.0 | 61.3 | 41.7 |
| France | 10.7 | 89.7 | 6.3 | 1.2 | 43.8 | 34.1 |
| Germany | 10.4 | 85.6 | 3.2 | 3.0 | 50.6 | 32.4 |
| Italy | 15.3 | 84.1 | 3.0 | 3.4 | 57.8 | 26.6 |
| Japan | .. | .. | 18.7 | 21.8 | 83.4 | 49.2 |
| Netherlands | 1.9 | 86.3 | 119.3 | 3.1 | 52.0 | 26.9 |
| Spain | 11.3 | .. | 2.3 | 1.6 | 61.4 | 23.6 |
| Sweden | 3.0 | 89.2 | .. | 9.4 | 73.5 | 67.4 |
| United Kingdom | 11.6 | 77.8 | 84.1 | 4.8 | 64.4 | 44.6 |
| United States | 20.3 | 91.7 | 74.4 | 13.1 | 68.1 | 53.0 |
Old-Age Income and Labor Market Participation
| Low-income rate of elderly (Percent of the elderly with income less than 50 percent of median disposable income) | Relative disposable income of the elderly (Percent of the disposable income of all individuals) | Participation rate, 2001, percent | ||||
|---|---|---|---|---|---|---|
| Private pension funds, 1999 (Percent of GDP) | Aged 55-64 | |||||
| Aged over 65 | Male | Female | ||||
| Australia | 16.1 | 67.6 | 63.8 | 6.0 | 60.0 | 36.9 |
| Canada | 2.5 | 97.4 | 45.7 | 6.0 | 61.3 | 41.7 |
| France | 10.7 | 89.7 | 6.3 | 1.2 | 43.8 | 34.1 |
| Germany | 10.4 | 85.6 | 3.2 | 3.0 | 50.6 | 32.4 |
| Italy | 15.3 | 84.1 | 3.0 | 3.4 | 57.8 | 26.6 |
| Japan | .. | .. | 18.7 | 21.8 | 83.4 | 49.2 |
| Netherlands | 1.9 | 86.3 | 119.3 | 3.1 | 52.0 | 26.9 |
| Spain | 11.3 | .. | 2.3 | 1.6 | 61.4 | 23.6 |
| Sweden | 3.0 | 89.2 | .. | 9.4 | 73.5 | 67.4 |
| United Kingdom | 11.6 | 77.8 | 84.1 | 4.8 | 64.4 | 44.6 |
| United States | 20.3 | 91.7 | 74.4 | 13.1 | 68.1 | 53.0 |
The Distribution of the Elderly by Population Income Quintile, 1980–95
(In percent)
The Distribution of the Elderly by Population Income Quintile, 1980–95
(In percent)
| Quintile | 1980 | 1990 | 1995 | Change, 1980-95 |
|---|---|---|---|---|
| Bottom | 39.7 | 25.2 | 17.5 | -22.2 |
| 2nd | 22.1 | 29.7 | 32.5 | 10.5 |
| 3rd | 12.2 | 16.2 | 20.0 | 7.8 |
| 4th | 13.3 | 14.9 | 16.0 | 2.7 |
| Top | 12.8 | 13.9 | 14.0 | 1.2 |
The Distribution of the Elderly by Population Income Quintile, 1980–95
(In percent)
| Quintile | 1980 | 1990 | 1995 | Change, 1980-95 |
|---|---|---|---|---|
| Bottom | 39.7 | 25.2 | 17.5 | -22.2 |
| 2nd | 22.1 | 29.7 | 32.5 | 10.5 |
| 3rd | 12.2 | 16.2 | 20.0 | 7.8 |
| 4th | 13.3 | 14.9 | 16.0 | 2.7 |
| Top | 12.8 | 13.9 | 14.0 | 1.2 |
18. The reduction in poverty among seniors reflects a strong increase in public pension benefits, partly offset by declining labor income. Between 1980 and 1999, the combined share of retirement income provided by OAS benefits and the CPP rose from one third to about 43 percent (Table 5). A large part of the increase in public pension payouts is related to the maturation of the CPP, but the relatively constant share of OAS income suggests that a substantial increase in basic pension benefits has also allowed poorer retirees to keep up with overall income growth. At the same time, the share of employment income has declined to only about 10 percent in 1999, reflecting the trend toward earlier retirement and falling labor participation rates among the elderly (see below). Table 5 also illustrates that the share of income from private assets has essentially been stable over the past two decades, except that there has been a major shift of privately invested funds into retirement saving schemes.
Sources of Pre-Tax Income for the Elderly
(Shares of total, in percent)
Sources of Pre-Tax Income for the Elderly
(Shares of total, in percent)
| 1980 | 1985 | 1990 | 1995 | 1999 | |
|---|---|---|---|---|---|
| Employment income | 26.4 | 20.1 | 17.3 | 16.7 | 10.0 |
| Investment income | 23.4 | 22.6 | 21.2 | 14.9 | 13.1 |
| Retirement income | 11.6 | 13.0 | 16.2 | 21.0 | 28.5 |
| C/QPP benefits | 7.7 | 10.9 | 14.3 | 17.3 | 19.0 |
| OAS/GIS/SPA | 25.9 | 28.0 | 25.1 | 23.6 | 24.0 |
| Other | 4.9 | 5.5 | 6.0 | 6.4 | 5.3 |
Sources of Pre-Tax Income for the Elderly
(Shares of total, in percent)
| 1980 | 1985 | 1990 | 1995 | 1999 | |
|---|---|---|---|---|---|
| Employment income | 26.4 | 20.1 | 17.3 | 16.7 | 10.0 |
| Investment income | 23.4 | 22.6 | 21.2 | 14.9 | 13.1 |
| Retirement income | 11.6 | 13.0 | 16.2 | 21.0 | 28.5 |
| C/QPP benefits | 7.7 | 10.9 | 14.3 | 17.3 | 19.0 |
| OAS/GIS/SPA | 25.9 | 28.0 | 25.1 | 23.6 | 24.0 |
| Other | 4.9 | 5.5 | 6.0 | 6.4 | 5.3 |
Participation rates and retirement age
19. The average retirement age for Canadian workers has fallen sharply over the past twenty years. Household survey data suggest that the labor force participation rate of 55–64 year old males has steadily declined from 86 percent in the early 1960s to 60 percent in the 1990s (Hoffman and Dahlby, 2001).13 Notwithstanding some increase in the labor participation rate in recent years, especially among 6064 old males, Canada has moved to the middle of the retirement age distribution for major industrial countries. On average, Canadians retire earlier (and stay in retirement longer) than workers in the United States or Japan, but later than many of their peers in continental Europe (Table 6).
Withdrawal from Labor Force and Retirement Duration, 1999
Withdrawal from Labor Force and Retirement Duration, 1999
| Age of Male Labor Market Withdrawal (In years) |
Duration of male retirement (In months) |
|||
|---|---|---|---|---|
| First Quartile |
Median | Third quartile |
||
| Italy | 54.5 | 58.8 | 63.4 | 20.7 |
| Finland | 56.0 | 59.6 | 63.0 | 18.9 |
| Germany | 57.4 | 60.3 | 63.9 | 18.8 |
| Netherlands | 57.8 | 60.4 | 64.1 | 18.2 |
| Canada | 57.8 | 62.4 | 66.5 | 18.2 |
| United Kingdom | 57.8 | 62.6 | 66.5 | 16.8 |
| Sweden | 59.9 | 63.7 | 66.7 | 17.5 |
| United States | 59.4 | 64.6 | 71.4 | 16.3 |
| Japan | 62.7 | 68.5 | 77.7 | 14.9 |
| Average | 58.1 | 62.3 | 67.0 | 17.8 |
Withdrawal from Labor Force and Retirement Duration, 1999
| Age of Male Labor Market Withdrawal (In years) |
Duration of male retirement (In months) |
|||
|---|---|---|---|---|
| First Quartile |
Median | Third quartile |
||
| Italy | 54.5 | 58.8 | 63.4 | 20.7 |
| Finland | 56.0 | 59.6 | 63.0 | 18.9 |
| Germany | 57.4 | 60.3 | 63.9 | 18.8 |
| Netherlands | 57.8 | 60.4 | 64.1 | 18.2 |
| Canada | 57.8 | 62.4 | 66.5 | 18.2 |
| United Kingdom | 57.8 | 62.6 | 66.5 | 16.8 |
| Sweden | 59.9 | 63.7 | 66.7 | 17.5 |
| United States | 59.4 | 64.6 | 71.4 | 16.3 |
| Japan | 62.7 | 68.5 | 77.7 | 14.9 |
| Average | 58.1 | 62.3 | 67.0 | 17.8 |
20. The public pension system contains a number of disincentives to work beyond the early retirement age. Gruber (1999) illustrates the choice between continuing to work and taking up retirement for Canadian men under a range of factors. Although the results are somewhat sensitive to the amount of nonpension income received by a retiree, marginal incentives to work drop sharply beginning at age 55, and specially after age 60 when (reduced) CPP benefits kick in. The steepest disincentives are for workers with little spousal and other income, owing to the sharp clawback of GIS benefits.14 However, Gruber also finds that the actuarial adjustment of CPP benefits for workers retiring after the statutory retirement age of 65 is insufficient.15
Are Canadians saving enough for retirement?
21. Lise (2001) suggests that Canadian pension arrangements will remain adequate for the foreseeable future, with even lower-income Canadians able to meet basic needs. On the basis of cohort-specific income and consumption data, Lise finds that elderly Canadians experience no sudden decline in consumption as they enter into retirement age, implying that existing pension arrangements are sufficient to maintain living standards in old age. These findings, which are robust across different income quartiles, are supported by evidence that saving rates are also broadly maintained and that even low-income households continue to make gifts as they age. Lise also observes that the saving behavior of those expected to reach retirement during the next two decades has so far been similar to that of previous generations. Therefore, he concludes, future pensioners should also be able to maintain consumption and living standards in retirement.
22. Nonetheless, another study suggests that a large share of Canadians have failed to amass sufficient retirement savings to avoid a dependence on public pension schemes. A survey by Statistics Canada (2001) indicates that about 3V million family units (close to a third of all families) had no private retirement savings at all. Moreover, even among families with household head approaching retirement (aged 45 and above), one third may not have saved enough to replace two-thirds of their earnings or secure an income above Statistics Canada’s Low Income Cut-Off (LICO) line. To be sure, this group includes a significant number of high-income households that may experience lower income after retirement but are still able to live relatively comfortably. Yet, about a quarter of households with income between C$20,000–40,000 was also found with insufficient savings, and thus remains dependent on retirement income from public sources. Although this study did not consider nonfinancial retirement assets or the continued accrual of benefits under DB pension schemes, which may alleviate the financial situation of many households, these findings have raised concern.
23. Other factors suggest a risk that relative poverty levels among the elderly could increase again.16 Seniors depending on public pension benefits are likely to see their relative incomes shrink, both vis-à-vis other retirees and the general working population, because:
The income replacement value of OAS benefits—which are adjusted to cost-of-living increases rather than wages—would be expected to decline over time.
Similarly, CPP benefits are wage-based at the point of retirement, but subsequent adjustments are also linked to the price level, implying a stronger decline in relative incomes as the duration of retirement increases with life expectancy.
Moreover, if industrial wage incomes were to fall relative to other incomes, e.g., in the service sector, an increasing share of CPP beneficiaries could see effective replacement ratios shrink.
D. Policy Issues
24. Although the Canadian pension system appears sound, there may be scope for further reforms ahead of the retirement of the baby boom generation. Consideration could be given to strengthening the private pension pillar, including by reviewing the structure of retirement saving vehicles and strengthening governance of corporate pension schemes. Amendments to the public pension system could also assist in fostering labor market participation among older workers, boosting pension saving, and relieving impending fiscal pressures. Moreover, over the longer term, care will be needed to ensure that the support provided by the basic public pension system is kept at adequate levels to avoid a rise in old-age poverty.
Reviewing personal saving vehicles
25. Tax incentives appear to have had only a marginal impact on private saving. For example, Burbridge, Fretz, and Veall (1997) suggest that the tax treatment of RPPs and RRSPs has mainly led to a re-allocation of savings into these vehicles. This view is supported by Veall (1999), who found that a substantial change in marginal income tax rates in 1988 had a negligible impact on RRSP contributions. Similarly, Milligan (2002) found that a 10 percentage point increase in marginal tax rates would increase the probability of RRSP participation by only 8 percent. This result implies that tax increases between 1982 and 1996 explain only 5 percent of the increase in RRSP contributions during the same period.
26. Nevertheless, the recent focus on increasing RRSP contribution limits appears appropriate. Against the background of increased labor market mobility and a trend away from lifetime attachment to a single employer, gradual increases in RRSP contribution limits, at least in line with incomes and other pension parameters, provide room for personal saving to increase, especially for those not covered by RPPs. The immediate fiscal implications of rising contribution limits would likely be minimal, and would likely be roughly matched in the long run by the tax paid on withdrawals.17 Moreover, these instruments also tend to improve the broader efficiency of the tax system by reducing the extent to which corporate income is double taxed, and by increasing the extent to which tax is paid on consumption rather than income.
27. Tax-prepaid savings plans (TPSPs) could usefully supplement existing private savings plans. In contrast to RRSPs, contributions to TPSPs would not provide an immediate deduction from income tax, but would enable tax-free accumulation of capital gains and benefit payments as well as tax-exempt withdrawals. As detailed in Kesselman and Poschmann (2001), TPSPs would have the advantage of allowing households to optimize their retirement asset allocation free from tax considerations. The authors suggest that overall economic efficiency could be increased as households shift their investments away from (tax-preferred) life insurance policies or real estate holdings. Moreover, TPSPs could provide a saving incentive for low-income households particularly if TPSP earnings do not cause a clawing back of GIS and SPA benefits.
Strengthening governance of corporate pension plans
28. Safeguarding the soundness of corporate pension plans remains a key priority. Recent changes in the federal supervisory regime—partly prompted by financial weaknesses among defined benefit (DB) plans—have already provided OSFI with the means to focus its surveillance more tightly on weaker pension funds. However, the extent to which supervisory practices at the provincial level have strengthened remains unclear. For example, most provinces have yet to follow OSFI in dealing with underfunded plans, and transparency about the state of provincial corporate pension funds could also be improved. These differences suggest that there exists a potential for closer harmonization of federal-provincial regulation and supervision, aimed at ensuring uniform adoption of best practices, improving system-wide transparency, and ensuring a more efficient use of supervisory resources.
29. For defined benefit plans, relaxing limitations on contributions to fully funded pension plans could strengthen their financial position over the cycle. Although most DB plans would be expected to return to being fully funded in the course of the next economic upswing, recent experience illustrates that placing a ceiling on plan assets at a cyclical peak can leave assets at an insufficient level to cope with the ensuing downturn. Therefore, an increase in the permissible surplus of pension funds (currently two years worth of pension contributions, or 20 percent of liabilities) could help encourage full funding over the cycle.
Encouraging labor market participation among the elderly
30. Unlike in many other countries, the Canadian pension system does not seem to weigh significantly on labor market participation among the elderly. Studies suggest that the generosity of public pension benefits has a sizable effect on retirement decisions in many countries, in many cases encouraging early retirement (Baker, Gruber, and Milligan, 2003; Gruber and Wise, 1999; Johnson, 2000). In Canada, however, the system appears to be relatively neutral, with some estimates suggesting that only about 20 percent of the trend decline in average retirement age is explained by public pension incentives (Baker and Benjamin, 1999; OECD, 2003).18 Indeed, while the CPP allows retirement from the age of 60, the OAS system does not provide an early retirement option at all. This contrasts with corporate pension plans, which have often been used to finance early retirement of employees in recent years, in an effort to mitigate the effect of corporate downsizing and restructuring programs.
31. Nevertheless, there appears scope to further reduce incentives for early retirement in the CPP. For example, the upward adjustment to CPP benefits for retirement after the statutory pension age of 65 is somewhat too low relative to the adjustment that is made for early retirement.19 Similarly, although eligibility requirements have been stiffened in recent years, disability benefits still seem to have dampened old-age labor participation rates (Campolieti, 2001). OECD (2003) research also suggests that disability insurance is being used as an exit route from the labor market by a significant share of male workers. Finally, recent proposals for reforming Quebec Province’s QPP could also be reviewed for their applicability at the national level (Box 2).
32. Especially in view of projected increases in longevity, there would seem to be scope for increases in the statutory retirement age.20 Assuming that the increase would apply to both OAS and CPP, and that the entry age for early retirement would also be shifted upward, potential advantages include the following:
Direct fiscal savings would accrue from a shorter period over which basic pension benefits are paid. Moreover, additional tax revenues would be generated as working lives were extended. However, increasing the retirement age would also imply that workers for whom early retirement has been primarily a means to exit from unemployment would need to be supported longer through the social safety net.
Increasing the retirement age could leave room for a reduction in CPP contribution rates. This would reduce the wage wedge and could have positive effects on labor market participation across all age groups, as well as facilitating a more efficient allocation of labor resources.
The accumulation of additional wealth would relieve some of the pressure on the two public pension pillars. The resources accumulated as a result of longer life-time employment could boost private pension assets and increase the share of retirement income from private sources after several decades of decline.
Reform Proposals for the Québec Pension Plan (QPP)
The QPP—an independent public pension plan for the residents of Quebec province—is designed to be very similar to the CPP. Both systems share the same basic parameters, including contribution rates, statutory retirement age, and maximum contribution and benefit levels. Minor differences include the design of disability and survivor benefits, which are slightly more generous in Quebec.
The Quebec government is currently considering more significant changes to the QPP, motivated by its less favorable actuarial position relative to the CPP. Owing to higher dependency ratios and lower immigration rates for Quebec, the actuarially neutral contribution rate of the QPP has increased to around 10.1 percent, compared to 9.8 percent for the CPP. The relatively low level of projected reserves and the growing gap between the CPP and QPP’s underlying contribution rates have led to calls for reforms.
The proposals aim at reducing the incidence of early retirement by providing commensurate financial incentives and allowing for a more flexible transition into retirement. Suggested measures include:
Adjusting the formula for the calculation of benefits at retirement by increasing the number of years in employment required to receive full pension benefits;
Providing an actuarially fair adjustment of pension benefits if retirement begins after the statutory age of 65;
Allowing beneficiaries to continue to work without financial penalty, and crediting additional pension contributions toward the beneficiary’s account (allowing pension benefits to increase until the maximum benefit level is reached).
The reform proposals also take into account the growing incidence of divorce and the large number of children living with only one parent. Proposed measures would focus survivor benefits to a larger extent on surviving children and no longer provide lifetime benefits for younger spouses. By also introducing elements of income testing, effective survivor benefit levels would decline slightly. Additional measures would reduce disability pensions in some cases to bring them more closely in line with pension benefits.
Maintaining adequate basic public pension benefits
33. Basic pension benefits are projected to decline significantly in real terms in coming decades.21 Assuming continued price indexation, the average basic pension benefit could decline from around 20 percent of average incomes in 2001 to 14 percent by 2030, with lower income groups facing a still larger decline in percentage points (OECD, 2003). Even on this basis, however, public pension expenditure is projected to increase by 2–3 percent of GDP through 2050—higher than in some other G-7 countries, including Japan and the U.K. Table 7). More generous benefit provisions would push spending considerably higher—a shift to wage indexation, for example, could result in an increase of 5 percent of GDP, comparable to some of the large continental European economies.
Projected Increases in Old-Age Pension and Social Spending
Projected Increases in Old-Age Pension and Social Spending
| OECD (2003) | Gruber and Wise (2001) | ||
|---|---|---|---|
| Change in public pension expenditure, 2000-50 (in percent of GDP) |
Old-age social spending, 1995 (percent of GDP) |
Change in old-age social spending, 2000-50 (in percent of GDP) |
|
| Australia | 1.6 | 3.1 | 3.3 |
| Canada | 2.0 | 4.6 | 2.9 |
| France | 3.9 | 12.3 | 2.7 |
| Germany | 5.0 | 11.1 | 4.0 |
| Italy | -0.3 | 13.0 | 4.8 |
| Japan | 0.6 | 6.1 | 4.3 |
| Netherlands | 4.8 | 7.3 | 3.5 |
| Sweden | 1.6 | 8.8 | 1.3 |
| United Kingdom | -0.7 | 8.1 | 2.7 |
| United States | 1.8 | 6.2 | 1.6 |
Projected Increases in Old-Age Pension and Social Spending
| OECD (2003) | Gruber and Wise (2001) | ||
|---|---|---|---|
| Change in public pension expenditure, 2000-50 (in percent of GDP) |
Old-age social spending, 1995 (percent of GDP) |
Change in old-age social spending, 2000-50 (in percent of GDP) |
|
| Australia | 1.6 | 3.1 | 3.3 |
| Canada | 2.0 | 4.6 | 2.9 |
| France | 3.9 | 12.3 | 2.7 |
| Germany | 5.0 | 11.1 | 4.0 |
| Italy | -0.3 | 13.0 | 4.8 |
| Japan | 0.6 | 6.1 | 4.3 |
| Netherlands | 4.8 | 7.3 | 3.5 |
| Sweden | 1.6 | 8.8 | 1.3 |
| United Kingdom | -0.7 | 8.1 | 2.7 |
| United States | 1.8 | 6.2 | 1.6 |
34. It therefore remains important to explore options for simplifying the existing system and targeting benefits more directly at the neediest group of elderly. Despite failed attempts to reform the basic pension system in the late-1990s, there appears considerable scope for simplifying and unifying benefits that are currently provided through different programs (including GIS, SPA, and the tax code). Merging these programs into one, and testing benefits for family income instead of personal income would contribute to increasing intragenerational equity and make the benefit structure more transparent.
References
Baker, M., J. Gruber, and K. Milligan, 2003, “The Retirement Incentive Effects of Canada’s Income Security Programs”, Canadian Journal of Economics, 36, No. 2, pp. 261– 90.
Baker, M., and D. Benjamin, 1999, “Early Retirement Provisions and the Labor Force Behavior of Older Men: Evidence from Canada”, Journal of Labor Economics, 17, No.4, pp.724– 56.
Battle, K., 2003, “Sustaining Public Pensions in Canada: A Tale of Two Reforms”, in Taste of Pie: Searching for Better Pension Provisions in Developed Countries edited by N. Takayama (Tokyo: Maruzen).
Burbridge, J., D. Fretz, and M.R. Veall, 1997, “Issues and Commentaries, Canadian and American Saving Rates and the Role of RRSPs”, Canadian Public Policy, XXIV, No.2, pp.259– 63.
Campolieti, M., 2001, “The Canada/Quebec Pension Plan Disability Program and the Labor Force Participation of Older Men”, Economic Letters, 70, No.3, pp.421– 26.
Gruber, J., 1999, “Social Security and Retirement in Canada”, in Social Security and Retirement Around the World, edited by J. Gruber and D.A. Wise (Chicago: The University of Chicago Press).
Gruber, J., D.A. Wise, 2001, “An International Perspective on Policies for an Aging Society”, National Bureau of Economic Research Working Paper No. 8103 (Cambridge, Massachusetts: National Bureau of Economic Research).
Gruber, J., 1999, Social Security and Retirement Around the World (Chicago: The University of Chicago Press).
Hoffman, M., and B. Dahlby, 2001, “Pension Provision in Canada”, in Pension Systems and Retirement Incomes Across OECD Countries, edited by R. Disney and P. Johnson (Cheltenham: Edward Elgar).
Johnson, R., 2000, “The Effect of Old-Age Insurance on Male Retirement: Evidence From Historical Cross-Country Data”, FRBKC Research Division Working Paper RWP 00-09 (Kansas City: Federal Reserve Bank of Kansas City).
Kesselman, J.R., and F. Poschmann, 2001, “Expanding the Recognition of Personal Savings in the Canadian Tax System”, Canadian Tax Journal, 49, No.1, pp.40– 101.
Lise, J., 2001, “Is Canada’s Retirement Income System Working?”, Department of Finance Canada Working Paper No. 2003-02 (Ottawa: Department of Finance).
Milligan, K., 2003, “How Do Contribution Limits Affect Contributions To Tax-Preferred Savings Accounts?” Journal of Public Economics, 87, No.2, pp.253– 81.
Milligan, K.,, 2002, “Tax-Preferred Savings Accounts and Marginal Tax Rates: Evidence on RRSP Participation”, Canadian Journal of Economics, 35, No.3, pp.436– 56.
Myles, J., 2000, “Incomes of Seniors”, Perspectives on Labour and Income, 12, No.4, pp.23– 32.
Palameta, B., 2003, “Profiling RRSP Contributors”, Perspectives on Labour and Income, 4, No.1 (January).
Organization of Economic Cooperation and Development (OECD), 2003, Canada: 2003 Annual Review (Paris: OECD).
Organization of Economic Cooperation and Development (OECD), 2001, Ageing and Income: Financial Resources and Retirement in 9 OECD Countries (Paris: OECD).
Office of the Superintendent of Financial Institutions (OSFI), 2003, Annual Report 2002.03 (Ottawa: OSFI). Available on the internet at www.osfi.bsif.gc.ca.
Office of the Superintendent of Financial Institutions (OSFI), 2002, Actuarial Report (19th ) Supplementing the Actuarial Report on the Canada Pension Plan: As at 31 December 2000 (Ottawa: OSFI). Available on the internet at www.osfi.bsif.gc.ca.
Office of the Superintendent of Financial Institutions (OSFI), 2001, Actuarial Report (18th ) on the Canada Pension Plan: As at 31 December 2000 (Ottawa: OSFI). Available on the internet at www.osfi.bsif.gc.ca.
Smeeding, T.M., and D.H. Sullivan, 1988, “Generations and the Distribution of Economic Well-Being: A Cross-National View”, American Economic Review, 88, No.2, pp.254– 58.
Statistics Canada, 2001, The Assets and Debts of Canadians: Focus on Private Pension Savings (Ottawa: Minister of Industry).
Tompa, E., 1999, “Transitions to Retirement: Determinants of Age of Social Security Take Up”, Program for Research on Social and Economic Dimensions of An Aging Population (SEDAP) Research Paper No. 6 (Hamilton, Ontario: McMaster University).
Veall, M.R., 1999, “Did Tax Flattening Affect RRSP Contributions?” Research Institute for Quantitative Studies in Economics and Population (QSEP) Research Report No. 342 (Hamilton, Ontario: McMaster University).
Prepared by Martin Muhleisen.
Residents of the province of Quebec are covered by the separate Quebec Pension Plan (see below).
For a discussion, see Hoffman and Dahlby (2001) and Battle (2003).
CPP premiums are tied to an individual’s pensionable earnings, defined as earnings up to Yearly Maximum Pensionable Earnings (YMPE)—which grows in line with the average industrial wage—less the Year’s Basic Exemption (YBE). Prior to the 1998 reforms, the YBE was set at one tenth of YMPE. CPP benefits are calculated by the following formula: CPP pension = 0.25 x (average YMPE over the previous 5 years) x (average ratio of pensionable earnings to YMPE over 85 percent of the individual’s working life). The working life is calculated by subtracting 18 years from the age when CPP benefits are first drawn, with up to 7 years of “drop-outs” being provided for periods when the individual is caring for a young child.
Provinces have the choice of rolling over non-marketable bonds placed with the CPP one more time until 2033. OSFI (2001) assumes that the ultimate asset mix will consist of 50 percent bonds and 50 percent equity.
The actuarial estimates assume a real rate of return of 4.5 percent and 5 percent on Canadian and U.S. equities, respectively, and of a 3.8 percent real return on bonds. Real average earnings are projected to grow at 1.1 percent over the long-run, and the steady-state inflation rate is projected at 3 percent. A 20 basis point increase in contribution rates would be required if the inflation rate were to equal 2 percent, ceteris paribus. Similarly, the contribution rate would have to increase by 40 basis points if the real rate of return were 1 percentage point lower.
These plans are typically registered at the provincial level, except for some 1,200 plans of companies operating in federally regulated areas of employment. These plans cover about 550,000 employees and are registered with and supervised by the Office of the Superintendent of Financial Institutions (OSFI, 2003).
The budget contained an increase in the amount of contributions to defined-contribution plans that can be deducted from taxable income from C$14,500 to C$18,000 by 2005. The maximum pension benefit permitted under defined-benefit plans was raised to C$2,000 per year of service by 2005 from the present ceiling of C$1,722. Both limits are indexed to average wage growth for subsequent years.
Two thirds of pension plans supervised by OSFI are DC plans.
According to a widely quoted UBS study, 49 of the largest 60 companies listed on in the TSX have DB plans. These plans had a combined funding shortfall of 3.2 percent of market cap at end-2002, compared with only 2.4 percent for S&P 500 companies.
Members of defined benefit plans are not insured against plan insolvency, except in the province of Ontario where the first C$1,000 per month of pension benefits is covered by a pension benefits guarantee fund.
The low-income rate is defined as the share of the population with disposable income less than half the median of the entire population.
The respective drop for males aged 65-69 is from 50 percent to 16 percent. For women, the trend toward earlier retirement is generally dominated by an age cohort effect in favor of higher participation in the labor market (Gruber, 1999).
For example, a worker in the tenth income percentile (no outside income) achieves a replacement ratio from public pension income of 42 percent if retiring at age 62, but would be subject to an effective 16 percent marginal tax rate if continuing to work. By contrast, the replacement rate for workers in the ninetieth percentile (with outside income) is 15 percent, and marginal tax rate 4 percent. At age 65, the low-income (high income) case receives a pension of 124 (32) percent of income at a 64 (18) percent marginal tax rate.
CPP benefits are reduced by 0.5 percent for each month that they are received before age 65, and increased by 0.5 percent for each month that retirement is postponed after age 65.
Most of the reductions in old-age poverty took place during the 1980s, owing to factors that are expected to weaken in the future (Myles, 2000). Chiefly among those is that public pension schemes reached maturity while real incomes of the working population stagnated during most of the 1980s and early 1990s, raising relative incomes of the elderly. The income distribution among seniors also became more even as the decline in elderly employment reduced a source of income concentration, whereas growing public retirement benefits were of a more equitable nature.
Milligan (2003) found that the option to accumulate unused contribution room has a negative short-term impact on RRSP contributions, as individuals attempt to smooth contributions over the life cycle.
Gruber (1999) and Tompa (1999) also found many early retirees to be already semi-detached from the labor market as a result of unemployment, part-time or low-income employment, or disability.
To achieve actuarial fairness, the pension benefit would need to be raised from 0.5 percent to 0.7 percent for every month of retirement after reaching the age of 65.
To ensure political acceptance and mitigate the impact on workers close to retirement age, any increase in the retirement age would need to be gradual and phased in over a longer time frame.
With population aging, voting power is shifting toward the elderly generation, possibly precipitating a reallocation of public spending toward meeting old-age needs.
