Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 5 - Evidence - April 22, 2010
OTTAWA, Thursday, April 22, 2010
The Standing Senate Committee on Banking, Trade and Commerce met this day at 10:30 a.m. to study the extent to which Canadians are saving in Tax-Free Savings Accounts and registered retirement savings plans.
Senator Michael A. Meighen (Chair) in the chair.
[English]
The Chair: I see a quorum, so we will call the meeting to order.
[Translation]
This morning, we continue our study of Canada's pension system. The pillars of Canada's pension system are Old Age Security, private and public pensions and personal savings. We will focus on fiscal incentives for personal savings.
[English]
According to our order of reference, we are studying the extent to which Canadians are saving in tax-free savings accounts, and registered retirement savings plans, RRSPs, federal measures that might be taken to increase use of these savings vehicles, as well as the fiscal cost of increased use and ways in which savings in these vehicles might be protected.
We are joined this morning by Leo Kolivakis, James Pierlot, Kevin Milligan and Richard Shillington, all of whom have comments to share with us about retirement savings and, more particularly, TFSAs, tax-free savings accounts, and RRSPs.
To begin, we are pleased to welcome Leo Kolivakis, a former senior investment analyst for the Caisse de dépôt et placement du Québec and the Public Sector Pension Investment Board, as well as the current manager of, and contributor to, the blog, Pension Pulse.
We are also pleased to welcome in the first hour of our meeting James Pierlot, an executive member of the pension and benefits section of the Ontario Bar Association, as well as an expert on pension issues. I understand Mr. Pierlot will lead off.
James Pierlot, Pension Lawyer and Consultant, as an individual: Thank you. I will start with a brief overview of what the status is in terms of TFSA savings and RRSP savings in Canada.
At the end of 2009, there was about $16 billion held in TFSAs, contributed by about 4.7 million Canadians, resulting in an average account balance after the first year of operation of the TFSA of about $3,400 per contributor. This fast rate of growth indicates that the TFSA has been quite well received by Canadians, but it cannot be expected to continue. Much of the capital contributed to TFSAs in the first year of its availability is not new savings, but transfers of existing non-sheltered savings to TFSA accounts.
To get an idea of how TFSA savings might grow in Canada, we can look to the U.K. where individual savings accounts, ISAs, with rules similar to the TFSA were introduced 10 years ago. With twice the population of Canada, savings in these ISAs amounted to a total of about 37.5 billion pounds held in 14.2 million accounts in July 2009.
The introduction of TFSAs has been a welcome development in terms of retirement savings options. It provided an overall increase in savings room for retirement, and offered a new opportunity to develop a saving strategy using RRSP and TFSA savings to reduce taxable income in retirement and clawback of income-tested benefits such as the guaranteed income supplement, GIS, and the OAS, old age security.
In general, saving for retirement in an RRSP is preferable if an individual's marginal tax rate on labour income saved is expected to be higher than the marginal tax rate on income in retirement, whereas saving in a TFSA is preferable if an individual's marginal tax rate during working life is expected to be lower than in retirement.
TFSAs can and should be an important component of retirement planning. In terms of tax effects, a TFSA is a mirror image of an RRSP. There are no deductions for contributions, but withdrawals and investment earnings are not taxed. Contributions are subject to an indexed annual limit that carries forward. This is quite punitive to older Canadians — in terms of fairness of access to TFSA savings — whose TFSA accumulation opportunity is significantly less than for younger Canadians.
If you are 25 years old and look at your contribution room over a lifetime to the age of 65, your contribution room would be about $323,000, assuming standard inflation assumptions. Based on an investment return of 6 per cent per year, you could accumulate about $1.3 million in a TFSA. However, if you were age 45, your contribution room to the age of 65 would be about $143,000, so you could accumulate about $271,000 based on the same rate of return to age 65. This suggests that, in terms of providing older Canadians, the baby boom generation, with greater opportunity for retirement savings, instead of having an annual limit on TFSA accumulations, a lifetime limit might make more sense in terms of providing equal opportunity to TFSA savings room.
At this point, the committee will be quite familiar with the three-pillar description of Canada's retirement savings system, the first pillar being unfunded income support programs such as the GIS and OAS programs; the second pillar being the partially funded C/QPP, Canada and Quebec Pension Plan, programs; and the third pillar being private savings in tax-sheltered vehicles such as pension plans and RRSPs.
For the 75 per cent of Canadians working in the private sector who do not participate in a pension plan, RRSPs and TFSAs are the only vehicles available for retirement saving. This is because, under current federal income tax rules, you cannot join a pension plan unless your employer provides one to you. Unfortunately, the data available on private retirement saving in Canada does not provide a clear picture of how much Canadians have saved for retirement and where the problems are. Nevertheless, there is substantial reason to believe that Canadians working in the private sector are not saving enough for retirement in their RRSPs.
According to Statistics Canada's 2005 survey on financial security, median retirement savings for Canadian families in which the major income earner is age 55 to 64 are quite low. For a family with an RRSP only, it is $55,000; it is $227,000 for a family with pension savings only; and $245,000 for families with a pension plan and an RRSP.
Assuming retirement at the age of 60, these savings would deliver indexed monthly pension incomes as follows: For a family with an RRSP only, $218 per month; pension plan only, $900 per month; and pension plan with RRSP, $972 per month. This suggests that there is a developing retirement savings problem.
Another way of looking at this is to look at the value of private retirement savings in Canada, which currently is roughly $1.8 trillion to $1.85 trillion. If you distribute that $1.85 trillion across the working-age population and retirees, you get an accumulation of roughly $146,000 per individual. Given that the median age of the working population is about 40 years old, this suggests the rate of accumulation, based on the total amount of retirement savings that currently exists in Canada, is not adequate.
The problem looks even worse when you consider the fact that, quite routinely, retirement savings of public sector workers are five to seven times as much as in the private sector. A pension plan member earning $70,000 at retirement will have, after 30 years of service working in the federal public sector plan, a pension accumulation worth about $850,000. For a two-income family, that is $1.7 million. These are multiples of the numbers in terms of accumulation that Statistics Canada reports for retirement-age families.
What we have here is a two-tier system. We have one in the public sector where 85 per cent of workers belong to a very good pension plan, and one in the private sector where 75 per cent of workers do not have a pension plan, cannot join one, and their accumulations are much less.
This is not to suggest that public sector workers do not earn their pensions or that they should be reduced. I do not want to make any comments on aggregate public sector compensation and whether it is fair. It is simply a question of what the accumulation opportunity is in the public sector vis-à-vis the private sector, and how we can equalize that by making the same opportunity available in the private sector.
With that, I will conclude my comments and take your questions.
The Chair: Would it be appropriate to hear from Mr. Kolivakis first?
Some Hon. Senators: Yes.
Leo Kolivakis, Independent Pension Analyst, as an individual: I am honoured to have been invited to speak to this committee and share my thoughts with you on retirement savings and how we can improve the Canadian pension system.
Let me give you a background about myself and then talk about the issue at hand. I am an independent pension analyst and publisher of the financial blog, Pension Pulse. I have previous experience working as a senior investment analyst with two of the largest public pension funds in Canada, investing in traditional and alternative assets such as hedge funds and private equity.
Before I get into specific recommendations, I would like to provide you with some context. The 2008 financial crisis exposed some serious weaknesses in the global financial system. It also exposed vulnerabilities of the real economy to financial disruptions. As credit markets seized, sending the global economy into the deepest recession in post-war history, unemployment soared, forcing governments to respond aggressively to stabilize their economies.
The unprecedented fiscal and monetary response to this crisis has stabilized the global economy but we are not out of the woods by any measure. Importantly, the fiscal response has saddled governments throughout the developed world with higher debts. Moreover, monetary authorities have flooded the financial system with liquidity.
Record low interest rates have been a boon to banks which continue to make enormous profits off their trading operations, but they have forced savers to take on more risk to rebuild their savings. Despite the rally in global equities since March 2009, record low interest rates have exacerbated pension deficits at public and private defined-benefit, DB, plans as pension liabilities exploded with the decline in real rates, outpacing the rise in asset values.
Throughout the world, underfunded public pension plans have responded by increasing contribution rates and the retirement age, cutting cost-of-living adjustments and slashing benefits. Ultimately, taxpayers are on the hook if underfunded public plans are unable to address their ever-widening pension deficits.
Private sector defined-benefit plans are becoming extinct as companies replace them with defined-contribution, DC, plans, effectively offloading the retirement risk to workers who are left fending for themselves in the new world of `casino capitalism,' dominated by large global banks, hedge funds and private equity funds.
More worrisome, underfunded public pension funds have increased their allocations to hedge funds, private equity funds, commercial real estate funds, infrastructure funds and other alternative investments in search of higher yields. Trillions of dollars flowing into these investments are sowing the seeds of the next financial crisis. Without any meaningful financial reform on the horizon, it is only a matter of time before systemic risk threatens the global economy once again, jeopardizing the retirement dreams of millions of workers and pensioners.
Given this context, it is not surprising to see that the appetite for pension reform is simply not there. However, I submit to you that the changing landscape I described above argues in favour of Canada and other nations taking bold steps to bolster their pension systems. If we do not take action, more workers and pensioners face the dire prospect of pension poverty. This committee has heard many experts representing public and private sector interests. You have scrutinized figures in great detail, so I will spare you of more figures.
Instead, I will simply offer you some recommendations which I will break down into short term and long term. In the short term, we need to change RRIF, registered retirement income fund, rules and scrap the automatic withdrawals at the age of 71. Moreover, self-employed workers who are currently working past the age of 71 should be allowed to contribute back into their RRIFs immediately. The government will lose some tax revenue, but this simple change will allow those self-employed workers to replenish some of their lost savings.
The introduction of TFSAs is a step in the right direction, but it will have a negligible effect for the great majority of Canadians already struggling to max out their RRSP contributions, if they contribute at all. High-income earners with a lot more discretionary income will easily invest in TFSAs, but low- and middle-income households will find it tough to save. Even if they manage to save, they will have to invest wisely or be great speculators to make these vehicles worthwhile.
The only real long-term solution to addressing the pension crisis comes from creating a mandatory universal pension plan, UPP, which addresses the retirement needs of all working Canadians. The current defined-benefit plans which cover teachers, police officers, firefighters and public sector workers should be extended.
The Chair: Could you please speak a little slower for the translators and reporters who are working very hard and efficiently? It is a tough race to keep up.
Mr. Kolivakis: I am sorry.
Besides the need for a mandatory universal pension plan, the Canadian pension landscape needs an immediate, crucial fix that will largely offset the effect of cyclical poor investment performance such as the one we saw in 2008.
The Income Tax Act limit of 10 per cent of liabilities applying to defined-benefit pension plan surpluses was increased to 25 per cent. This should allow the build up of continuation reserves for private defined-benefit plans, which are federally regulated by OSFI, the office of the superintendent of financial institutions, and provide a buffer during bad years. However, at the federal level, OSFI allows plan sponsors to take contribution holidays as soon as the surplus exceeds 5 per cent of liabilities. This will induce further pension deficits that would otherwise be mostly avoided if OSFI rules were changed to 25 per cent in harmony with the Income Tax Act rules. Perhaps it is time we consider scrapping private pension plans altogether, replacing them with public defined-benefit plans.
Introducing a mandatory universal pension plan in an era of fiscal restraint seems like a daunting undertaking. However, if done correctly, the benefits to corporations, individuals and eventually government revenues and the economy will far outweigh the costs. All stakeholders can play a role in shaping this new pension system, but everyone will need to concede something in order to make this work. Importantly, when it comes to pensions, there is no free lunch.
Finally, I cannot overemphasize the need to focus on pension governance. Instead of concentrating power in the hands of one or two funds, we should set up new defined-benefit plans spread throughout the country, which incorporate world-leading pension governance standards.
Even the best governance standards do not guarantee that defined-benefit plans will never suffer pension deficits. We need to pool our collective resources to figure out a way to create a viable, long-term pension system that addresses the retirement needs of all our citizens. All Canadians deserve the right to retire in dignity and security.
The Chair: Thank you both for your presentations. Perhaps I could start by just throwing out to you for comment a suggestion that was made to us by a previous witness: Perhaps we should give consideration to the establishment of a new national RRSP pension program, so as to deal with everything from cost to availability. Does anyone have comments on that?
Mr. Pierlot: I think there are good arguments to be made in favour of establishing what people have described as a supplementary CPP. This would be layering defined-contribution or RSP-style accounts on top of the CPP. I understand that is what you mean. Is that correct?
The Chair: Yes.
Mr. Pierlot: I am agnostic as to whether that is the right solution. The question is really who can provide vehicles better: The private or public sector? There are examples worldwide of both.
We do not know the answer yet of who can do it better because we have not given the private sector a chance to try. The tax and regulatory structure for pension saving in Canada is so complex that very few people can understand it. We have two solitudes. Essentially, an employer can sponsor a defined-benefit plan on the one hand or a defined- contribution plan on the other. There is nothing in between.
Not only that, but there is no possibility for various individuals. I understand now that 80 per cent of workers work for small businesses or are self-employed. Those organizations have no resources, or have insufficient resources, to set up pension plans. The solution could be a supplementary Canada Pension Plan, or changing the tax rules which are fundamentally what control how pension plans can be established, to allow multiemployer plans that those people could join on a subscription basis. That is not possible under the current regulatory structure.
The set-up of a supplementary CPP could take quite a bit of time and has significant expenses, as experience in the United Kingdom is showing. Therefore, I would like to see some attempt to change the tax rules to facilitate large multiemployer pension plans that would operate in the private sector on a competitive basis with each other. In that way, small businesses and self-employed people, where the pension saving problem truly is, could join on a subscription basis. If that does not work, then we could go to a supplementary Canada Pension Plan arrangement.
Mr. Kolivakis: I take a differing view from Mr. Pierlot on this. Private sector solutions to pensions have been an abysmal failure. Everything from mutual funds to defined-benefit contribution plans have failed. If you look closely at it, you will understand that they cannot compete with the large public sector defined-benefit packages in delivering cost-effective plans. That is because large defined-benefit plans are able to pool enormous sums of money, and they carry much more weight in terms of lowering the external management fees. They also internalize many of these assets. We need to focus on creating either a supplemental Canada Pension Plan, or to rethink outside the box to create new defined-benefit plans across the country. Perhaps we could adopt the Swedish model that includes several large defined-benefit plans and governance standards to oversee these large DB plans. I am highly critical of the governance of large public sector defined-benefit plans. We have a great deal of improvement to make in terms of transparency and accountability on these large DB plans. For example, the Healthcare of Ontario Pension Plan is a good example of a private, multiemployer defined-benefit plan that is doing a great job.
I would like to take that model and use it not only for private sector, but also for providing access to a universal pension plan for every Canadian. The reason is simple. Can you imagine if corporations did not have to worry about their defined-benefit pension plans, and if Canadians who are working for one corporation or one Crown corporation or one municipality, could simply shift from one area to another and not worry about pension portability issues? Currently, there is so much waste in the system. In one of my recent blogs, I said that Canada took the lead in creating universal health care. Canada should take the lead again and create universal pension plans. There will always be a place for the private sector, but the dominant allocation of pensions in my view must be the public sector. The private sector knows this. The banks, mutual fund companies and insurance companies are fighting tooth and nail to not have public defined-benefit pension plans and a universal pension plan because they know they cannot compete. There are great examples in Canada of phenomenal public sector defined-benefit plans. There are also good examples of multiemployer private plans. We should rethink the way in which we deliver pensions to Canadians because the existing system is not working for the majority of Canadians.
Mr. Pierlot: Mr. Kolivakis and I differ quite a bit but less than he might have suggested. In 2008, I wrote a paper which suggested exactly what he has recommended. The public sector plans, such as the Healthcare of Ontario Pension Plan, the Ontario Municipal Employees Retirement System and the Ontario Teachers' Pension Plan are very well run arrangements that operate at approximately 30 to 35 basis points in operating costs. That public sector model, which works so well in the public sector, is what I envisage being deployed in the private sector. The issue is that Mr. Kolivakis' and my recommendation is not possible under the current federal income tax rules.
The Chair: Either solution is not possible.
Mr. Pierlot: That is correct.
Senator Ringuette: There is unanimous consent that the fees to manage RRSPs are too high.
Senator Greene: There is not unanimous consent around this table, perhaps.
Senator Ringuette: Certainly, there is unanimous consent among the experts who came before the committee. I do not consider myself an expert on RRSPs, but I accept the expertise of our witnesses in respect of those fees.
We have been told that we need to look at lifetime limits to RRSPs. What is your opinion on that?
Mr. Pierlot: My opinion is very much in favour of lifetime limits because I was the first one to propose them in a C.D. Howe Institute paper published in 2008. Under the current federal tax system, there is a significant difference in availability of tax deferral room to people who save in defined-contribution plans and RRSPs as opposed to defined- benefit pension plans. This is because the method for equalizing savings room between the two vehicles greatly understates the value of participating in a good defined-benefit pension plan. In the paper that I published, I looked at the numbers in great detail with the assistance of an actuary, who performed a number of calculations that are disclosed in the paper. They effectively demonstrate that, throughout a career, the percentage of income that you can defer in a defined-benefit pension plan is much greater than the percentage of income you can defer in an RRSP or a DC pension plan. In some cases, it is twice as much.
With a lifetime limit, if you choose a hard cap of $2 million that you can accumulate in your life, it would be indexed to inflation, irrespective of the kind of plan to which you contribute. Everyone would have the same access to tax- deferred savings room. That would make sufficient room available so that any middle class person could accumulate an adequate pension.
As well, it is a little-known fact that some people have RRSPs worth tens of millions of dollars. We have a system that limits contributions to RRSPs when, in reality, the objective is to limit access to tax-deferred retirement saving. The only way to do that in a way that is equal for all Canadians is to have a lifetime accumulation limit.
Senator Ringuette: You have crunched a lot of numbers. Do you have a proposed number for a lifetime limit to suggest that the committee consider?
Mr. Pierlot: In my 2008 paper published with the C.D. Howe Institute, I chose a number in the $1.5-million range. An amount between $1 million and $2 million is appropriate. If you look at the accumulations of retirement income in a public sector pension plan, for anyone earning $40,000 to $130,000 per year, the accumulations per individual go up to about $1.4 million to $1.5 million. Under the current tax rules, if you participate in the most generous defined- benefit pension plan that the rules allow, you can accumulate a pension that has a cash value of roughly $2 million. That is why I picked $1.5 million. The existing defined-benefit plan rules currently allow that, whereas the defined- contribution plan rules do not allow that.
Mr. Kolivakis: I do not have much expertise on the exact figures of lifetime RRSP limits but I will provide some figures proposed by John Crocker, president and chief executive officer of the Healthcare of Ontario Pension Plan, in a recent article for The Toronto Star. He said that a defined-benefit plan is there to replace about 67 per cent of your income when you retire. He said that, for a private individual to have access to $50,000 per year in retirement income, he would have to save $1 million. If he saves half of that, $500,000, it would be $25,000 a year in retirement income.
The thing about it in terms of the investment horizon, which is something we have to think about here, say you retire in a year like 2008 and took a substantial hit in your defined-contribution plan or your RRSP, if you were lucky — my father who is a physician showed me an article, the title of which is "What Happened to my Retirement?" Basically, it was showing how older doctors are coming back. They are self-employed, they got hit during the crisis, and to retire, they had to come back and work longer because they did not have enough retirement income. Doctors are notoriously bad at investment decisions.
It comes back to this issue. Kevin Gaudet, president of the Canadian Taxpayers Federation, recently wrote an article saying there is a two-tier pension system, one for the public sector and one for the private sector. His solution was defined-contribution plans, which is, as I say on my blog, not a solution at all.
With respect to the DC plan, again, think about the investment horizon. If you retire in a year when the financial crisis hits, you can be in for a very nasty surprise. You will get hit in your retirement income. When we say investment assumptions of 6 per cent, I think you would be very lucky to get 6 per cent going forward. All you have to do is look at the low bond deals right now and the mess that we are in throughout the world in terms of debts exploding everywhere. I am a little bit worried. Then we are expecting individuals to be great investors, such as accumulating large RRSP accounts. It will just not happen. That is a fantasy. This is what worries me. We have these expectations that individuals can take care of their own retirement savings, which is just false. In reality, it does not work.
Senator Ringuette: The expertise is just not there.
Mr. Kolivakis: No. You are right, by the way; the management expense ratios in Canada are obscenely high. They are among the highest in the world. It is scandalous.
Senator Ringuette: Yes, they are. I totally agree with you.
I am trying to imagine how your suggestion of having a universal pension plan for all Canadians would work. With respect to the process of merging employee-employer pensions, the process of CPP that we currently have, and the public pension funds, to be fair, how could all of that be merged into one big pot?
Mr. Kolivakis: Good question. I have an answer to that. I am in contact quite frequently with the former chief actuary of Canada, Bernard Dussault, as well as Susan Eng, who is vice-president of advocacy of CARP. There is enough brainpower in Canada, both on the actuarial side and on the investment side, to sit down and decide what we do need to do. What are realistic investment assumptions? As I say in my paper, everyone must concede something.
The public sector unions must concede something. You cannot retire at the age of 65 any longer. Everyone is moving to the age of 67. We are living longer; lifespans are longer. I think it was David Dodge, he was here yesterday, who came out about two months ago and said we need to have an adult discussion on entitlements. If we sit down and everyone wants a gold-plated pension and we do not figure out a way to fund this fairly, then it will never work. There will always be interests who will be arguing against this.
However, if we sit down and say this is not working any longer — by the way, I have not even talked about municipal pension plans. There is a mess out there that I do not discuss. We need to amalgamate all these pension plans and figure out a way to deliver cost-effective pensions to as many Canadians as possible.
I submit to you, if you ask self-employed Canadians, the Canadian Federation of Independent Business, what their biggest concern is going forward, it is how they will have enough money to retire. They want access to a defined-benefit plan, but they cannot afford it and it is not available to them. We have to figure out a way to make this work. I am not sure if the political will is there right now, but I am challenging politicians in private emails by encouraging them to get this done. Canada has the resources to do this. Do we have the political will? I am not sure.
[Translation]
Senator Massicotte: We hear lots of information and it is important to understand it. The Department of Finance says that only those who have incomes of over $125,000 per year on average can expect a replacement income of less than 70 per cent of their average income at the time of their retirement.
On average, all Canadians will receive at least 50 per cent more than the replacement income. Even among those whose income is higher than $125,000 per year, 70 per cent have a high level of unused RRSP contribution room, they do not contribute up to the limit.
When looking at the demographic data, we see that the problem exists within the private sector. Public sector employees have a relatively generous retirement system compared to the private sector. Only a third of private sector employees are covered by a pension plan, therefore, obviously, two-thirds are not.
We can draw the conclusion that for the private sector, the major problem is that people do not save enough. I am not talking about those who earn less than $50,000, but the high-end employees who do not save enough.
Given the situation, there are two issues. Should we create a national or governmental system that compels these people to save more? This is a philosophical type of discussion. Should we set a savings rate for these people? Should the taxpayer subsidize them through the RRSP program or through another program, especially since we know that this problem does not affect the least fortunate in our society?
The third discussion has to do with governance, professionalism and mostly the cost of managing RRSP funds which is much too high. It is said that a national program or a collective management will solve all these problems. Everyone is asking for a higher RRSP limit and for the government to be more generous. But this money must come from somewhere, it will come from the taxpayer of course.
Why subsidize people who already earn a high income? I am not convinced that a subsidized collective program would be effective in helping those who earn a higher income to save.
[English]
Mr. Pierlot: If I understand you correctly, are you asking why we should create a system that would assist people at higher levels of income?
Senator Massicotte: I can buy the argument that we should create a structure to get people to save. The problem I am having, playing the devil's advocate here, is why should we fool around with RRSPs, which is indirectly a subsidized savings account, when the people we are trying to help are those with upper incomes? That is where the deficiency is. Why should the average Canadian subsidize those people to save more? I am talking about tax-assisted here.
I can appreciate the idea of a national savings program. There is a good argument there. People are not saving enough in the private sector. Maybe we need to nudge them along, using an expression I borrowed from someone else. Should they be subsidized? That is what an RRSP is.
Mr. Pierlot: I am not sure I agree that an RRSP is a subsidy. An RRSP is tax deferral. Effectively, the government is a partner in saving in an RRSP because the tax foregone today will be collected tomorrow with interest, assuming, of course, that the individual invests appropriately.
This actually points to a real problem with performance in RRSPs. When the individual loses money, the government does too because the money that comes out of that RRSP down the road is reduced. That means the taxes from it are reduced.
I think the government has a strong interest in doing something to ensure that this money is managed better.
I think it is not really a subsidy because, conceptually, an RRSP is an income-deferral vehicle. The tax that is not collected today is collected tomorrow; in real terms, in other words, it is adjusted for interest. You cannot characterize it as a subsidy. I think it is saving for the government and the individual.
There are actually long-term macroeconomic reasons why you would want to encourage higher- or middle-income earners to save more in these vehicles because, down the road, as the baby boomers move into retirement, income taxes from the working population will be reduced. What will replace that? If you have more money in RRSPs and pension plans, and if you look at the tax receipts from those plans today, they are very significant; you will actually have some tax revenue to replace what you are losing as people leave the workforce. That is with an RRSP.
I agree more with your comments regarding the TFSA. The TFSA is the mirror image of an RRSP: Once money goes in there, there is no tax period, anymore. I think its effects are a little bit different from an RRSP because any saving in those plans is ultimately completely sheltered from tax.
The TFSA is a great vehicle. I think it is good for lower-income people to save because they do not lose their entitlements to the GIS, et cetera. However, I think that, because it is an absolute loss of tax revenue, it also argues in favour of a lifetime limit to limit the advantage of that vehicle to very high-income people.
Mr. Kolivakis: I agree with Mr. Pierlot. I do not view RRSPs as a subsidy at all. In fact, one of the comments he made was absolutely right: RRSPs are tax deferral. At the end, the government will tax you as you withdraw money from your RRSP. However, if you do not invest properly or if you get hit hard because of a financial crisis, you get hit, the government gets hit, everybody gets hit.
There is an alignment of interests here. I think we are arguing the same point. There is an alignment from the government standpoint and the individual standpoint to ensure these investments are doing well over your lifespan. Right now, again, I do not see that happening.
I would take issue with the idea that most people are doing well in their RRSPs. If we really scrutinized the performance of RRSPs, I believe they have done very poorly over the last 20 years. I would take issue with this argument.
If you instil a universal pension plan, RRSPs and tax-free savings accounts kind of become irrelevant. Let us face it, tax-free savings accounts are a joke for high-income earners. Anybody can put in $5,000 a year. There is a bit of what I call a wealth problem here because, again, rich people do not have any problems putting away $5,000 a year. Low- income people do have problems saving $5,000 a year; they have problems putting away money for their RRSPs. There is a large portion of the population right now that is having problems, for a lot of reasons. Canada is also going through a bubble in real estate.
I am worried about what will happen in Canada in the longer term. Everything is going so well and everyone is talking about how the Canadian economy has escaped relatively unscathed. I have a feeling we will hit a rough patch in the next five years. If that happens, it will just exacerbate the retirement problem.
I would prefer if we do not use words like "we are subsidizing a certain portion of the population" because then it becomes a class-warfare type of issue. I would want us to think about what is best for the collective of Canadians, despite whatever your income is.
Senator Massicotte: I have a little bit of difficulty saying there is no subsidy with RRSPs because, obviously, the government is foregoing revenue and their costs of bonds is 4 per cent or 5 per cent. That is a value.
Let me go on to the issue of structuring and managing a collective. We always say public sector or private sector, and I think we are getting confused with the use of the words. Let us say we buy into the thought that there should be a larger pool of capital, which can be better managed, and hopefully at a lower cost. Once you accept that concept, you make out that big difference, saying it cannot be the private sector. Are teachers a part of the private sector? Is that your comment?
Who should manage it? Why not do what I think the U.K. or some country — Australia, perhaps — said? It is collective. Make the proposal call to the public sector. Here are the criteria. The management costs cannot be this much. We need your history of performance and governance principles. Why not let the private sector manage those funds?
You seem to be stuck on saying it cannot be.
Mr. Kolivakis: I will tell you why. The Australian superannuation plans got hit very hard. They were amongst the worst performers. It just has not worked for them. We have to be honest here. Canada has amongst the best public defined-benefit plans in the world. We also have a great large, private multiemployer called the Healthcare of Ontario Pension Plan, HOOPP. We have great defined-benefit plans in Canada on the private and public side.
We argue for public. These multiemployer private plans can work, as in the case of HOOPP. However, I believe we have to push the envelope even further because, if you create a right structure and again encapsulate the collectivism of Canadians, you will make the whole system a lot more efficient. You will not have to worry about what happens if Nortel goes bankrupt; what happens to the pensioners and the disabled, which is a huge scandal. I can tell you about large corporations right now.
Senator Massicotte: Be specific. Why is it different? People managing the public pension funds in the federal service used to manage private pension plans. It is not an issue of competence. What is the difference? What makes such a difference?
Mr. Kolivakis: It is an issue of costs. They are able to deliver the service at a much lower cost.
Senator Massicotte: They can do it cheaper than the big private public plans, than CN or CP?
Mr. Kolivakis: CN is a good example of a well-run private plan but, yes, they can compete against these private plans on a cost basis.
Senator Massicotte: I agree they can compete, but you are saying go public regardless. I am trying to understand why.
Mr. Kolivakis: It is the same reason we have public health care. You still have a private sector in health care, but why do we have private health care? It is a public good. There is a reason why we have public health care.
The same reasons we have public health care should be the reasons for creating a universal public pension plan for Canadians. We will be able to deliver the service at a much lower cost. It will not be perfect, but I think we should really consider having a dominant public plan to deliver these services. I do not know if Mr. Pierlot disagrees with me.
Mr. Pierlot: I would like to have a brief follow-up. I think your questions are very well taken. I think that we have to ask ourselves why it is that DC plan members and other members are not getting results as good as the public sector pension plans. It comes down to an alignment of interests of agents and principals, and governance of the plans. The people who are managing the public sector plans have a mandate and, indeed, an incentive structure in their pay to maximize returns and operate the plans in the members' benefits.
That is also true of private sector employer pension plans. Any time a private sector pension plan gets to a size of $1 billion or more under management, its operating costs are about 0.3 per cent to 0.35 per cent, very comparable to a private sector plan, and its investment performance is comparable to a public sector plan.
Based on what I have seen about the rates of return, the management of the plans and the governance, it is not about whether it is private or public sector. It is about how it is governed and what the incentive structure is for the people who are managing the plan. Those rules apply whether you are in the public or private sector.
Senator St. Germain: Thank you, gentlemen, for appearing today. Mr. Kolivakis, you mentioned something about the banks. How much erosion has taken place in the wealth of our elderly who have traditionally relied on interest rates received on GICs, guaranteed investment certificates, and what have you? I have always invested only in that type of investment. Now we are down to about 0.25 per cent or 1 per cent, and the Bank of Canada's policy has been to keep this interest rate low. There must have been tremendous erosion on the financial base of our elderly because they will have to spend their principal.
Mr. Kolivakis: I completely agree.
Senator St. Germain: You make reference to the enormous profits off their trading operations.
Mr. Kolivakis: Right.
Senator St. Germain: In your perspective, where is the balance there? My view is that the ridiculous management salaries and bonuses that the banks are indulging in are unreasonable.
Listen, I believe that we have a good banking system, but I think there is a balance, and I am wondering whether we are out of whack at the present time based on the policies of the Bank of Canada and just the attitude of the banks in general.
I will speak from personal experience. In my businesses, which I operate very little now since I have been a senator, I always had prime-plus-a-half-per-cent interest. Then, all of a sudden, out of nowhere, about nine months ago they came back and said they would be charging me more. I was not using any money. They said it would not bother me, then. What does it do to people who are still actively involved in business? They just arbitrarily bumped the rate up, with no excuse.
I am concerned about the erosion because of the problems that have erupted as a result, whether it is income trusts or what have you, where there was a lot of money lost by many of our elderly people.
Mr. Kolivakis: I have a feeling that the last financial crisis hit the elderly extremely hard, and that is why I talk about pension poverty at older ages. We have a crisis, especially among the elderly. What is happening currently is that, while interest rates are low, the Bank of Canada and the Federal Reserve are basically following the old model that the way to fix the economy is to fix banking profits.
These bankers, mostly in the U.S., took a bunch of bad loans off their books, and in order to recapitalize the financial system, lowered the interest rates so the banks borrowed at next to nothing, and then they invested all around the world on emerging markets and corporate bonds, and they are making a killing in trading operations.
Senator Ringuette: With our money.
Mr. Kolivakis: It is not just U.S. banks. Canadian banks are also making a killing. If you look at the annual reports of all the major Canadian and U.S. banks in the last quarter, read them, and you will see what percentage of the revenues are coming from their capital market operations as opposed to traditional lending.
If you go to the Bank of Canada's website and look at business credit delivered by the commercial banks, it is still negative. I think it is minus 14 per cent. They are not lending to small- and medium-sized enterprises because there is no incentive to do so. Instead, they want to trade in capital markets and make a killing, and they will continue to do so as long as interest rates are low. However, the low interest rates are forcing elderly people to take risks that they probably should not be taking if they want to keep the same — excuse me?
Senator Ringuette: As long as we supply them with liquidity.
Mr. Kolivakis: Exactly. Banks are in the business of making money, but when you see them making so much money off trading and not lending to small- and medium-sized enterprises, using the financial crisis to hike borrowing costs across the board, even to good lenders, then you start seeing that they are using any excuse to make even more money. I worry about that.
I agree with you that the elderly have been hit very hard. We do not have official statistics, but I believe if you talk to people with Statistics Canada when the next census comes out, you will see they were hit hard.
Mr. Pierlot: I am not a banking expert, so I will keep my comments brief.
I think the low interest rates in Canada are really a reflection of a global phenomenon. We have low interest rates all over the world. I am aware of banks increasing the rates at which they lend money. I speculate that that is, in part, probably to recover losses and to prevent having taken on too much risk in the past. That is a bit of a speculation.
I think what causes seniors' economic difficulty is the fact that the net worth of people going into retirement is quite low. The median net worth of about 13.3 million family units in Canada was $148,000 in 2005, or $75,000 per earner. According to a recent paper by Jack Mintz where he reported on retirement income adequacy, the net worth of a typical family, not a high-income family, a middle-income family going into retirement, is about $300,000. That includes pension savings, real estate, everything.
I think that, certainly, it is the case that low interest rates and lower returns on invested assets are contributing to seniors not having enough to live on, but I think that the problem is probably more due to inadequate savings rates during working life.
Mr. Kolivakis: Could I just follow up very quickly?
The Chair: Certainly.
Mr. Kolivakis: What happens if we get into another financial crisis and we have a Japanese-style deflationary period in Canada and the U.S. where low interest rates of zero per cent are present for 10 or 20 years? That is what I am worried about when it comes to income disparities for the elderly because they will get hit very hard.
Senator St. Germain: Absolutely. If you look at someone who has saved $400,000 or $500,000 and traditionally receives 6-per-cent return on their investment, they are getting $24,000 a year. Now they are down to nothing. Now they get into the asset base and basically spend their way into poverty. We are doing this, that and the other thing.
I agree; I believe the TFSA is a great idea, but if you look at people who are making $50,000 to $60,000 a year and are raising kids, they will not be able to take advantage of that. They just do not have the disposable income to invest. Thank you for allowing me the time.
Senator Massicotte: If we had a Japanese scenario in 20 years, what is your answer to that?
Mr. Kolivakis: If such a scenario were to develop, government revenues will get hit.
Senator Massicotte: What would you do?
The Chair: What is your answer to prevent it?
Mr. Kolivakis: To prevent it? I think your answer points to what Ben Bernanke and pretty much every central banker is doing out there; they are not only printing more money but using non-market operations such as quantitative easing to try to avoid deflation at all costs. What worries me about this is what I call everything-but-the-kitchen-sink approach, in that there is a tremendous amount of leverage being built up in bond markets now throughout the world, and what we are seeing going on in Greece can pretty much happen in the rest of Europe.
Senator Massicotte: What would you do differently? You say you agree with what they are doing.
Mr. Kolivakis: I am not here to comment on the policies of the Bank of Canada or other central bankers. With respect to what they are doing, they have pretty much decided to try to recapitalize the banking system and to keep rates as low as possible for as long as possible. By doing that, it is like pulling an elastic band. When the bond vigilantes start smelling blood, they will pretty much short your sovereign debt risk and they will come at you very hard, no matter whether you are in Greece, Canada or the U.S. They do not care any longer. These speculators are in the business of making money.
You will see market rates going up very quickly, and that is another fear of mine. If that happens, if interest rates start going up very quickly and aggressively, we will have another wave.
Senator Massicotte: Will pension funds and all their investments go arm's length?
Mr. Kolivakis: Pension funds will get hit because they are long stocks, long real estate and long private assets. They will get hit hard if there is another wave.
Senator Massicotte: Unless they have cash as you predicted.
Mr. Kolivakis: That cannot happen because of investment policy. They will be hit hard unless they are prepared for this.
The Chair: On that happy note, I thank our witnesses very much indeed. They have obviously sparked the interest of committee members.
Allow me to introduce our next panel of witnesses: Kevin Milligan and Richard Shillington. Mr. Milligan is joining us by videoconference as a professor at the University of British Columbia. He has published several papers on retirement, including Tax-Preferred Savings Accounts and Marginal Tax Rates: Evidence on RRSP Participation, The Retirement Incentive Effects of Canada's Income Security Programs, The evolution of elderly poverty in Canada, and Lifecycle Asset Accumulation and Allocation in Canada.
We are also joined in Ottawa by Richard Shillington, a statistician at Informetrica Limited. He has published several articles on retirement, including The Dark Side of Targeting: Retirement Saving for Low-Income Canadians; Hit the Least Vulnerable in Cutting `MTRS'; and his electronic book, Retirement Planning for the Rest of Us.
This promises to be an interesting session. Mr. Milligan, please proceed.
[Translation]
Kevin Milligan, Assistant Professor of Economics, University of British Columbia, as an individual: Thank you for having invited me to speak to the committee.
I will briefly address three essential points. After that, I will be pleased to answer your questions.
[English]
I will speak to RRSPs first. I want to draw attention to the breadth of participation in RRSPs as many have concerns that not everyone participates. Non-participants often have very sensible reasons for their decision. Older Canadians in the bottom quartile of the income distribution already receive public pension benefits that are sufficient to sustain their pre-retirement lifestyles without RRSPs. Moreover, the effective tax rate on RRSP withdrawals can be extremely high, making RRSPs an unwise choice for low-income seniors. In addition, those Canadians who have solid employer-sponsored pension plans might not need additional savings to sustain their lifestyles. For these reasons, we should not expect to see all Canadians participating equally in RRSPs.
I have a couple of comments on tax-free savings accounts. The TFSA is an interesting innovation for our tax system and offers the potential for many more Canadians to save in a tax-advantaged form. However, one concern with the TFSA is its long-running impact on the tax system as the TFSA system matures. In the first year, only $5,000 of contribution room was available to each Canadian. However, as the system matures over the next generation, the impact will grow to be much more substantial. For example, in 20 years, a married couple will have $200,000 of TFSA contribution room between them.
This means that for all but the very wealthiest Canadians, there will be no taxation of capital income at all. This might be desirable for the economy, but we really need to consider the long-run implications of the TFSA on the tax system. There will be a substantial impact on tax revenue and on the progressivity of the tax system.
For my third point, I would like to propose a new tax credit to encourage saving. Our current system of tax-assisted savings suffers from two flaws: First, there are subtle non-economic psychic barriers to participation. Many Canadians are intimidated by the complexity of the tax system, by filling in complicated forms and by talking to a banker about investments. These kinds of barriers can have a powerful impact on participation.
Second, many of the tax benefits are distant in the future and not salient to someone considering opening a new account now. Not everyone likes to build spread sheets and make extensive plans that incorporate future tax benefits. Both of these flaws lead to one implication: The biggest potential improvement in participation in RRSPs and TFSAs comes from making it easier to open an account.
Small changes to existing rules, such as contribution limits or subsidization rates, might have some impact on the sophisticated investors who like building spread sheets. However, these people are surely already in the system and contributing. To mobilize new participants, a different approach is necessary. I propose a new Canada savings credit. This credit will be paid upon opening a new account. It will be paid either into an RRSP or a TFSA. It will be similar in concept to the Canada learning bond that is now a part of the registered education savings plan program.
There are three advantages to this kind of Canada savings credit. First, it aligns the timing of the tax credit with the incurrence of the psychic costs of opening an account. Second, it can be targeted on income so that it targets Canadians and income groups that might need a push to get into the system and open an account. Third, it is much less fiscally expensive to give a one-time benefit than to give an ongoing annual subsidy to savings.
Once someone has an account, they will receive positive reinforcement from their quarterly account statements from the bank. Once in the system, their comfort with the system will grow. The goal of the Canada savings credit is to get new contributors into the system.
I look forward to comments by Mr. Shillington. I am happy to answer any questions.
The Chair: Many Canadians are intimidated by the complexity of the tax system. I venture to say all Canadians, with the possible exception of tax lawyers.
Mr. Shillington, please proceed.
Richard Shillington, Potential Value of Tax-Free Savings Accounts, Informetrica Limited: Thank you for this opportunity to speak to you about tax-free savings accounts. I have spent a career publishing research about the effectiveness of old age security, the guaranteed income supplement and the Canada Pension Plan; about financial literacy; about how these programs work in the economic circumstances of seniors; and on financial literacy. I welcome this opportunity.
My involvement with this issue started with my research that was published by the C.D. Howe Institute, demonstrating that RRSPs are a terrible investment for Canadians who, later in life, receive the guaranteed income supplement. To understand why, you need to understand how the GIS works.
About 38 per cent of seniors receive the GIS. The majority of seniors who retire without an employer pension plan will be eligible for the GIS. GIS benefits are reduced by 50 cents for every dollar of income. Income that affects the GIS includes RRSP withdrawals, investment income and some forms of earnings. In addition to reducing GIS benefits, these sources of income are also subject to income tax. Thus, the effective tax rate on income for those on GIS is least 50 per cent, often 75 per cent and sometimes 100 per cent, and sometimes more. This is well known to people who are experts in this area.
To illustrate, imagine that a senior on GIS removes $1,000 from their RRSP. Their GIS cheque during the next tax year will be reduced by $500. On top of that, they might pay income tax of $200 on that $1,000 RRSP withdrawal. If they live in social housing, their rent will go up by $300. The $1,000 is now gone. In addition, it is possible, depending on their income and province of residence, that their deductible for prescription drugs will increase; their cost of home care will increase; their cost of meals on wheels will increase; and their cost of nursing home fees for them or their spouse will increase. A GIS recipient living in social housing where their rent is 30 per cent of income is almost certainly at a 100 per cent tax rate.
RRSPs for GIS recipients are like a mutual fund with a 50 per cent backend load, to put it in financial language but still taxable on the full amount before the load. TFSAs could potentially benefit two populations who could not be more different. They reside at the two extremes of the income distribution. For Canadians who recognize that they will be low income at retirement, TFSAs will be a way to save for retirement while avoiding the GIS clawback. TFSAs were not my preferred solution to the problem created by the GIS clawback, but TFSAs are the option that we have.
For Canadians with extraordinary wealth, TFSAs are a way of passing assets to their children over a lifetime that could accumulate to extraordinary pools of funds of $1 million, and yet leave them still eligible for the GIS at retirement because the TFSA is exempt for GIS eligibility.
To my mind, there are two problems with the TFSAs as proposed. Lower-income Canadians could use them, but they would need financial advice to do that. I do not believe they are getting that advice. I did the experiment with my bank. I walked in to my bank and asked the person at the cubicle which people would be better off with a TFSA versus an RRSP. The person had no idea. In the last 30 years, we have seen no advertising to say that RRSPs were a terrible investment for 38 per cent of the population. In the last two years, I have seen no advertising that claims to help people make the choice between RRSPs and TFSAs. I do not believe it is happening.
For modest- and lower- income Canadians, most without an employer pension, TFSAs are a preferred option to RRSPs. However, we are still getting cookie-cutter homogenous financial advice. For higher-income Canadians, RRSPs and TFSAs both have their advantages and disadvantages depending on the circumstances. For lower-income Canadians, TFSAs provide an option and RRSPs are toxic. I said in one article published by the C.D. Howe Institute that people were being defrauded, and some people challenged me. I said that they were promised benefits by saving in an RRSP that were not real, and that the people providing that advice knew that. I still think it is the right term. The first problem with TFSAs is the lack of financial advice for the retail investor. The second problem, which has been alluded to by the previous witnesses, is that we are creating a financial tax-free loophole that, in the long run, could accumulate funds to make the system lose credibility when someone is able to collect the GIS while sitting on $1 million in assets. There should be some form of lifetime limit. For the people that I worried about in Retirement Planning for the Rest of Us, a lifetime limit in TFSAs of $100,000 would satisfy most.
That ends my prepared talk but, based on the conversation I heard over the last hour, I want to make one other quick comment, if I may, to help you to understand the circumstances for the roughly one-half of Canadians who are retiring without a pension plan. The average income of such people is $15,000, and 80 per cent of them have an income below $20,000. Are they poor? Are they not poor? It depends critically on how you measure poverty. I published a fact book on poverty in 1989, which gives you an idea of how long I have been thinking about how we measure poverty. The poverty rate for seniors varies dramatically based on the income threshold, but 80 per cent of them have an income below $20,000. Why is that the case? Old age security pays roughly $6,000. The Canada Pension Plan pays a maximum of $10,000 with an average of $7,000 for men and $5,000 for women. Those two plans add up to $13,000 to $14,000. The GIS maximum benefit pay is about $6,000, with an average benefit of $3,000. That brings the total to about $15,000. In fact, the more CPP you receive, the less GIS you will receive. If you have saved in an RRSP, your GIS benefit is reduced. It will be hard to have an income of more than $18,000 to $19,000 as long as you are in receipt of the GIS.
The question was asked about the circumstances of seniors and how good they are. One simple observation is that, to qualify for the GIS, a single person needs an income of less than $15,000, excluding OAS, and 38 per cent of seniors meet that criteria. I think we can do better.
The Chair: Thank you, Mr. Shillington.
Senator Harb: Mr. Milligan, recently British Columbia introduced a kind of pension system. Without getting into too much detail, perhaps you could give us your views of it and how it works and tell us whether it could be applied across the country?
Mr. Milligan: I will answer briefly. There has been discussion of a provincially sponsored pension plan in B.C. and in Alberta, referred to as the ABC plan. People talk about it as a model for how we might change our pension system. The important question to ask is: What is the problem you are trying to solve with this policy change?
When I see some of these proposals, I worry that we are trying to kill a fly with a sledgehammer in the sense that there are areas where the public sector has a big role to play and can improve on what the private sector can do. There are other things that the private sector does a pretty good job on.
What I worry about when I see some of these proposals is that we are putting in a big innovation that is replacing not only what the public sector can do well, but also encroaching on what the private sector is already doing well.
Senator Harb: Doctors cannot contribute to a pension plan, and statistics show that thousands of them are leaving the country. They are going to the U.S. and elsewhere partially because they were hit so hard. A witness earlier said it is because they do not receive proper advice, but they cannot do so because there are income tax implications. The Income Tax Act does not allow them to do so because they are considered to be self-employed and, as such, they would need an amendment to the act in order for them to set up a plan of any sort. That is why I was intrigued by what the Province of British Columbia was trying to do. I think with a system such as the one you are talking about, despite some of the challenges in it, it might solve that problem.
Mr. Milligan: I do not mean to be too pessimistic about the B.C. or the Alberta plan. I do not have the details of them in front of me and have not studied them in great detail, but as I have reviewed accounts of those plans, the question I always bring forward is to be clear about what problem they are trying to solve. The problem you have highlighted is one that is certainly worth addressing.
Senator Harb: Mr. Shillington, you alluded to the fact that you would not advise people with low incomes to contribute to RRSPs. Correctly so, statistics show that very few people with low incomes contribute to an RRSP. In fact, less than 10 per cent of the population with less than $30,000 a year in income contribute to RRSPs, so your wish has come true.
One of the witnesses who appeared before us was a bit of a contrarian to what you are talking about in terms of the seniors' population. He said that seniors are the best savers. In fact, seniors who rely on the public system for their pensions are far better off than many other people in our society as a result of what you mentioned, that they receive close to about $15,000 a year in income, they have social housing, medication, transportation and so on. That was his point.
A previous witness from this morning said there is a crisis in the senior population, as many are living below the poverty line. With two witnesses before you talking about this issue, could you briefly comment on it as well?
Mr. Shillington: I did get my wish in that we have a tax-free savings account, so there are ways for people who are destined to be low income at retirement to save effectively, although they will only do so if there is someone prepared to give them that advice, and I do not see that happening.
I am quite sure I know who said that seniors are better off than other parts of the population, and for some populations he is absolutely right. For a single person in Ontario, welfare is roughly $6,000 a year. If you are on welfare because of a disability, I believe it becomes $9,000. When they turn 65, it will become $13,000 or $14,000. Yes, when you go from age 64 to 65, if you have no other means of support, your income doubles. That gentleman was absolutely right.
I am not sure what the remedy is. I hope the remedy is not to push the $13,000 or $14,000 down to $6,000. Certainly, the poverty rate for seniors will vary dramatically depending on how you measure it. With any measure, the poverty rate for seniors has dropped dramatically over the last 25 or 30 years, regardless of measure, because of a growth in the Canada Pension Plan and the maturation of the program, the growth in female participation rates, and the growth of their pension income. The female participation rate growth is primarily in the public sector, which has the best pension plan. The CPP income is increasing and the pension plan is increasing, but I suspect all of those things that led to the improved circumstances run their course. We are not likely to see an increased female participation rate, I gather. That does not bode well for the future in terms of any improvement.
Senator Harb: Would a guaranteed annual income be the answer?
Mr. Shillington: One could not answer that question in two or three minutes. Everyone that I know of who has an opinion on a guaranteed annual income is in favour of it. I am in favour of a guaranteed annual income that would provide a poverty-level income with a reasonable tax rate. Many other people are in favour of a guaranteed annual income of $6,000 and a 100 per cent tax rate. The term is a very large envelope.
Senator Hervieux-Payette: Mr. Shillington, I was a bit surprised by your comments about retirement savings plans in that you did not seem to be overly enthusiastic about them. I have a brief outline of the BMO report to the government. In it, they say that dramatic warning bells are still ringing, as if we were near a cliff and people will be falling off it. I feel we took precautions some years ago and that we are right to intervene now, but with regard to preventive measures as opposed to panic situations. Do you agree? Are we in a panic situation when it comes to pension funds today? Are we on the verge of a big crisis?
Mr. Shillington: I am a mathematician by training and have worked in this town for my whole career, so I am aware that the way you see data can depend a lot on where you sit.
If your major interest was in replacement rates, such as who was at risk of having a dramatic drop in the standard of living, then we can ignore all those people I talked about with incomes below $15,000 or $20,000. I still do not think that is a great deal of money, and I think most of us would not want our single mother living on that income in a major city. Even absolute levels of income are a concern.
Turning our focus to relative income, I do not think there is much dispute that the real problem with replacement rates is, in that population of private sector people who are middle to upper-middle income, most have had a career. If they did not have a pension plan, that probably means they did not have a drug plan or a dental plan. I speak from personal experience. The experience is that the median amount of money sitting in an RRSP for people without a pension plan when they retire is around $50,000. That is not a lot of money. Therefore, the people who will suffer the greatest drop in income are — most people know this — middle to higher-middle income people in the private sector. They are experiencing dramatic drops in the standard of living. I think that is not a social good.
Senator Hervieux-Payette: The BMO report says that one of the proposals is to go ahead with removing the age of 71 for the conversion of the RRSP to a RRIF. Do you feel that conversion is something that makes a big difference in the overall picture?
Mr. Shillington: For the population we are talking about and the issues we are discussing, I think that is irrelevant. The people who are affected by that decision are spending their winters in Florida or France.
Mr. Milligan: I want to echo what Mr. Shillington was saying. In terms of a crisis, we can see the pattern of retirement incomes that we have had so far.
I think it would be a stretch to say there is a crisis in retirement incomes. As Mr. Shillington pointed out, there is a set of people, middle- to higher-income groups, who do not have an employer-sponsored pension plan. I know you have had some discussion in the committee already about whether the appropriate replacement rate out of pre- retirement income is 70 per cent, 60 per cent or 50 per cent. A lot of the perception of whether there is a problem depends on what number you think is the appropriate replacement rate.
In terms of a crisis here, it is as Mr. Shillington said. When you are talking about a 50 per cent replacement rate for a high-income person versus a 70 per cent replacement rate, you are talking about whether they spend their winters in Florida or France. In terms of a social policy issue we should be spending our time worrying a lot about, that is not high on my list.
Senator Hervieux-Payette: I hope we are not qualified as saying that. The conclusion of the report is that the government should contemplate having a mandatory gradual increase in contributions to the CPP to double the current maximum pension benefits to about $19,000.
Does that go along with your own thinking of the low $15,000 that you would not like your mother to live on?
Mr. Shillington: I think the only remedy out of the situation we are facing is an increased role for some type of a mandatory expanded role of something like CPP, to begin with. We could have opt-out provisions for people we are not worried about, but there should be a significant nudge towards participating in an expanded CPP.
We must recognize that this is a remedy for the population that is now age 30 or 40. It is not a remedy for the population that is age 50 to 65. It is for the long run.
I want to make one comment about the replacement rate, whether 70 per cent or 50 per cent. We know the Canada Pension Plan is designed to replace 25 per cent. Remember that 25 per cent is not the same as the 70 per cent. They are not comparable. They are not similar numbers at all.
The Canada Pension Plan replaces 25 per cent of your lifetime earnings. The 70 per cent is usually applied to your pre-retirement income, or the past five years. Twenty-five per cent of your lifetime earnings is like 10 per cent of your best five years, and the 25 per cent is capped at 25 per cent of $40,000. For somebody with an income of $100,000, the CPP is not giving them 25 per cent or even 10 per cent. It will give them about 5 per cent, right?
If we think 70 per cent is more than is needed for high-income people, then I welcome proposals that, once the DB pension plan is providing more than 50 per cent for high-income participants, the tax favouring ends. I do not think that will happen.
Very high-income people with DB pension plans still get 70 per cent even though I gather the consensus is they do not need it, and I still think we subsidize it through the tax system.
Mr. Milligan: I rest on that.
Senator Hervieux-Payette: One of the past experiences of the last couple of years is that many people who set aside money in their RRSPs saw it evaporated, sometimes at the speed of light. We read that we will repeat the same mistake in the future. Some people came and proposed to have a supplementary government pension plan put in place, saying that we should not rely just on the private sector because the interests of the pensioners and the interests of those who are administrating may not be the same, no matter what the fee is all about.
How can we have the best of both worlds, which is minimizing the risk but, at the same time, having a regime whereby we do not tell the private sector to not be involved; what mechanism should we put in place so we do not have that happen?
Coming from Quebec, I know that Caisse de dépôt has lost $40 billion. It is not true to say that, if government is doing it, we are exempt from some downfall. At the same time, I think the Canada Pension Plan is a government organization but it deals with private sector investment experts.
I have some problems when people are in conflicts of interest. How could we avoid these conflicts of interest — that people would invest in things that would benefit them first and eventually to the pensioner? This is where the big flaw of the system has occurred in the past.
Maybe you both have some guidelines that you could give us. How could we have the best of both worlds?
Mr. Shillington: The Canada Pension Plan and the QPP are now participating in some part in the equity market, so you will get 30 per cent to 40 per cent drops every few years. It is kind of guaranteed. I am old enough to remember when the Canada Pension Plan was limiting itself to long provincial bonds.
Senator Hervieux-Payette: Yes, Ontario, Quebec and so on.
Mr. Shillington: That decision has been made. If we are to participate in the equity market, we have to recognize that you will have negative years. If I remember correctly, 25 per cent to 30 per cent of years in the stock market will be negative. That is one thing.
In terms of conflicts of interest, I am so disappointed that we still have a situation where the average Canadian who wants to know whether they should purchase an RRSP and what kind of RRSP and whether to put money in a tax-free savings account, has no place to go except to somebody who sells these things. If you are high income, you can pay the $250 an hour for somebody who has your interests at heart, and who can shave your marginal tax rates by 2 per cent, 3 per cent or 5 per cent. However, the difference between those situations is a 50 per cent or 75 per cent tax rate for low- income people.
It is kind of like deciding whether you should replace your car with a bicycle and going to a car dealership to ask their advice. There is no place for people to go.
When I published seven or eight years ago the piece about RRSPs being toxic — defrauding low-income people — we had at that time 30 years of the homogeneous advertising that everyone should maximize their RRSP, even though experts in this town absolutely knew that was wrong for a significant proportion — 38 per cent — of the population. This is not a small fringe group that the advice was wrong for. The advertising really has not changed. Everybody should maximize their savings.
I would love to have a financial institution — not a bank but an organization — that would have a website where someone could go in and say, here are my circumstances. What would be the effect of my tax rate at retirement if I do homeownership, cash out my RRSPs and pay down my mortgage, and what about TFSAs versus something else?
I have a very trial version of this that I created on my website for which I do not have a client. I do not have three clients. I have no clients for this. If a federal agency took it upon itself, you could do something very helpful. I cannot tell you how many emails I get. I get emails from regular Canadians because of the media attention on some of my work. I get about two or three a week seeking financial advice: "Can you point me to somebody who can give me advice?"
I know they are in social housing or they are a GIS recipient. What financial adviser understands how their income source affects eligibility for nursing home subsidies? Nobody. "Nobody" is extreme, but there are very, very few. Nobody has taken it upon themselves to provide advice to the 80 per cent of Canadians who cannot afford $200-per- hour financial advice.
Mr. Milligan: On the question of management fees and advice people may be getting from the financial system, I am sympathetic to a lot of what Mr. Shillington has said. The interesting thing to me is that there are low-cost investment options available out there. I participate in some of them in my own financial life, but people do not seem to always choose them, perhaps because they are getting bad advice. It is interesting that it is not that the options are not available, but rather that people are not using them.
There are a couple of approaches one could take to try to fix this. One approach is more education, using websites and other resources. I am not sure how much better that will be than what we have. People do not seem to want to learn some of this stuff.
An approach that I think might be interesting is the Canada savings credit that I mentioned earlier. What if there were an amount payable only upon the opening of a low-fee account. In that way, a bank trying to sell you a new tax- free savings account that includes a cheque from the government will have that transaction realized only if they use a low-fee account. That would be quite simple to do and would align the interests of the bank with the interests of the investor.
Senator Hervieux-Payette: Thank you for your advice. Perhaps you could send us a note on how that works so we provide the correct and understandable information to people. A recent news release on financial literacy said that 70 per cent of people cannot understand what they read. In my experience, I have met many professionals with university degrees who do not understand the system. If people with higher education do not understand, how will people with high school education make a choice that is in their best interests? Mr. Shillington, perhaps you have some advice for us in that respect.
Mr. Shillington: You could have a non-market neutral agency whose job is to provide websites and other ways of informing people.
A senior couple contacted me. They had done pension splitting. They moved some income from one to the other and saved a few hundred dollars on income taxes. One of the couple lives in a nursing home where the fee is subsidized. The subsidy is based on the individual's income, not on the family income, at 100 per cent. They moved $5,000 from one to the other to save a few hundred dollars of income tax, and their nursing home fee subsequently went up by $5,000. How do we expect people to anticipate that?
The lower you are in income, the more you receive in benefits from home care, nursing homes and prescription drug plans. No agency has the responsibility to ensure that the combined effect of all those programs makes sense. For people who are very well off, we know that a lot of effort goes into making sure that the tax treatment of dividend income makes sense between corporations and personal. We have things like a dividend tax credit, et cetera, to ensure that the combined effect of provincial and federal programs makes sense. No one does this for the low-income end of the spectrum. There are silos and levels of government each saying it will target and reduce benefits only to those who are most needy, thereby targeting the programs by bringing in clawbacks, but the combined effect creates a situation.
One part is to give people reasonable, easy-to-understand financial advice that they can trust is not coming from a marketer. The second part is to simplify the system so that people can make intelligent, reasonable decisions and be treated fairly.
The Chair: For the record and so that I understand, if I may, I heard you mention earlier about the effect of RRSP withdrawals. We heard from previous witnesses who pointed out and suggested that it was quite proper to take it into income and be taxed. However, it should not be taken into consideration in terms of the GIS and other such programs. I gather that is your view as well.
Mr. Shillington: Yes. If you receive a tax deduction when you contribute to the RRSP, then you should be taxed at the other end. I agree totally. However, taking money out of an RRSP will affect your GIS benefit but taking money out of a non-registered bank account will not affect your GIS benefit. As well, converting your house into an annuity will not affect your GIS benefit. Only withdrawals from your RRSP will affect your GIS benefit. That is beyond me.
The Chair: I understand.
Senator St. Germain: Do you agree that the age limit of withdrawing RRSPs should be at the discretion of the holder of the RRSP and not at a pre-set specific age? Possibly, that would help some of those people.
Mr. Milligan: It is appropriate to have some age limit. The reason is that we allow the tax sheltering for the purposes of saving for retirement. In the absence of an age limit, people might accumulate a large amount of money and then be able to roll it over through their estate and avoid taxation on the principal. I would be worried about allowing a totally open age limit. Whether the right age limit is 69, 70 or 71 years, I will leave to the actuaries.
Mr. Shillington: I have no interest in the issue because it does not affect the bottom half of the population.
Senator Ringuette: Mr. Shillington, you indicated that people have no place to go for proper advice. I could not help but think that we are funding, to the tune of many millions of dollars a year, an agency called the Financial Consumer Agency of Canada, which should have that responsibility. It should at least acknowledge the dire need for unbiased financial advice for people on pensions, RRSPs, et cetera. We have a place for that but they are not taking up the task.
Last summer, I visited all the seniors' complexes in my area. On July 1, 2009, senior citizens of Canada received an increase in the old age security benefit, but because of that increase of $350 per year, their GIS benefit was cut by $500 per year. The poorest of our seniors, beginning last July 1, received a net loss in income because of an average increase in the old age security benefit of $200. In every seniors' complex in my area that I visited, I was asked what happened because they would have less to live on thanks to that increase. What you described is the reality for at least 80 per cent of our retired senior citizens, who are low income and receiving the GIS.
Correct me if I am wrong on this in respect of the TFSA. The last time I looked at the statistics on low- and high- income Canadians, high-income Canadians with an income of $100,000 and more totalled about 2 per cent of the Canadian population, and the low-income — below the poverty line — Canadians totalled about 15 per cent.
As I say, maybe those numbers are slightly wrong now because it has been a few years since I looked at them. Your comment is that the tax-free savings account benefits either the very low income or the very high income. This is an expensive program, due to the unremitted taxes, that does not respond to 83 per cent of the population.
Mr. Shillington: I think you misunderstood me. When I said tax-free savings account, "low-income" was probably too strong a term. The tax-free savings account is a very useful mechanism to get out of the GIS clawback problem, which will help low- and middle- income people who do not have a pension plan, and that is useful there. The impediment is financial literacy and an agency to help inform people, so I think it is a useful thing.
There has been enough evidence about the fact that, for the extraordinarily high-income people who have maxed out their RRSPs, and are now taking money that is not sheltered and moving it into a tax-free savings account, some of that might be reasonable, but there should be some limit on that.
I think the tax-free savings account is a reasonable thing. It was not my first proposed remedy for the GIS problem, but it is what we got, and it can be useful. However, to be useful, we need agencies that will give average people, who cannot afford to spend thousands of dollars for financial advice, reasonable information.
Mr. Milligan: To pick up briefly on the question of financial education, I will continue to beat on the same drum of the idea of a Canada savings credit. You could also use this as a tool to give incentives to improve financial education. Making websites, handing out pamphlets is not working right now. I am not sure why we think doing a better job of the same thing would improve the outcomes an awful lot.
What if you were only able to receive the Canada savings credit to be deposited in a new account if the financial institution delivered to you a curriculum that was designed by some kind of neutral financial education body, just as in the schooling system sometimes in some provinces you get a subsidy so long as you deliver the publicly designed curriculum. In this way, you get your $500 at your local bank through the Canada savings credit, but you only get that credit if the bank delivers to you the publicly designed, neutral education curriculum. In this way, you get someone into the system; they get a low-fee account potentially. They get a little bit of neutral financial advice. I think that would be a big improvement over the situation we have right now.
Senator Moore: Thank you, witnesses, for being here. Mr. Shillington, we had a comment from a witness earlier this morning, Mr. Kolivakis, who was quoting John Crocker of the Healthcare of Ontario Pension Plan, and I think he said that, in order to achieve a 67 per cent replacement rate, one would have to contribute $1 million over his or her working life, and I am thinking here in terms of the tax-free savings account. You said that they create a tax-free loophole and that you would recommend a lifetime limit of $100,000.
I am trying to reconcile the apparent need for people to save for retirement and Mr. Crocker who was quoted as saying $1 million. Whether it is one million or half a million, you are saying $100,000. What is the basis of that figure? In view of those comments of Mr. Crocker, do you think it should be changed or should there be a limit at all?
Mr. Shillington: If you consider that the tax assistance for savings is a subsidy, then there should be some limit to the subsidy. If you go back to the 1983 green book on pension policy, they recommended a cap not on the contributions to RRSPs but the size of an RRSP.
Senator Moore: So a lifetime cap?
Mr. Shillington: On the size, not the contributions. Once your RRSP got to a point where you could have a pension of one-and-a-half times average wages, the public subsidy would end. You can supplement it after that, but you are on your own dime. You will not be able to lever off the tax deferral.
I do think this should be a general principle. I am not sure what the mechanism should be that says once you have enough saved to provide a pension income of some figure tied to average wages, you no longer get the tax assistance. If people do not think it is a preference, then they should not object to losing the tax assistance, correct?
Senator Moore: How did you come up with the $100,000 figure? That seems to be low in view of all the evidence we heard from everybody here.
Mr. Shillington: My bias is to worry about retirement planning for the rest of us, people who do not have employer pension plans backed up by the biggest pockets of the country, the Government of Canada.
The average amount of money in an RRSP for people retiring now without an employer pension plan is $50,000, and they lose half of it to the GIS. If I could find a mechanism where they could save $100,000 — it is $100,000 of contributions, so hopefully it will grow to more than $100,000 by the time they retire — that will satisfy most of them, because people who are working in regular jobs without benefits with three children who might go to university are not going to, no matter what you do, save millions of dollars.
Senator Moore: They cannot afford to.
Mr. Shillington: Not if they are going to fix their children's teeth and put one or two of them through university, and so for that half of the population, the 38 per cent that are in GIS, you could make the limit $100,000 or $500,000. It will not affect them. They will not save $1 million. Even if you make the limit $2 million, which some people would like to have because they know people who find the current 20-some-odd-thousand-dollars-per-person-per-year confining, it will not affect that population. I have been quite clear in my bias. My concern is a system that would allow people who are below average incomes to save effectively for their retirement without having it all clawed back.
Mr. Milligan: To build on what Mr. Shillington was saying, I appreciate his concern for the rest of the people who do not have employer-sponsored plans, but thinking about everyone in general, and even those who do, even the high- income guys, it is not clear to me at all what the point of lifetime limits is for the following reason: We already have a carry-forward mechanism that allows you to carry forward unused contributions when you are young to be used when you are older. The vast majority of households when they are younger have a lot of other responsibilities, as Mr. Shillington was saying, of setting up a house, paying for their children and all of the other things that means they do not often use a lot of the contribution room when they are young. When they hit 50 and it is time to start beefing up the pension, they have a large amount of accumulated room.
The only point in having a lifetime limit would be to allow you to access that room when you are younger, because when you are older you will be able to access your unused room from when you were young. The only point of having a lifetime limit would be to allow you to access it when you are young. The point is when people are young they are not in a position to save.
I am really curious about this emphasis on lifetime limits when we have a carry-forward mechanism. If I could speculate a bit, I wonder if this is just a way for people to try to sneak in an increase in the overall limits. If that is what they want to do, that is fine. Let us advocate for a bigger limit, but let us do it in the system we have, which is the annual limit with carry-forwards, rather than trying to sneak it through the backdoor of lifetime limits. I see the lifetime limits as something that is just a policy that would carry no water.
Senator Ringuette: I have one supplementary for Professor Milligan. I thought that the RRSP accumulation was only for a period of maybe five years back from the fiscal year you invested. You cannot accumulate the carry-forward for 10 or 20 years and at the end of 20 years sell your home and put it all in an RRSP.
Mr. Milligan: That is correct, senator. Initially when the carry-forward mechanism was put in place in the early 1990s, it was only going to be a seven-year carry-forward.
However, that was removed in the mid-1990s such that carry-forward is now indefinite. Therefore, with room that you accumulate when you are 20, you can do exactly as the senator suggests, and roll whatever money you like in there when you are 60. Initially that was the plan, but it was changed in the mid-1990s.
Senator Ringuette: Mr. Shillington, you indicated a report done in 1983. Which report was that, so we can try to acquire it?
Mr. Shillington: Your researchers will be absolutely familiar with it and Professor Milligan might know what it is. It was a green paper, a task force on pension policy. I believe it was 1983 or within one year of that.
The Chair: Do you have a better memory, Professor Milligan, than the rest of us?
Mr. Milligan: No, I am afraid I do not recall the exact publication.
The Chair: We will find it.
Mr. Shillington: If your research staff cannot find it, have them call me. I have a copy on my shelf.
The Chair: All right. Thank you very much for that offer, we appreciate it. Thank you both for your very interesting and helpful testimony this morning.
Mr. Milligan: Thank you very much.
The Chair: Not at all.
Mr. Shillington: Thank you.
The Chair: Special thanks to you, Professor Milligan, for getting up so early.
Mr. Milligan: It was my pleasure.
The Chair: Colleagues, this meeting is terminated.
(The committee adjourned.)