Friday, December 24, 2010

Need to buy more gold-plated pension?

In the NY Post there is an article about the difference between retirees in the public sector and those in the private sector. It highlights some of the rhetoric used to identify the difference.
Defenders of public employee pension systems often make the case that pension benefits are not all that generous. The outrageous cases you see on the news — Long Island police retiring in their 40s with pensions in excess of base pay, administrators “retiring” with six-figure pensions and then going back to work with another government agency, one ex-FDNY firefighter running marathons on his $86,000 “disability” pension — are the exceptions, they say.
The data, however, tells a different story. According to the Census Bureau, the average New York retiree receiving a corporate or union pension — a retiree from the private sector — was receiving an annual benefit of $13,100 in 2009. For state and local government retirees, that figure was more than twice as high: $27,600. And that average figure includes retirees who were part-time workers or only spent part of their careers in government; full-career retirees often do far better.
The Average Pension is not the Average Pension 
The public sector unions always use the example of the "average pension" when they try and show that pensions are not really too high. One key component is missed in the average pension approach. It includes retirees who have been retired for as long as 30 years. 
An example are the pensions of federal public servants in Canada. It is commonly reported that the average pension is $ 24,506 per year. What is not pointed out that last year the new average pension was $39,312. This is the average pension of someone retiring last year. 
Add a full CPP pension onto the average pension and you have a retirement for a newly retired federal civil servant of over $ 50,000 per year. Much higher than the average working Canadian wage of $44,000. Add in the 70% increase that a pensioner has in disposable income and heck, it's like they never retired at all. Just they do not have to go to the office any more!
Just how much is that pension worth?  
Pension Bomb offers a quick pension calculator. In Canada most pensions would be the same as the after 1/1/2010 pension example. 

Still Not Enough?

If you find that the pension you are being offered by taxpayers is a little anemic take advantage of the pension buy-back. Pension boss’s taxpayer-funded deal
Like many city employees, former pension administrator Lawrence Grissom signed up for a great deal starting in 1999 — he used $116,000 to add five years to his city service record without having to work those extra years.
That boosted his pension by at least $24,000 a year for life.
Unlike any other city employee, however, his purchased service credits didn’t actually cost him anything. Taxpayers picked up the tab.
Now a 68-year-old retiree living in Colorado, Grissom is expected to collect an additional $456,000 in retirement because of the deal if he lives until age 82, the average life span for men.
Grissom’s pension is $118,000 a year, based on the 18 years he worked and the five years he purchased under his special deal. He retired in April 2006 at 63.
Before you get too excited... I know I can hear you already... "but Bill this is an example from California how can it be relevant to us?" sorry but it happens here too. 

It is a common public sector pension benefit called the pension buy-back.  

Ottawa Example  
At the start of the year the the new Auditor of the City of Ottawa had a special provisions written into his contract that gave him a $100,000 signing bonus. This bonus was used to buy-back a pension that he had with another level of government. 

The move was severely criticized especially as it came from someone who had the job of protecting taxpayers interests. I blogged about it in Obscene taxpayer and pension abuse in Ottawa

Ontario Teacher Pension Plan buy-back example: 
For example, in 2009, Nicole takes a leave of absence from her full-time teaching job to travel around the world. Her annual rate of pay immediately prior to her absence is $60,000. Here’s what it will cost Nicole to buy back the leave: $60,000 x 12.0% (contribution rate for 2009) = $7,200 + interest charges

We use the standard interest rates in effect from the end of your leave until your buyback is completed. For example, interest rates were 2.78% in 2009 and 1.90% in 2010. If your leave spans more than one school year, we also apply an escalation factor to your salary to account for year-over-year changes in employment information.
So in this example, a contribution of $7,200 would buy one year's pension worth $42,000. Also it will give an extra year of service boost to her total pension worth about 2% of her income. It will be for the rest of her life worth about another $36,000 over the next 30 years. It also allows her to retire one year earlier that her total working credits would allow. 

How much pension buy-back can I sell you?

Bill Tufts
Fair Pensions For All

Monday, December 20, 2010

Ministers Agree to PRPP ... now the hard part

The UK NEST Plan .3% Management Fees

It appears that Canada the country is on track to solving the pension predicament. 

The Finance Ministers from all provinces have agreed to go ahead with the plan introduced last week by Flaherty, the federal finance minister. He calls the plan the Pooled Registered Pension Plan. The PRPP focused on those Canadians most in need of pension triage. 

The PRPP is being introduced as an alternative to enhancing the CPP plan. An enhancement that the provinces and labour groups across Canada have advocated for. A CPP boost would have the impact of eliminating the billion dollar pension shortfalls that exist in public sector pensions. Most of the pension shortfalls are in provincially administered pension plans so the provinces would have benefited greatly from a CPP enhancement as well. 

Urgent Action Required
This pension reform was needed to help those who are in danger of falling through the gaps in the current system. 

Insurance companies in Canada support the new plan. They administer most of the pension assets in Canada and were at risk of losing substantial assets to the CPP plan if it is boosted. The insurance companies are now on board, selling the benefits of the plan. Sun Life Financial welcomes milestone
 PRPPs will benefit Canadians by making pension coverage more broadly available:
  • Benefit from economies of scale. 
  • A plan that is easy to administer for the employer 
  • The advantages of a pooled plan and the management that it can offer 
  • Automatic enrollment to promote higher participation rates 
  • Linked to salary to provided increased contributions over time. 
Rubber to the Road
Now that the insurance companies are glowing from the introduction of the PRPP, they will have to make good on their promises. 

Part of the promise is to provide pooled investments with reasonable investment fees. If this does not happen the PRPP program will not work. At the same time it will mean billions of dollars coming from the pockets of  the financial services industry in Canada.

Here is an excellent podcast that is an interview with Katherine Strutt the head of Saskatchewan Pension Plan i is from Sheryl Smolkin. It does an excellent job of describing the benefits of the PRPP concept. The interview points out that the cost of management fees in retirement plans are around 2.5% to3%. The Saskatchewan Plan is able to manage the pool for well under 1%. Sheryl has a series of excellent interviews on her website.   

Is this small pension plan Canada’s best kept secret?

The Secound Pension Problem
The trip to Kananaskis primarily focused on one of two major problems affecting our pension system in Canada. This first problem is the low enrollment for working Canadian in pension plans. The secound problem is the serious erosion of value in  retirement plans from MER's or the expenses charged by financial services institutions to manage these funds. 

Please note: I make a portion of my personal income from consulting on these plans for Canadian businesses. The sales and marketing expenses of these plans is a large cost for the Canadian insurance companies.

The Canadian Labour congress did put out some analysis tools to show the effect of high MER's on retirement savings in Canada. Straight Talk on RRSP and mutual fund management fees

In the UK they have introduced a PRPP plan and have called it the NEST program.The only difference from the Canadian plan is that employer contributions will be mandatory in the UK. In Canada, at this time they are voluntary. 

Neil T. Craig, Senior Pension Consultant from Stevenson and Hunt pointed out to me the NEST has a up front management fees of 1.8% on new contributions into the plan. After that however, the plan is managed with only .3% or 30bps in fees. The illustration at the top of the blog includes this up front fee in the calculations of long term pension values. It comes from an article in the Daily. The charges that wipe out your hard-earned pension pot

The Wealthy Boomer had an overview of comments from some of Canada's top pension experts. The most direct comment came from Keith Ambtachtsheer who pointed out the three things needed to make the PRPP fly: 
1.) Auto-enrolment of all workers without a RPP into a PRPP (with an opt-out clause).
2.) A standard default option with a prescribed contribution rate and investment policy.
3.) Oversight of all PRPPs by an independent fiduciary body to ensure cost-effective delivery.
The government has given the insurance companies what they want. Now it is time for the insurance companies to give Canadians what they need. 

Bill Tufts 
Fair Pensions For All  

Thursday, December 16, 2010

The Pooled Registered Pension Plan

There was some very big news today from the office of Finance Minister of Canada. 
He released a report recommending that a new Pooled Registered Pension Plan to be established in Canada. It appears that the idea of enhancing the CPP is no longer viable and the PRPP is in play. 

Benefits Canada reports:
The draft claims that “moving forward with PRPPs will provide Canadians with a new low-cost accessible vehicle to meet their retirement objectives. This will be particularly beneficial to Canadians who do not have the benefit of an employer-sponsored pension plan, including the self-employed.”
A third party would take the role of managing the administrative aspects of the plan, which could be a benefit to small and medium-size employers. However, there are some tasks the employer would need to be responsible for, such as determining employer and employee contribution levels (if applicable), collecting and remitting contributions and informing the administrator of new members a termination of employment.
The investment industry reacted swiftly and favourably.
Canada's life and health insurance industry currently administers 70% of Canadian pension plans, so the in industry sees itself as a potential winner if the PRPP proposal is adopted.
What is a PRPP?

Here is the way similar plans work in other countries.   
The PRPP appears to be modeled after other successful plans around the world including the recently created NEST program in the UK and the Kiwi Saver Plan from New Zealand. In those plans, however, employer contributions are mandatory. It appears that the new PRPP plan will only be mandatory for employees. 

Employers will be given the option to make contributions into the PRPP. 

In other countries the plans are designed so that employees are enrolled on a mandatory basis. They will have to make an active selection to opt-out of the plan. In the experience of those countries that offer the opt-out very few employees actually make the move to opt out of the plan. 

It offers large pools of investments that are managed by the private sector insurance and investment companies. The investor is given the option to choose who he wants to invest it with.

Why a PRPP 

Jim Flaherty draws sharp political arrow from pension quiver
» The nose of the baby boom touched 65 last year, and many, many more will cross that threshold in the next decade. A frightening proportion have done too little to plan for their retirement, and are now faced with the realization that government programs will be nowhere near adequate to help them live the lifestyle they want.

» With interest rates stuck at record lows, even those who start pumping cash into retirement savings accounts today will be losing ground to taxes and inflation unless they take some risk with their money. For the last few decades Canadians have been getting more comfortable with risk products such as equities but the global stock market meltdown slashed RRSP account values and shredded the self confidence of many retail investors.

» Among the casualties of the stock market collapse have been large defined benefit pension plans operated by large corporations for their employees. Recent problems only accelerated a trend that had been under way for years. The “get a job after school, stay with a company for decades and retire with its pension” life arc is rare indeed, at least in the private sector.

Investment Basics
The financial services industry in Canada is very happy about the plan. They will be participating as providers for the savings plans. Although at much lower rates then they provide RRSP's and small group pension plans today. UK Nest program excites asset managers

Here is an example of the types of companies that employees will be able to deposit their savings with. Kiwi Saver Plan Providers. 

The advantages of this plan are reflective in the Saskatchewan Pension Plan. This plan is evidently being examined as a model for the new PRPP. Major changes to the Saskatchewan Pension were announced by Flaherty a few weeks ago. This was odd because pensions are provincial jurisdiction and the Saskatchewan plan had quite anemic performance in terms of member participation. The major plan changes announced for the Saskatchewan Pension were obviously made to help in announcing the PRPP. 

The Saskatchewan Pension Plan has had excellent investment performance.  This is mainly because of the lower investment fees within the plan, which should be a key part of the new PRPP. These MER's have a dramatic impact on the long term effect of pension plan performance. How do investing costs hurt returns?

I expect the only difference to the PRPP will be the ability to choose from various private sector investment management companies to manage your funds. 

The link to the plan can be seen here at Framework for Pooled Registered Pension Plans

Investment Advantage

The key advantage to this plan taken here from the Saskatchewan Pension include: 
  • Voluntary - no obligation to contribute;
  • Flexible - payment at any time during the plan year;
  • Portable - people can join and contribute to the Plan regardless of where they reside; and
  • Professionally managed - The return has averaged 8% since it started in 1986. 
  • Low investment management fees - The Saskatchewan Pension has management fees at about .75%. In the UK the plan fees are expected to be a low as .3%. 
  • Optional employer contributions - the CPP option would force employer into another payroll tax. It appears the employer can have an optional contribution in the PRPP. More dynamic thinking businesses will contribute to the PRPP as a way to retain and attract key employees. 
  • Personal Accounts - Today when a single person dies at age 66 his future CPP earnings are lost forever. With a personal account in the PRPP there will be a benefit to the estate of the deceased.
  • Greater participation - This will give employers the opportunity to provide a retirement plan for employees without the high perceived costs of setting up a pension or savings plan.
Tax Treatment 
The new TFSA has been receiving excellent reviews by investors an excellent tax efficient way to save money. So much so that at a Round Table with the Finance Minister  of Ontario concerns were cited about the long term loss of tax revenue from the TFSA accounts compared to the RRSP. 

The Finance Department has a chance to rectify this  boo-boo and create a mandatory PRPP that is treated the same way as RRSP's and recoup some of the taxes loss when the pension funds are redeemed.

Bill Tufts
Fair Pensions For All

Pension Replacement Levels

What are fair income replacement levels?

Why do we pay 70% replacement pensions for public sector employees? Many will retire with a higher standard of living  and with more disposable income than they had while working. 

Other sources of personal income are not taken into account. What is a fair replacement level?  

Public sector pensions are designed to provide 70% of final year's income. By contrast the CPP is designed to provide 25% replacement income. 

Most Canadian retirees see substantial drops in the cost of living at retirement. The most significant factor is that in Canada about 85% of Canadian over age 65 have no mortgage. On the other hand for most working Canadians about 28% of salary goes into paying a home mortgage. 

At retirement there are reductions in payroll taxes. For example, the CPP pension or EI contributions are no longer required. The CPP is a payroll tax of 4.95%. Also the pensions contributions that public sector employees make, around 10% of income are no longer required.

Many public sector employees will retire with more disposable income and a better lifestyle than they had when they were working.  Is it fair to pay public sector employees a taxpayer funded pension that provide a replacement income of 70? 

I recently covered this issue more fully in How Much is Enough?

 Bill Tufts 
Fair Pensions For All

Wednesday, December 15, 2010

Pension limits for public sector pensions

Pension limits for public sector pensions 

No information is available regarding the amounts paid to current retirees in public sector. For example how many earn more than $200,000 in pensions, how many are over $150,000 and how many are over $100,000?

Many states require this disclosure as part of the Sunshine Laws that many jurisdictions have enacted. Ontario has one for the salaries of public employees but not for pensions. This needs to be changed. 

There are thousands of public sector employees earning pensions in excess of $100,000 per year at all levels of Canadian government.  Most employees in government earning over $140,000 per year will get a pension in excess of $100,000. That is a fixed income for life never to work again.

Some jurisdictions in North America  have put limits on pensions of $100,000 per year. This would be generated from a final retiring income income of about $142,000 a year. ie. 70% of $140,000. One idea is to base to pension limit on a factor of the Canadian average wage. The average wage for working Canadians is a little over $42,000. Set the pension limit at two times this amount and say that a public sector pension limit of $84,000 is fair. 

A supplemental pension is available to big earning public sector employees. These supplementary employee retirement plans were "set up to provide pension benefits to senior employees beyond the maximum permitted registered pension plan benefits as set out in the Income Tax Act." So that once public sector employees went over the pension and earning limits set out for taxpayers they created these special pensions for themselves. 

The supplemental pension limit is around $132,000. Any pensions paid over of this limit are paid into a supplemental pension plan designed to fund the excess amounts. The limit has been raised substantially in the past few years.

While the average Canadian is earning an income of just over $42,000 for working. The PSP federal pension plan shows that the average employee retiring this year starts on a pension over $39,000 most at age 55, for never working again. 

We have to consider the opportunity cost to our society for setting adrift large numbers of public sector employees into retirements at early ages. Most public sector pensions have indexing that will see them will surpass the average working wage within just a few years.

The most popular blog here has been Tales from the other side of the aging catastrophe.
It explains and has examples of what will happen when our society has more retirees than workers.  

Bill Tufts 
Fair Pensions For All

Tuesday, December 14, 2010

Fair contributions for existing employees.

 Cartoon from the terrific editorial cartoon staff at the St John Telegraph-Journal

Currently the federal public sector contributes 8.4% into a plan that is worth about 34% of salary. The taxpayer is left picking up 25.6% of the existing plans. Changes be made to the existing plans to make them more fair?  
PSP Pension profile  Average pension paid - $24,506
PSP Pension rates
PSP Pension financials  Average new pension paid - $39,312
Average Canadian CPP pension - $6,000

Since any major changes in pension plan design for the public sector will be made for future employees, there are millions of public sector employees under the current pension regime.
As serious effort needs to evaluate what is a fair contribution by employees towards these plans.

The CD Howe estimates that currently these plans cost 34% of salary. The current contributions by employees fall far short. It is possible that the CD Howe estimate is too generous.

The head of the federal public sector pension board recently commented
As I observed in the 2010 Annual Report, the first 10 years of PSP Investments were challenging times. According to the Wall Street Journal, the first decade of the 21st century turned out to be the worst ever for US stocks based on records going back to the 1830s. Total returns for the period 2000-2009 amounted to negative 0.5%. That compared with a high of 18% in the 1950s and was even lower than the negative 0.2% return for the 1930s Depression era.
Courtesy: The Pension Pulse  PSP Investments' second Annual Public Meeting

Taxpayers holding the bag 
Holding the bag: It actually dates back to the middle of the eighteenth century in Britain. The original version was to give somebody the bag to hold, meaning to keep somebody occupied or distracted while you slipped away. Figuratively, it meant to leave somebody in the lurch, to let them stay around to take the blame for something that had gone wrong.

This is what taxpayers are left with, holding the bag. 

Bill Tufts 
Fair Pensions For All 

Monday, December 13, 2010

Essential elements of pension reform in Canada - Part I

It is recognized that retirement savings pensions in Canada are in crisis, at least for the private sector. Of course there is no crisis for public sector employee pensions, because they are backstopped by taxpayers.

Canadian Finance Ministers head to Kananaskis for meetings on December 20, 2010. The prime item on the agenda is retirement savings reform. 

Over the next week I will list the key elements that are required to make the retirement savings system more fair in Canada. Fair for public sector employees and fair for the taxpayers that fund the pension system for the Protected Class. 

Convert Public Sector Plans to Defined Contribution (DC) Pension Plans  
By the very nature of their design DC plans cannot have a shortfall. This is the type of retirement plan 80% of workers in the private sector have. A minority actually have pensions and the rest of Canadian have access to RRSP's.

Why do we give very generous pensions to the public sector for which they pay a small portion of the real cost? When they go bust or into shortfall the taxpayer picks up the tab.

This is not fair to taxpayers.

The future benefits for new employees should be changed from Defined Benefit pensions to DC pension plans. All new employees should would be enrolled into DC plans. Current DB plans should be frozen where they are today and all future pensions should be contributed into a DC pension.

There will be controversy over a move like this. Some experts suggest that you can’t eliminate pension benefits already promised? Although this has not been brought forth to higher level courts in Canada, it probably will be upheld because most members of the judiciary in Canada have one of the best pensions paid for by taxpayers. 

If this move is made expect major legal battles over the issue.  The strategy of the unions at this point will be to prolong any changes as along as possible as because a significant number of union members are set to retire in the next few years. The longer it takes to make changes the more members there will be who will get fully loaded gold-plated pensions.

Bill Tufts 
Fair Pensions For All

Tuesday, December 7, 2010

How much is enough?

As we head towards the finance meetings in Kananaskis there is much debate on the issue of pensions. Most Canadians are unaware and have minimal knowledgeable of the real issues surrounding pensions in Canada.

The photo above is from a magazine issue this year from Reason magazine. It describes what has happened in Canada and the US as our public servants have become our masters.  

How much is enough???

One major actuarial firm in Canada attempted to calculate how much Canadians need in retirement. One issue that came to light was the 70% replacement income pensions of public sector employees. 

One of my associates looked into the issue and discovered: 
The standard of living of a public sector couple (one earning $90k and the other $60k) can rise by 72% after retirement.  The example is conservative, meaning the result could have been even higher.For instance, if it is I assumed they would receive just 90% of CPP and assuming their mortgage payments (made over 25 years) represented just 20% of income whereas banks say it is safe to go up to 28% (on the mortgage payments .)
Canadians have been told to expect that 70% of working income needs to replaced in retirement. This is what the public sector and politicians have set up for themselves in pensions. 

The rest of us who pay for the pensions of the Protected Class will have to get by with much less.

This is a stunning report. It was written by one of Canada's top actuarial firms. It shows that a 70% pension for someone in the public sector actually produces a lifestyle equivalent to 170% of their former working salary.

The PDF report is called "Saving for Retirement: a Fresh Perspective" and was written by Morneau Sobeco. It shows that although taxpayers fund public sector pensions at the rate of 70% of retiring income, there are is numerous reasons that most Canadians do not need a replacement income this high. In fact, a replacement pension of 50% would replace 100% of lifestyle income for a public sector employee. 

Why do taxpayers fork over for a 70% replacement pension? 

The first reason is that for most Canadians their highest expense is the mortgage they pay on their homes. Almost 90% of seniors who own a home have no mortgage on it. Statscan Automatically this fact gives retirees a bonus on incomes up to 30% over working Canadians. 

Next on the list is the fact that Canadians stop making payments for retirement saving when they retire. The public sector pension costs 34% of annual salary. Public sector employees pay about a third of this or 10% of their income. This payment stops at retirement and so is another 10% bonus for their incomes. 

The list of deductions from a $100,00 income that Morneau gives includes the following:
      Expenses Specific to Pre-Retirement Period (Annual)
          CPP & EI deductions                           $2,000
          Retirement saving at 9% of pay*               $4,900
          Child-related expenses                              $18,000
          Employment expenses                                $4,000
          Mortgage payments                                  $20,000
                    Total deductions                                $48,900 

The question of how much replacement income is required is starting to be asked by more and more players in the pension reform game. Jack Mintz himself questioned the level of retirement income required by Canadians. He suggested that a replacement for high income earners, such as public sector employees, needs to be only 50%. 

So the question becomes...  
Why do working taxpayers have to fund so much in taxes to pay for the gold-plated retirements of the public sector? 
Especially when the public sector employees will retire into a standard of living much higher than their already inflated government incomes. 

Bill Tufts 
Fair Pensions For All