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Canadians headed for a retirement crisis

The warning bells have been clear, but they are growing increasingly louder: Canadians are not saving enough for retirement, and they’ve got to do something about it, quickly.

“I think there’s a broad consensus that we are heading for a retirement income crisis,” said Murray Gold, managing partner at Koskie Minsky law firm, and a pension specialist who advises the Ontario Federation of Labour.

“Two-thirds of the workforce doesn’t have any pensions, and the kinds of pensions we have aren’t as good as they were 20 years ago,” he said.

Since the 2008 financial crisis, the provinces have called for reforms to boost payouts under the existing Canada Pension Plan, but the federal government has balked at the idea.

Premier Kathleen Wynne has said Ontario will go it alone and develop its own pension plan, with details to be revealed in this spring’s budget. It is expected to be a key plank of the Liberal platform if an election is called.

Nearly 1.3 million workers in Ontario do not have access to any type of employer-sponsored workplace pension. In Canada’s private sector, only one person in five has a workplace pension.

That has resulted in an erosion of pension coverage, and an erosion of quality, Gold said, raising questions about whether future retirees will be able to maintain their standard of living. If not, there would be a domino effect that would hurt the overall economy.

premierewynnThe oldest Baby Boomers are turning 68, some happily retired with company pensions and good nest eggs, thanks to equity in booming housing markets. But others are struggling, opting to work longer, even after the typical retirement age of 65.

The picture is even bleaker for the Boomers’ children and grandchildren, who are trying to find that first job, or jumping between jobs, which in all likelihood don’t include a company pension, and certainly not a defined benefit plan.

In recent years, companies have been getting out of defined benefit plans, which offer guaranteed payouts at retirement regardless of how investments performed. Instead, employers that do offer a pension are often moving to defined contribution plans, where employees essentially manage their own plans, much like a RRSP, with no promised set payout at retirement.

“People have now learned the ropes enough to know that there’s something at stake here, which is my retirement security or my kids’ retirement security,” said Susan Eng, vice-president of advocacy for CARP, formerly known as the Canadian Association of Retired Persons.

Eng says her members are watching their kids trying to eke out a better life, but can’t find work or can’t save enough. So those approaching retirement age end up helping the next generations financially.

“Our members are the people who will never benefit from this (pension reform) themselves. It’s too late for them,” she said, adding they want to ensure a safety net exists for future generations.

With talk of a proposed Ontario pension plan expected to heat up in the retirementcoming months, here’s a look at proposals to fix our pension woes.

Enhanced Canada Pension Plan.

Almost all Canadian workers contribute to the Canada Pension Plan, which pays out in retirement or if someone becomes disabled. Under the current funding model, CPP pays out a maximum annual pension of about $12,000, though many people receive far less.

Some have argued that boosting CPP contributions is the easiest way to raise overall retirement incomes, though critics say raising pensions for all, including the affluent, isn’t the best solution.

Business groups have warned that hiking premiums would hurt employers, and potentially impede job creation.

Even though provinces have pushed for enhanced CPP for several years now, the federal government has signalled it has no desire to go this route.

Little action is expected here, because any changes to CPP would require Ottawa’s backing, along with approval from at least seven provinces representing two-thirds of the country’s population.

Pooled Registered Pension Plans (PRPPs)

Instead of an enhanced CPP, Ottawa has passed legislation permitting pooled registered pension plans, as have a few provinces, such as Quebec, Alberta and Saskatchewan. These plans are managed by financial institutions, with participants selecting options that set contribution rates.

Unlike defined benefit plans, these do not pay out a guaranteed retirement income. The payout depends on how the pool’s investments perform.

Small- and medium-sized businesses say they favour this model because it offers flexibility.

“There is a certain elegance to them. They enable a degree of choice, but at the same time nudging people toward virtuous decisions,” said Josh Hjartarson, vice president of policy and government relations for the Ontario Chamber of Commerce.

Hjartarson argued that enhancing CPP is a blanket move that would benefit people who don’t necessarily need it, while PRPPs are the preferred option for pension reform for its members.

He said many employers would choose to participate in a PRPP as part of an employee retention strategy, though others may not be financially able to do so.

“Let’s be honest, particularly in the current climate, not every employer is in a position to do that,” he said, adding that employees could also benefit as they could opt out if they don’t want to join.

There isn’t agreement on whether employers who offer a PRPP should be required to contribute to the pooled registered pension plan. The Ontario chamber surveyed nearly 1,000 employers in February, of which 33 per cent said yes, while 48 per cent no.

Critics say these plans are similar to group RRSPs, which simply can’t get to the size and scale needed to deliver predictable pensions with low management fees.

A middle way.

Keith Ambachtsheer, director of the International Centre for Pension Management at the Rotman School of Management, argues that lower-income earners and high-income earners are well-served by current programs.

“If you are neither rich nor poor, nor in the public sector, then (pensions are) something you should be interested in,” said Ambachtsheer, who says something is needed between PRPPs and an enhanced CPP.

He argues that families with an annual income in the $30,000 to $100,000 range are at greatest risk if there isn’t pension reform. Low-income earners can receive CPP, old age security, which is clawed back based on income, as well as the guaranteed income supplement.

Ambachtsheer has put forward a proposal, published by the C.D. Howe Institute, calling for such a middle way.

He proposes to replace 60 per cent of middle-income family earnings after retirement, which would take an additional 6 per cent of pay contribution rate above the current 9.9 per cent CPP contribution rate. These contributions would be split 50-50 between employer and employee (so 3 per cent each), and would be phased in over a number of years.

While employers complain this model would be too costly, Ambachtsheer says they just want to say no. “I don’t have a lot of patience for these naysayers,” he said.

He insists such a model can be created, noting that even in tight times, employers often make annual inflationary pay increases. So, for example, instead of giving a 2 per cent wage increase, an employer could afford a 1 per cent contribution to pensions and then give 1 per cent in salary, and gradually increase pension contributions, he said.

Ontario pension plan.

Details of what the province will propose for its made-in-Ontario solution are under wraps, though the plan has already drawn interest from provinces such as Manitoba and Prince Edward Island, whose populations are too small to go it alone.

Ambachtsheer argues that voluntary programs clearly don’t work, noting Canadians aren’t putting money into their RRSPs and tax-free savings accounts even though the tax incentives are there.

He says the keys to any Ontario pension plan are that it would need to ensure mandatory participation, and that it would need to be independently managed to keep fees lows, possibly modeled on the CPP investment board or the Ontario Teachers’ Pension Plan.

“Let’s get people saving, and do it in a way that is low-cost and professionally managed,” Ambachtsheer said. “We know how to do this. There’s nothing to be invented.”

The advantage is, given the working population of Ontarians, a pension plan could easily get to a size that would give it the advantages of scale. It would be much bigger than plans such as Teachers’ or the Healthcare of Ontario Pension Plan (HOOPP), and could invest in ways that would deliver higher returns than small plans or individual investors can get.

Savings and discipline.

CARP’s Eng says the hard truth is that people must realize they have to ante up the cash. The general rule is that you need to contribute 18 to 20 per cent of income to earn a pension that pays 70 per cent of pre-retirement income, she says.

“It’s almost 18 per cent, split between employer and employee, that would otherwise be cash in your jeans,” Eng said. “Are people prepared to pay what it takes? I think we are getting close. There will be some sticker shock.”

She says those who envy Ontario teachers or other public sector workers with their good pensions need to remember they are making hefty contributions. Teachers contribute about 12 per cent of their income, matched by their employers.

But telling people they need to save more isn’t working, given Canadians aren’t taking advantages of existing RRSPs and TFSAs. And even if they are, individuals can’t easily invest in the same way as big pension funds, getting good returns with low fees, compounded over years.

Ambachtsheer blames inertia, saying only a small minority of people carefully plan their future, noting most are just dealing with busy lives without time to deal with retirement plans.

But given that 80 per cent of employees in the private sector do not have a pension, the urgency is growing.

“The societal question is, do we create a framework?” he said. “Is there some public initiative that would help these people?

“It’s just a matter of whether we can collectively wrap our heads around actually doing it.”

Would the Real “Fund” Please Stand Up!

high_riskDuring this two-part series, I examine some of the basic funds and ETFs available, and why most investors would be better off sticking with index funds and index ETFs. Part-1 is a basic definition of mutual funds, index funds, and ETFs. In Part-2, I cover the different types of ETFs in more detail. I also cover the associated risks with many of the actively-managed ETFs on the market.

Part-1: Mutual Funds, Index Funds, and ETFs

Confused about the differences between mutual funds, index funds, and all the ETFs (Exchange Traded Funds) available to invest in? Well you’re not alone.  According to the Investment Funds Institute of Canada, at the end of May 2011 there were some 2,157 mutual funds listed in Canada, with $66.7 billion in assets. There were also some 184 ETFs listed on Canadian exchanges, worth over $41.9 billion dollars. This represents a combined total of over $108 billion dollars invested in both mutual funds and ETFs in Canada.

Canadian ETFs

Since the launch of RBC’s new target-date-bond ETFs last week, the total number of ETFs in Canada is probably now closer to 200. On top of that there are a bewildering difference of investment strategies and types of funds and ETFs available for investors. While ETF sales have soared in Canada since 2007, that’s not to say investors have had a better choice of products to choose from. Unfortunately many of these products are simply unsuitable and unnecessary for the average investor.  On the flip-side there are also many more indexed products available, though some of these ETFs also use swaps and covered-call strategies. Confused? Who wouldn’t be?  Let’s clear up some of these confusions and get back to basics!

 WTF (What the Fund)?

Everything seems to be called a fund these days! The word “funds” can be quite misleading, and that is where people get confused:  Mutual Funds, Index Funds, and ETFs (Exchange Traded Funds) are all different animals. And even within the ETF umbrella, the diversification of strategies and types is staggering. Danielle Arbuckle at Financial Highway covered some these points briefly in a recent post about investing in Exchange Traded Funds. Dan Bortolotti regularly scrutinizes new ETF products in detail, at the Canadian Couch Potato.

Here are the basics on “funds” from the Dividend Ninja perspective:

Mutual Funds

Most people have a basic understanding of what Mutual Funds are, since they have invested in them at some point in their retirement plan.  A mutual fund is basically a pool of funds collected from many investors for the purpose of investing in securities such as stocks and bonds. Most mutual funds are actively managed, in other words an investment manager decides on the securities to purchase, and manages the portfolio. In addition Mutual Funds rely on print and advertising media which also adds onto their costs. This results in a higher MER (Management Expense Ratio).  According to a recent article by Rob Carrick, The average Canadian equity mutual fund has an annual MER of 2.43%, which is in addition to any trailer fees or commissions.

Mutual funds have also been under heavy criticism for many years, since they are often sold with commissions, as well as trailer fees (kick-backs to brokers for selling them). While most mutual funds allow the small investor to get started, most underperform the very benchmarks they are compared to, in combination with high fees.  While mutual funds are a win for the companies who manage them and the brokers who sell them, most investors are paying a premium for underperformance.  This is something I have been doing the research on lately, for yet another blog post. I was quite surprised to find by how many percentage points, the top performing mutual funds are lagging the index.

Index Mutual Funds (Index Funds)

Index Funds are also a type of mutual fund. But that is where the similarity ends!  Index Funds are not actively managed, but simply invest in a basket of securities that matches an index (i.e. the S&P 500 or the TSX Composite). Therefore the investment style is referred to as passive management or passive index investing. In other words the entire performance of an index fund is tied to the market, and not the performance (or underperformance) of a mutual fund manager.

For example a Canadian Index Fund such as, TD Canadian Index Fund e-series, would track the S&P/TSX Composite Index. If you don’t understand what that means, think of it this way: The TD Canadian Index Funds simply buys all the stocks that comprise the S&P/TSX Composite index (currently 260), which are the majority of Canada’s biggest companies. You then buy a share of the TD Index Fund, and become a part owner of all of those stocks without having to buy all the companies yourself.

Index Funds are usually bought through banks without commissions. Since brokers and mutual funds dealers don’t make money selling them, or are able to sell them, almost all index funds have no trailer fees. Index funds are not usually promoted in print or media advertising, so all these administration costs are saved through a much lower MER. In fact, the MER for the TD Canadian Index e-series Fund is only 0.32% – compared to the Canadian equity mutual fund average of 2.43% (mentioned above).

So the two key differences between Index Funds and Mutual Funds are: (1) Mutual funds are actively managed with high fees, and (2) Index Funds are passively managed with low fees.

Note: Be careful with mutual funds that masquerade as “index funds”. These mutual funds still have the high MER, the trailer fees, and associated commissions. There is no evidence to suggest that no-load mutual funds or low MER mutual funds have better performance, than their higher-fee counterparts. Stick with true index funds!

ETFs (Exchange Traded Funds)

Similar to mutual funds, an Exchange Traded Fund (ETF) is a security that tracks an index, a commodity or a basket of assets like an index fund (or a sector mutual fund), but trades like a stock on an exchange. By owning an ETF, you get the diversification of a mutual fund as well as the ability to sell short, buy on margin and purchase like a stock. Unlike mutual funds however, ETFs have very low MERs, and no trailer fees. Although you must pay the regular brokerage fee to buy and sell ETFs, you gain the benefit of low operating expenses and therefore a lower MER.  ETFs are suited for the investor with a large portfolio, who can purchase enough shares to be able to DRIP (Dividend Reinvestment Plan) their shares, and make the fees to purchase negligible.

ETFs can be either passively managed or actively managed. Most ETFs hold the underlying securities they are tracking. However many ETFs, have strayed from their passive roots and become inverse, hedged, swaps, or covered-call ETFs. I’ll cover more of this confusion in Part-2.

Index ETFs

Index ETFs are much like index mutual funds.  As explained by Investopedia, these ETFs follow a specific benchmark index as closely as possible, but use a passive investment strategy, only making portfolio changes when changes occur in the underlying index. The benefit of and Index ETF over an Index Fund, is of course the much lower MER (Management Expense Ratio). In the Globe and Mail article mentioned above, Rob Carrick compares iShares XIU-T, the most popular ETF in Canada which tracks the S&P TSX-60 Index. It has an MER of only 0.17%. Index ETFs offer you true index investing at a low cost, with more options available than only holding index funds. However they are suitable for investors with larger portfolios, who can absorb the transaction or rebalancing costs.

Note: Horizons BetaPro HXT and BetaPro HXS are being heavily promoted and advertised as low-cost index ETFs across various media. They have an incredibly low MER of only 0.07%. However employ caution! These ETFs do not hold the securities they invest in (for the most part), and use a swap agreement to guarantee the index returns. Since they do not hold the securities they invest in, for this reason alone, I do not consider these true index products. Back in October 2010, I wrote about the issue with Horizons HXT, and why I feel it’s a poor choice for investors.


In Part-2, I cover the different types of ETFs in more detail, and some of the associated risks with the newer ETFs on the market. These are namely the actively managed ETFs that employ: covered-call strategies, swaps, forward agreements, inverse or hedged options strategies. Although they may give you a higher return so comes the higher risk. I’ll also explain why I feel the majority of these ETFs are not suitable investments for the majority of investors.

Stick with true Index ETFs and Index Funds that do hold the securities they are tracking, and use passive investment strategies. As the Canadian Couch Potato would say – “stay passive my friends.”
The Dividend Ninja – Jul 12th, 2011

Are Canadians Over Taxed?

taxVANCOUVER – A new study says the average Canadian family was spending more on taxes than on food, shelter and clothing combined. The Fraser Institute study says that in 2013, the average Canadian family earned $77,381 and paid $32,369 in total taxes _ or 41.8 per cent of income _ compared with 36.1 per cent for food, shelter and clothing combined. By comparison, Continue reading

Household Debt Record New High

Canadian household debt compared with income rose to a record in the second quarter, highlighting one of the key vulnerabilities to the financial system the Bank of Canada is watching.In the wake of low oil prices, the central bank said earlier this year the biggest domestic risk is that jobs and income decline enough to reduce Canadians’ ability to pay their debt, leading to a housing correction. Continue reading

Eliminate Your Mortgage Debt

mortgage debtThe Financial Equalization concept was created in 1986 by Charles S. Bell I, while working as a successful financial advisor for a financial firm in Montreal, Quebec. Mr. Bell’s interest in authoring a totally new approach to mortgage and debt reduction was prompted by a personal family financial crisis. Continue reading