A version of this commentary appeared in the Vancouver Sun, the Huffington Post and the Winnipeg Free Press
We can learn that retiring with any real level of financial security is expensive. Employers in Australia must contribute a minimum of 9 percent of an employee’s gross earnings into a privately managed fund and these contributions will rise to 12 percent by 2019-20. It seems strange that those proposing a move to the Australian model were the same players who opposed a recent Canada Pension Plan (CPP) reform proposal that would have cost employers 1.55% of pay (matched by employee contributions).
If Canadian employers will not accept a 1.55% rise in contributions how will they ever accept 12 percent contributions?
The Australian contributions go into individual accounts that are privately managed. There is a wide variety of choices here and these funds compete heavily (e.g., advertise a lot) for the worker’s money. These accounts are very similar in nature to Canada’s RRSP system. Again, if you can’t get Canadian employers to set up Group RRSPs for their workers how will you get the Australian system to work here?
The only way to make it work is to make the system mandatory, as it is in Australia. So, no advantage here over the CPP which, of course, is mandatory.
Because the Australian monies go into individual accounts, we are told that that gives the individual worker full flexibility in how to invest his or her funds. Sounds attractive. But change the word flexibility to responsibility. Canadian workers would now be fully responsible for investing their funds. You would not have the CPPIB doing the investing for you.
Most Canadian workers realize that they are not equipped for this task. So, they will turn to fund managers to do the investing for them. Now, that comes at a cost — a very high cost.
Canadian fund managers charge anywhere from 1.5 to 3 percentage points (management expense ratio) to actively manage your money. These management expense fees are killers in a low return economy as we now have. Every additional 1 percent fee over a 40-year period reduces final assets by about 20 percent. Stated another way, a 3 percent fee per annum will cut in half your retirement replacement rate (your standard of living) versus an account with no fees.
In this matter, Australia is no shining example. Despite the mandatory “Superannuation” system there, management fees still range from 1.5% to 1.75%. Canada’s CPP operates with an expense ratio of less than 1 percent.
There is also no evidence that these fees for active management reap the fund holder any higher returns. Passive accounts do just as well on average (and after the impact of the fees is taken into account, passive investing does much better on average).
Then, we come to retirement. When you retire in Canada, you let the CPP administration know that you want your cheques started. And that’s what happens. You start to get monthly pension cheques. Not only that, but your retirement benefit is indexed to inflation.
Now, in Australia, you get a lump sum pay-out (hardly any Aussies annuitize their lump sum). Once again, you have to manage your retirement on your own. Now, even if you knew exactly when you were going to die, this would be difficult, but when you have no idea of your personal life expectancy, this is a problem beyond the capabilities of the average Canadian.
So, the Australian system would cost employers about twice as much as the CPP (9 percent rising to 12 percent versus 4.95 percent). Both systems have mandatory employer contributions. But, the Australian system leaves all of the risk such as investment risk, timing risk, inflation risk, longevity risk on the shoulders of the individual worker, whereas the CPP spreads these risks across the shoulders of all Canadians.
So, maybe there is something to learn from the Australian model. The lesson is that we can do it better here.
Robert Brown is an expert advisor with EvidenceNetwork.ca and a Fellow with the Canadian Institute of Actuaries. He was Professor of Actuarial Science at the University of Waterloo for 39 years and a past president of the Canadian Institute of Actuaries.
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