Wednesday, December 22, 2010

Well said

Douglas Peters nicely sums up the numbers and principles behind the choice of the CPP or private-sector funds as the federal government's preferred form of retirement savings:
The Howe study uses historical nominal rates of return of 6 per cent (4 per cent real plus 2 per cent inflation) on investments for pensions but reduces such returns to just 3 per cent (1 per cent real plus 2 per cent inflation) for RRSPs and 4.5 per cent (2.5 per cent plus 2 per cent inflation) for defined-contribution Registered Pension Plans (RPPs). The reduction for individuals is the result of “investment-management and other costs” plus the poorer performance levels of individual investments.

What kind of results would these numbers produce for a 30-year-old individual who saves $100 a month in an RRSP for 35 years at an annual return of 3 per cent? What pension would he or she would accumulate?

By contrast, what would the same $100 a month invested in the CPP at an annual return of 6 per cent less the cost of CPP management yield after 35 years?

The CPP investment would yield a pension approximately 80 per cent greater than an investment in RRSPs.
Another that the individual cannot know how much one needs to save for retirement. This is because the individual does not know how long he or she will live. And, in addition, the rate of interest on annuities may be based on government bond rates of say 16 per cent (as in the early 1980s) or just 3 per cent (as is the case now). But the large pension funds like the Canada Pension Fund can estimate quite accurately the life expectancies of the large numbers of its members. Thus the CPP is a far more efficient pension scheme than any individual RRSP or defined-contribution RPPs.

The CPP, then, both lowers the costs to the individual saver as well as reducing the individual’s risk.
(A)n increase in savings, whether from increased CPP premiums or larger RRSP contributions or other savings, has exactly the same effect on the economy.

The exception is that increased RRSP contributions will make the financial institutions better off, while an increase in CPP contributions will make Canadian pensioners better off.

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