The RRSP Mirage

Too many personal plans are coming up way short. The push is on to reinvent Canada's deal with retirees.

Can Canada restitch the fraying financial safety net citizens count on when we stop working?

On Dec. 17, federal and provincial finance ministers will meet in Whitehorse for talks focussing on retirement and pension reform. Hopes are high for an historic moment -- the dawn of "Pensioncare."

Fears are equally high -- that the history will have more to do with squandered opportunities and fumbled balls.

Triggering this confab is the growing consensus that Canada needs to figure out a way to get pensions for people who don't have them, and to shore up the retirement savings for people who aren't accumulating what they expected.

It is now clear that the Registered Retirement Savings Plan (RRSP) system has failed to secure the futures of enough middle class workers and, in the words of one C.D. Howe Institute researcher, has "defrauded" lower income workers.

Proponents of RRSPs stress the tax-sheltered vehicle empowers individuals to take control over their financial futures. But not even one in three people who can take advantage do so. "Almost $500 billion in unused RRSP contribution room is being carried forward," calculates Monica Townson, whose primer on Canada's pension problem for the Tommy Douglas Research Institute was published in October of this year.

If RRSPs aren't getting it done for enough people, what about the private pensions some workers get from employers to top up their payouts from the Canadian Pension Plan (CPP)? If you get such benefits, consider yourself lucky. You belong to a dwindling minority.

While Canada has enjoyed a well-earned reputation for taking care of its elders, "the fundamental fact remains that many workers in their 40s and 50s today -- and especially younger Canadians -- can expect a much less comfortable and secure retirement than those who are now in their 70s and 80s," warns Andrew Jackson, national director of social and economic policy with the Canadian Labour Congress. If policies don't change, say a number of experts interviewed for this series, a growing percentage of the coming generation of retirees will plunge into poverty.



And so the finance ministers are jetting to Whitehorse in the dead of winter. Some believe the timing and location are indicative of the Harper government's muted enthusiasm for a topic that could no longer be avoided. With companies going bankrupt, pension schemes floundering, pension coverage declining and the baby boom cohort approaching retirement age, public concern is undeniable. The provinces of Nova Scotia, Ontario, Alberta and B.C. have all fielded reports on pension reform, and the latter two are on the verge of initiating a regional pension scheme.



Meanwhile, the Canadian Labour Congress, the Canadian Association of Retired Persons and the C.D. Howe Institute have unveiled public pension proposals that would significantly augment the current system. Financial experts ranging from Don Drummond, chief economist for the Bank of Nova Scotia, to David Dennison, president and CEO of the Canada Pension Plan Investment Board, have expressed support. The federal Liberals and NDP are on board. No wonder the CLC's Joel Harden calls it a "Tommy Douglas moment."



In response, Prime Minister Harper has appointed Alberta MP Ted Menzies, parliamentary secretary to Finance Minister

Jim Flaherty, to head a pension initiative. The two will meet with their provincial counterparts in Whitehorse to sketch the way forward.

There are some clear and important differences between the various plans to be floated at that meeting, as we will explain in coming installments of this series, "Finding a New Pension Fix." First, though, a closer look at why RRSPs are failing the futures of too many.

The fading RRSP dream

The problem with the current situation does not lie with government pension offerings -- CPP, OAS (Old Age Security) and GIS (Guaranteed Income Supplement) -- which in general have proven to be adequately funded and efficiently run. The problem is that these provide limited income and were never intended to do anything other than augment private pensions and personal savings.



Meanwhile, both of these elements are in decline, if not indeed crisis. Beyond the fear that the current roster of failing pension plans is just the tip of the iceberg, there is the inescapable fact that the iceberg itself is melting: only 23 per cent of private-sector employees are currently enrolled in a plan, the lowest proportion since the 1950s.



The decline of private-sector pension plans isn't a complete accident, either. While public sector unions made pensions a priority, in many cases bargaining away higher wages and other benefits to secure them, other employers and employees accepted the idea that saving for retirement could also be accomplished via the Registered Retirement Savings Plan, which was introduced in 1957.



Somewhat ironically, to the extent that the program has been criticized at all, it has been for being too rich a benefit to the generally middle- and upper-income Canadians who could afford RRSPs and -- at one time, anyway -- embraced them. In the 1990s, with the stock market booming, "Freedom 55" seemed well on its way to replacing "Peace, order and good government" as the national ideal. 



Since then the dream has gradually died. RRSP contributions peaked in 1997, and by 2008 fewer than 30 per cent of those eligible made a contribution. The advent of a lost decade for stock prices perhaps played a part, as did a rise in residential real estate prices, which convinced some people that they were living in their pension plan. But perhaps also, Canadians began to twig to the dirty little secret of the RRSP: try as one might, it is almost impossible to generate a healthy return -- and therefore a secure retirement -- because the system is rigged against individual investors.

Who really profits from RRSPs?



A tantalizing hint of this surfaced in September during a dispute between Ontario's McGuinty government and the financial services industry, which objected to the prospect that sales tax harmonization would apply to mutual fund investments. In response, officials in the McGuinty government threatened to release a document on the negative effects of high management fees.



While some observers objected that the McGuinty government was indulging in threats and blackmail, others wanted to see the smoking-gun document. That has not been released, but there is plenty of research into the shortcomings of mutual funds, especially in the U.S., but also in Canada, which has some of the highest management expense ratios in the world.



A 2007 article in Canadian Investment Review by Rob Bauer, a finance professor at the University of Maastricht, and Keith Ambachtsheer, director of the Rotman International Centre for Pension Management at the University of Toronto, is particularly relevant. The article quantifies the cost to Canadians of mutual fund investments by comparing them to equivalent pension fund investments. 



How yawning is the gap? In the case of Canadian equity funds (historically the most common type of mutual fund purchase), during the period 1996 to 2004 Bauer and Ambachtsheer pegged the difference at 3.8 per cent a year in the case of so-called no-load funds, and even more for funds that charge additional sales fees.



The disparity is somewhat attributable to the investing record of mutual funds (on average somewhat poorer than institutionally managed pension funds), but mostly to their high management fees. Canada's management fees are among the highest in the world. The fees are high partly because mutual funds are generally smaller than pension funds, and therefore have higher overhead, but also to pay for marketing and sales commissions, not to mention the imperative to return a profit.



Over time a difference of that magnitude becomes truly monumental.

A startling disparity in returns


As an example, consider the case of someone who at 25 began investing $2,000 a year in a mutual fund that delivers annual returns of 4 per cent. At 65 he or she will have accrued $197,653.07 -- which would then pay out $12,165.54 a year in a 25-year annuity returning the same 4 per cent.



But if the same $2,000 a year had been invested with a pension fund that returned 8 per cent (an additional 4 per cent a year as indicated by Bauer and Ambachtsheer), the equivalent amount would be $559,562.08 -- generating an annual annuity payout of $48,535.20, assuming a continuing 8 per cent return over the same 25-year term.



Of course, there is no law saying Canadians must invest their RRSPs in mutual funds. It's just that there are few other viable options available to small investors. It is possible to make an end run around high management expenses by investing instead in index funds or ETFs, whose expense ratios can be as low as 0.15 per cent (and are almost always below 1 per cent, compared to the 2 and 3 per cent charged by mutual funds). But these as well produce returns inferior to those of most institutionally managed pension funds. Under some circumstances, such as during the recent market turmoil, they can trail the performance of even mutual funds.



It's also possible to buy simple GICs or to concentrate on bonds. Especially over the past ten years, default strategies along those lines have worked out relatively well. Yet even taking into account the stock losses of the past year and a half, most pension funds, with their enormous pools of capital, diverse investment baskets and ultra-low management ratios, will still have come out ahead of the individual investor.



Making matters worse, there is also the tendency of individual RRSP investors to be (put on the shoe that fits): ignorant, negligent, apathetic, impressionable, excitable and erratic when it comes to investment decisions. As well, investing is something most people are not trained in and would rather not be doing, so they may fail to (again with the shoes) research their options, weigh their risks, read their contracts or even open their statements. Or they may do these things, but badly.

What, then, does the distribution of RRSP winners and losers look like? The average sized RRSP saved by Canadians today is about $60,000. At current interest rates, that amount rolled into an annuity will pay a mere $200 a month.

A 2003 paper published by the C.D. Howe Institute found that about one in five households headed by people nearing retirement had no savings. But author Richard Shillington reserved his greatest pity for those he called "futile savers," the one in three who had less than $100,000 in savings, having put aside on average $23,000. These people would be eligible for GIS, but the sacrifice they'd made to scrape up small RRSPs would yield them almost nothing. "The primary beneficiary of this saving," wrote Shillington, "will be the federal and provincial governments because most of the income from it will be confiscated by income-tested programs and income taxes. To the extent that these households were misled, they have been defrauded."

'Confidence shaken'

At the moment, however, it isn't just the lower earners who are feeling ripped off by the promise they could expect a comfortable, RRSP-cushioned retirement right on schedule. A poll last month found that 37 per cent of Canadians are now planning to delay their retirement, up from 28 per cent just a year ago. "Many Canadians may have had their confidence shaken by events of the past year," concluded Jack Courtney, assistant vice-president of the Winnipeg-based Investors Group, which commissioned the poll by Harris/Decima.

What's going to be on the table in Whitehorse are a number of proposals aimed at restoring that confidence, as well as the security of Canadians suddenly realizing their retirement years may be in jeopardy.

Next: A labour-backed plan to double the CPP pension amount for the coming wave of retirees.