A recent editorial in The Globe and Mail advocates for a shift in the way Canadians approach their Canada Pension Plan (CPP), encouraging them to invest more in this globally respected program.
The article proposes that Canadians consider voluntarily purchasing additional CPP benefits as a way to bolster their retirement income and improve long-term financial security.
The Canada Pension Plan: A Quick Overview
The Canada Pension Plan (CPP) is designed to provide Canadians with a reliable source of income during retirement.
To fund the CPP, workers contribute approximately 6% of their earnings throughout their careers, with employers matching this contribution. Upon retirement, individuals receive a pension that is roughly 30% of their highest-earning year’s wages.
While the CPP is complex in structure, it offers a significant benefit: an inflation-adjusted life annuity that continues for as long as the retiree lives.
This design eliminates the need for retirees to manage the decumulation of their savings as they age, providing a stable and predictable income.
International Recognition of CPP’s Design
Globally, the CPP is widely praised for its effective design, management, and governance. In 2024, the UK Chancellor of the Exchequer, Rachel Reeves, visited Canada and engaged in discussions with managers of the country’s largest pension plans, including the CPP.
This recognition highlights the strength and stability of the Canadian pension system.
Delayed CPP Benefits: A Missed Opportunity
Currently, Canadians who choose to delay receiving their CPP benefits until the age of 70 can increase their monthly annuity by about 40%. For instance, instead of receiving $1,000 monthly at age 60, retirees who wait until age 70 could receive approximately $1,400 a month.
Despite strong advocacy from financial experts, a relatively low number of Canadians take advantage of this strategy.
As a solution, the proposal suggests that Canadians be allowed to voluntarily purchase additional CPP benefits, known as “income units”, starting at age 60. These income units would be activated when the individual reaches 70.
How CPP Income Units Would Work
Under this proposal, CPP income units could be offered at a fixed price. For example, a unit could cost $10, providing $1 in annual inflation-adjusted income starting at age 70.
To receive an additional $100 per month, or $1,200 per year, a retiree would need to purchase $12,000 worth of units. By increasing the investment, individuals could receive more significant benefits.
The price of these units would be adjusted periodically by CPP actuaries to ensure fairness. This strategy would be particularly beneficial for those still in the workforce who wish to purchase additional CPP benefits.
For tax purposes, these purchases would need to be made through a Tax-Free Savings Account (TFSA), ensuring that the additional income remains tax-free and does not impact other government benefits, such as Old Age Security (OAS).
Behavioral and Psychological Benefits of the Proposal
In addition to the financial mechanics, the proposal highlights several behavioral and psychological advantages. Seeing others invest in CPP units may encourage early claimants to reconsider their strategy. The thought process might be: “If others are buying into this good deal, why should I sell?”
Furthermore, the income units could act as longevity insurance, protecting retirees from the risk of outliving their savings and reducing reliance on unpredictable stock market returns.
The transparent pricing structure would also help individuals understand the present value of their CPP benefits, making it easier to assess the long-term impact of waiting until 70 to begin drawing from the plan.
For example, if a retiree learns that delaying their CPP benefits results in a monthly payment of $2,000, they can calculate the total value of their future pension by multiplying that amount by 12 (months) and the unit price ($10), revealing a pension worth $240,000.
Addressing Market Gaps in Longevity Annuities
Although this proposal may seem to contradict Adam Smith’s economic philosophy, which cautioned against government interference in private markets, the article argues that it is necessary to address a market failure.
In particular, Canadian insurance companies have largely avoided offering true longevity annuities, which could provide retirees with the financial stability they need in later life.
This proposal would likely impact investment funds rather than insurance providers, introducing market discipline into the system and helping to ensure that CPP remains financially sustainable over the long term.
Expanding Access to CPP: A Global Solution?
In addition to providing Canadians with a chance to enhance their retirement security, the article suggests that allowing Americans to purchase these income units could be a beneficial step.
By offering this option to Americans, Canada could help diversify their retirement portfolios while also generating additional revenue through a modest fee or tariff.
Key Considerations
While the proposal has the potential to enhance retirement security for many Canadians, there are potential risks to consider.
Mispricing these income units could threaten the sustainability of the CPP, but the introduction of market discipline could mitigate this risk.
| Proposed CPP Income Unit | Cost per Unit | Annual Income per Unit | Monthly Income from $12,000 Investment |
|---|---|---|---|
| Income Unit | $10 | $1 | $100 |
In conclusion, the proposal to purchase additional CPP benefits could provide a much-needed boost to retirement security for many Canadians.
It offers a simple, transparent, and flexible way to enhance pension payouts while addressing key market gaps in longevity annuities.
This proposal could be a vital step in ensuring that Canadians have the financial stability they need as they move into their retirement years.
FAQs
What are CPP income units?
CPP income units are voluntary units that Canadians can purchase starting at age 60 to increase their CPP benefits once they reach age 70.
How much would it cost to receive an additional $100 per month from CPP?
To receive an additional $100 per month, retirees would need to invest $12,000 in CPP income units.
Can Canadians buy CPP income units using their TFSA?
Yes, Canadians can purchase CPP income units through their Tax-Free Savings Account (TFSA) to ensure the income remains tax-free.