Pension

A pension is a lifetime payment by a government or employer in consideration of past service after individuals have retired from employment because of age or disability; after death this payment may be continued, usually at a reduced level, to the individual's spouse or other survivors. The Canadian pension system has 3 tiers: elderly benefits (public), social insurance (public) and employer-sponsored pension plans and individual retirement savings plans and associated tax advantages (private). The pension system has 2 basic goals - to ensure elderly persons a basic income (the anti-poverty objective) and to maintain a reasonable relationship between an individual's income before and during retirement (the income-replacement objective).

The first tier of Canada's pension system includes the federal Old Age Security program for low-income and middle-income seniors, Guaranteed Income Supplement for low-income seniors and Spouse's Allowance for low-income widowed and married persons age 60-64 (see OLD-AGE PENSION). Five provinces and the 2 territories provide income supplements for their elderly poor. The income tax system provides a non-refundable tax credit for low-income and middle-income elderly taxpayers and a non-refundable pension income credit for all taxpayers with private pension income.

The second tier is made up by the CANADA PENSION PLAN (CPP) and parallel QUÉBEC PENSION PLAN (QPP), which are earnings-based social insurance programs covering virtually the entire labour force. The third tier is constituted by employer-sponsored private pension plans financed by employers and employees and individual retirement savings plans (Registered Retirement Savings Plans or RRSPs) paid for by individuals. The income tax system provides tax breaks for contributions to employer pension plans and RRSPs.

Public plans are schemes for intergenerational transfers, providing pensions to the aged and retired which are financed by taxes (in the case of elderly benefits) and contributions (the CPP and QPP) paid largely by the working and non-aged population. Contributions to private pension plans and RRSPs are invested in the market; contributors "own" their contributions and any element of intergenerational transfer is incidental. Public pension plans cover all or most of the population, whereas membership in private employer-sponsored pension plans and RRSPs is concentrated among Canadians with above-average incomes.

Canada's pension system has been the subject of considerable debate and change over the past two decades. Critics argue that the system fails to achieve its basic objectives, leaving many single seniors (most of them women) with incomes below the poverty line and many lower- and middle-income Canadians with insufficient pensions to maintain their standard of living in retirement. At the same time, the rapid AGING of Canada's population, along with a marked slowdown in economic growth and an unstable labour market, have imposed serious cost pressures on the pension system. Both public and private pensions have undergone major reforms since the mid-1980s.

Public Pensions

The first national social-security system for old-age pensions was established by German Chancellor Otto von Bismarck in 1889, although Canada was probably more influenced by the British legislation of 1908 which introduced a non-contributory, means-tested old-age pension at age 70. By 1925, most European states had enacted similar schemes. In 1935 the American Social Security Act created a pay-as-you-go system in which current contributions paid for current pensions with only a small fund to cover fluctuations in the ratio of contributions to pensions.

Under Canada's first public pensions legislation, the Old Age Pension Act (1927), the federal government reimbursed provinces for 50% of the cost of means-tested public pensions for persons aged 70 or older. In 1931 the federal share was increased to 75%, but the plan became national only in 1937 when all provinces adopted compatible legislation (see SOCIAL SECURITY). The level of benefits and other provisions was adjusted periodically until 1951 when the Act was replaced by the Old Age Security Act, which paid $40 a month ($259 in inflation-adjusted 1997 dollars) to everyone aged 70 or over (later lowered to 65), regardless of income. In the first quarter of 1997, Old Age Security (OAS) paid $400.71 a month, though benefits are reduced by income taxes and are no longer paid to upper-income seniors (over $85 000).

With the legislation (1965) of the Canada Pension Plan (CPP) and Quebec Pension Plan (QPP), 91% of the labour force (all but those earning only a few thousand dollars a year) was covered by compulsory earnings-based public plans. The CPP and QPP are pay-as-you-go plans financed by contributions (ie, payroll taxes) on employers, employees and the self-employed. Retirement pensions are calculated as one-quarter of average lifetime earnings up to the average wage, to a maximum of $736.81 a month in 1997. In addition to retirement pensions, the CPP and QPP provide disability, survivor, orphan and death benefits. All benefits are fully indexed to the cost of living on an annual basis.

The Guaranteed Income Supplement (GIS), also legislated in 1965, was intended to provide (in combination with Old Age Security) a basic income guarantee for the aged. The GIS is an income-tested program which provides (in the first quarter of 1997) a maximum of $476.20 a month for single seniors and seniors married to non-seniors and $310.18 for seniors married to pensioners; the maximum benefit is reduced by $1 for every $2 of non-OAS income. The Spouse's Allowance, created in 1975, is an income-tested program for low-income widowed persons and spouses aged 60 to 64, and pays a maximum monthly benefit in the first quarter of 1997 of $710.89 for spouses and $784.92 for widowed persons, mainly women. OAS, GIS and the Spouse's Allowance benefits are fully indexed to the cost of living on a quarterly basis.

Public pension programs cover large groups of the population, in contrast to private employer-sponsored pension plans and RRSPs. In January 1997, OAS went to 3.5 million seniors, GIS to 1.4 million elderly and the Spouse's Allowance to 104 000 persons. The CPP paid out retirement pensions and other benefits to 3.6 million Canadians and the QPP an estimated 1.1 million recipients, for a total of 4.7 million. At last count (1993) 1.4 million taxpayers reported income from employer pension plans.

The 1996 federal Budget announced a new income-tested Seniors Benefit that will replace OAS, GIS and the age and pension income tax credits in 2001. The Seniors Benefit will combine a GIS-style component (with the same steep 50% reduction rate as GIS) and an OAS-like component (with a $25 921 family income level for maximum benefits and a 20% reduction rate). The Seniors Benefit will pay $120 more than the current maximum OAS/GIS for both singles and couples, providing an income guarantee of $11 420 for single seniors and $18 440 for elderly couples in 2001.

The Canada Pension Plan and Québec Pension Plan have been the subject of controversy because the contribution rate will have to rise substantially in future to pay for the increasing costs of pensions due to the aging population. Critics argue that the younger generation will have to pay substantially more than its parents and grandparents to sustain the CPP and QPP. There are (unfounded) concerns that the plan "is going broke" and many younger Canadians are convinced that the CPP "will not be there for them" when they retire.

To resolve the crisis of confidence in the CPP, the federal and provincial governments (which have joint responsibility for the plan) have agreed to move from pay-as-you-go funding to partial funding. By accelerating the present schedule of increasing contributions levied on employees, the self-employed and employers, a larger CPP fund will be accumulated equal to about five years worth of benefits (up from the current two years). This larger fund will be invested more broadly than at present, in a diversified portfolio of securities, to achieve a higher rate of return and thus help keep down future contribution rates.

Under the pay-as-you-go system, the CPP contribution rate would have continued to rise gradually each year, from its 1997 rate of 5.85% of earnings between $3500 and $35 800 (shared equally between employees and employers) to a forecast 14.2% by 2030 when the baby boomers reach old age. Under partial funding, the contribution rate will increase more quickly to move from 6% in 1997 to reach 9.9% by 2003 (compared to 7.35% in 2003 under the present system), but thereafter will remain at this "steady state" level with no further increases. In addition, governments decided to freeze the year's basic exemption (the $3400 earnings level below which employees and employers do not pay CPP contributions), which will over time have the effect of increasing the amount of contributions that will be collected and extending pensions coverage to more part-time workers.

The federal and provincial governments decided not to make major cuts in CPP benefits or to increase the age of eligibility for benefits. Instead, some relatively modest reductions will be introduced. Pensions will be calculated on the average of maximum pensionable earnings in the last 5 years, instead of 3 years. The administration of disability pensions will be further tightened; applicants must have worked and made contributions in 4 of the last 6 years (instead of the current rule of 2 of the last 3 or 5 of the last 10 years); retirement pensions for disability beneficiaries will be calculated using the average wage at the time of disablement instead of when the recipient turns 65; and the ceiling on combined survivor-disability benefits will be set at one maximum disability pension. The one-time death benefit, currently equal to $3580 or 6 months of retirement benefits, will be reduced to $2500 and frozen.

Private Pensions

Even before the 19th century, governments provided pensions for disabled veterans and for war widows. Pension plans for public servants, which replaced various ad hoc payments, were instituted in the last half of the 19th century. The GRAND TRUNK RAILWAY introduced the first private-sector employee plan in 1874, but the Labour Commission criticized the GTR for compelling its employees to pay 80% of the cost of their own benefits and for requiring them to waive their rights to any disability or death allowances, even if these resulted from company negligence.

The coverage of private-sector plans established by railways and financial institutions has been expanded into other areas of the economy, but it is still partial and a matter of public concern. In 1983, only 45.4% of paid employees worked for employers that provided private pension plans; in 1993, coverage had declined to 44.6%. The reason for the decrease is the fall in private pension membership among male paid workers, which went from 52.4% in 1983 to 46.8% in 1993, attributable to the severe recessions that opened and closed the 1980s and economic restructuring which has shed jobs in male-dominated industries such as manufacturing and construction that often provided employer pensions. By contrast, private pension plan coverage has improved among female paid workers, increasing from 35.9% in 1983 to 41.9% in 1993 because more and more women have been joining the paid labour force (many in government jobs, which offer virtually 100% coverage) and because of improvements in federal and provincial pension standards legislation which now require employers with private pension plans to extend such coverage to part-time workers (most of whom are women).

Private pension plan coverage measured as a percentage of the entire labour force - not just paid employees, but also the self-employed and the (officially) unemployed - is much lower. In 1983, 36% of the labour force belonged to private pension plans; by 1993, the figure had declined to 35.4%. The percentage of male labour force participants with private pensions declined from 40.8% in 1983 to 36.4% in 1993, whereas women improved their coverage somewhat from 29.1% in 1983 to 34.1% in 1993. Private pension plan coverage is weak amongst lower-paid workers, private-sector workers and those who work for small- or medium-sized employers. Women are also less likely than men to belong to employer-sponsored pension plans (2 248 561 women versus 2 966 086 men), though the gap between the sexes has been narrowing because of the deterioration in coverage among men.

Proposals made during the "Great Pension Debate" of the early 1980s to solve the coverage problem by requiring all employers to provide pension plans or all workers to contribute to RRSPs were unsuccessful. However, the federal and provincial governments have strengthened their legislative standards governing employer pension plans and enriched tax incentives to encourage Canadians to save in RRSPs.

The coverage problem was improved somewhat by requiring employers which already provide pension plans to extend coverage to all full-time employees in an occupational group covered by the plan after 2 continuous years of employment and to their part-time workers, subject to certain conditions (in most jurisdictions, part-time workers become eligible if they have earned at least 35% of the average wage after 2 consecutive years of employment). In most jurisdictions, vesting now must occur after no more than 2 years of membership; "vesting" means that plan members become entitled to their employers' pension contributions made on their behalf. Pension contributions must be "locked-in," meaning that plan members cannot get at their employee and employer contributions until they retire.

Employer pension plans must provide survivor benefits (though spouses can elect to waive this provision), and accumulated private pension benefits must be divided between divorcing spouses. Plan sponsors must allow early retirement using actuarially reduced pensions. Portability provisions were improved; plan members who change jobs can transfer their accumulated pension contributions to their new employer's plan, if one exists, to a locked-in RRSP or to an annuity that pays benefits upon retirement.

However, there are no requirements regarding indexation, one of the key weaknesses of employer pension plans and strong points of the CPP and QPP. Despite some improvement in inflation protection over the years thanks mainly to the efforts of trade unions, only 43.7% of employer pension plan members (mostly public sector workers) are in plans which provide some form of indexation to protect benefits from the ravages that even low rates of inflation can cause over a number of years (average life expectancy is increasing); only 14.1% of plan members enjoy full indexation. In addition, there is a trend away from defined benefit plans, which promise a retirement benefit based on a formula that takes into account years of service and average or recent earnings, to defined contribution plans in which the pension depends upon the amount of contributions and investment earnings built up over the years; defined benefit plans provide a important element of security that defined contribution plans (which are essentially savings plans) cannot.

Registered Retirement Savings Plans

Registered Retirement Savings Plans (RRSPs) are intended to encourage private savings for retirement and thus contribute - along with employer-sponsored private pension plans - to the earnings-replacement objective. Tax deduction limits for contributions to RRSPs have been boosted in recent years as an added incentive to save for retirement, although the federal government lowered the limit temporarily from $14 500 in 1995 to $13 500 for 1996 and 1997, after which it will rise again to eventually reach $15 500 in 1999 and thereafter be indexed to wages); the $5500 limit for taxfilers with no employer pension plan in 1985 has been raised gradually over the years and will reach $15 500 in 1999.

Although there has been some progress in the use of RRSPs over the years, only a minority of Canadians put aside money for their retirement in this vehicle; in 1980, 13% of all taxfilers claimed a deduction for RRSP contributions and that figure increased steadily to 25.9% in 1993. Use of RRSPs and average contributions increases with income; in 1993, only 3.1% of taxfilers with incomes under $10 000 used RRSPs as opposed to 73.7% of those in the $250 000-and-over group, and the average contribution ranged from $1079 for the tiny group in the under-$10 000 range with RRSPs to $12 806 for those with incomes over $250 000. Higher-income taxpayers also enjoy larger income tax savings from their RRSP contributions because they contribute more and are in a higher tax bracket. Among taxpayers with incomes over $50 000 - the top 10% - 66.6% contributed on average $5861 to RRSPs in 1993 and realized an average federal-provincial income tax savings of $2524 as a result. For the 90% of taxpayers with incomes under $50 000, only 20.9% contributed on average $2456 to RRSPs for an average income tax savings of just $732.

Improvements to the private tier of the pension system are important, but benefit mainly Canadians with above-average incomes who belong to employer pension plans and contribute to RRSPs. Most people must rely on public programs for the large part or all of their retirement income. Recent changes to elderly benefits and the Canada Pension Plan are intended to ensure that the public pension system can sustain the increasing costs of the aging population and prepare the way for the onslaught of the baby boom generation, which will swell the ranks of the aged after 2010.