Like many developed nations, Canada continues to refine its retirement system. As part of that effort, the provincial governments will soon authorise a new savings vehicle – Pooled Registered Pension Plans (PRPPs). With the right policy decisions, PRPPs will go a long way towards increasing retirement security for millions of Canadians.
Canada already has a sophisticated retirement savings system. It has a financially stable public pension programme, and it offers substantial tax benefits to private savings. Even with those incentives, however, less than half of all Canadian workers – highly concentrated in large employers – participate in a private plan.
The provincial governments hope to boost the level of private savings through the introduction of PRPPs. In broad outline, workers would direct a portion of their salaries to national investment pools, which would be run by a small number of financial institutions. Employers, on the other hand, would not be required to contribute.
Many other critical programme details continue to be debated. Here is a quick summary of the issues policymakers will need to consider, along with our take on how the decisions will affect the success of the initiative.
- Universal access. While Canadian employers need not make contributions to PRPPs, we suggest that employers (with more than 10 employees) be required to provide access to these plans for their workers, if they do not already offer another type of workplace retirement plan. Such a universal access provision would ensure that almost all employees have the ability to contribute to a retirement programme through payroll deduction. To offset the administrative costs of linking a payroll system to the PRPPs, employers would receive a tax credit.
- Automatic enrolment. Employees earning above a specified minimum should be automatically enrolled in PRPPs – though they would have the ability to stop or reduce contributions at any time. Experience with US workplace retirement plans has shown that this “opt out” approach leads to higher levels of participation compared to processes that require workers to “opt in” to start saving.
- Default contribution rate. If policymakers endorse automatic enrolment, they then must decide on a default contribution rate.
In other words, what percentage of salary will be deducted from a worker’s salary and contributed to the PRPP, barring instructions to the contrary? We would recommend an initially low rate of 2 per cent or 3 per cent of wages, but would also suggest this rate increase slightly after the worker is in the plan for a specified period, such as five years.
- Default investment option. Many of the employees participating in a PRPP will not actively decide how their contributions will be invested, so policymakers must make that choice for them. This default investment option should be broadly-diversified, holding both stocks and bonds. We favour balanced funds, with a relatively stable allocation between asset classes. However, target-date funds, which gradually change asset allocation over time, may be appropriate if their changing mix is clearly disclosed.
- Costs. Keeping costs down is key to the programme’s success, because lower costs mean higher returns. One way to keep costs in check is to take advantage of economies of scale. The savings will be easier to realise if financial institutions can create PRPPs that are available nationally, but that will only be possible if the provinces harmonise their rules. Given the small average account size anticipated, providers will also need to use web technology effectively to provide customer service and communicate with participants.
Although expenses for retail mutual funds in Canada can be quite high (often 200+ basis points), institutional retirement accounts are much more reasonably priced at an average of 60-70bps. Thus, pooling must allow for PRPPs to closely resemble these institutional accounts.
- Oversight obligations. The provinces should relieve employers of all oversight obligations for the PRPPs – as they seem prepared to do – making the PRPP feasible for small employers. The financial institutions sponsoring the PRPPs should provide general oversight, though they should not be required to provide advisory services, nor should they be held liable for investment losses if the pools hold a diversified portfolio.
In short, PRPPs have the potential to increase significantly retirement savings in Canada, but the success of the programme will depend on a number of key design decisions. Although each province will set its own rules, we encourage the federal government to take a leading role in framing the issues and persuading the provincial governments to adopt uniform policies.