On July 13, the Financial Post published a column by noted pension expert Keith Ambachtsheer in which he offered up his latest response in our ongoing exchange about common myths regarding expansion of the Canada Pension Plan (CPP). One of the most glaring problems with Ambachtsheer’s latest response is an assumption that he makes about the investment returns generated by the CPP Investment Board (CPPIB), which manages the CPP’s assets, and how those returns will affect the returns of individual Canadians eligible for CPP benefits.

The purpose of this blog is to clarify this assumption.

But first, we have to distinguish the returns that the CPPIB generates on its investments from the returns that individual Canadians receive on their CPP contributions in the form of CPP retirement benefits. The returns of the CPPIB do not in any direct way influence the CPP retirement benefits received by individual Canadian workers. CPP retirement benefits are based on the number of years a person works, their earnings in each year (relative to the maximum under the CPP), and the age at which they retire.

A recent Fraser Institute study calculated the rate of return under the current CPP system for Canadians and found it is a meagre three per cent or less for those born after 1956 —declining to 2.1 per cent for those born after 1971.

Ambachtsheer appears to believe that the rate of return for individuals will be higher under the expanded CPP. Rather than speculate, we re-calculated the new rate of return based on the limited details available on the proposed CPP expansion. The results point to a slightly higher comparable long-term rate of return (2.5 per cent). In other words, there is only a small increase in the long-term rate of return for individual Canadians under the expanded CPP—2.5 per cent after expansion versus 2.1 per cent before expansion.

While more pre-funding stemming from increased mandatory contributions is likely responsible for the increased return, the rate of return under the expanded CPP is still meagre. For Ambachtsheer to assume even higher rates of return, he must assume that the government will increase the benefit rate and/or lower the contribution rate and that the CPPIB continues to outperform the required rate of return of 4.0 per cent.

Critically, the CPPIB itself must generate a 4.0 per cent return (after inflation) simply to keep the program actuarially sound (ensuring contributions cover the required benefit payouts). In recent years, the CPPIB has been generating returns well above this required 4.0 per cent rate and this has led some, including Ambachtsheer, to speculate that this will lead to higher returns for individual Canadians.

Ambachtsheer is correct to note that the CPPIB’s investment performance matters indirectly when it comes to the individual returns of Canadians. However, the assumptions that the government will either increase CPP benefits and/or lower CPP contributions and that the CPPIB will sustain its recent over-performance into the future are not a foregone conclusion.

For one thing, changing either the CPP contribution rate (tax) or the level of benefits is a political decision that will require agreement among Canada’s federal and provincial governments. Is it possible? Yes, but it’s not pre-determined.

Moreover, if the CPPIB were to underperform and fall short of the required 4.0 per cent needed to ensure the program remains actuarially sound, this could result in either lower CPP retirement benefits and/or higher CPP contributions.

Yet another, and arguably more plausible, outcome based on the assumption that the CPPIB sustains its over-performance—and remember, this is just an assumption (the other scenario could occur where the CPPIB misses its required 4.0 per cent target)—is that the CPP moves towards a system that is increasingly more of a pre-funded approach rather than pay-as-you-go. In this scenario, benefit payouts from the CPP will rely more on past contributions rather than current contributions.

As a final point of clarification, Ambachtsheer states that we sing “the praises of people saving for their own retirement,” which is yet another unfortunate example of very loose and misleading language.

In fact, what we did was note that private savings in vehicles such as RRSPs have advantages absent in the CPP. For example, all money saved privately can be transferred to a beneficiary in the event of death. In the case of RRSP savings, Canadians can pull a portion of their funds out for a down payment on a home, to upgrade their education, or in the case of financial emergency. These benefits are not available through the CPP. And this is a downside to CPP expansion that Ambachtsheer overlooks when he claims that the CPP is of higher quality.

The question, then, is who’s best situated to decide the comparative value of those benefits: individual savers or the government?