Tuesday, August 11, 2015

ORPP is a Better Deal than the CPP

Stephen Harper is "delighted" to make the implementation of the Ontario Retirement Pension Plan (ORPP) more difficult. At the same time, he is not proposing any changes to the CPP. However, the ORPP is a much better deal than the CPP:

- under the ORPP, workers contribute 3.8% of their earnings (1.9% themselves, 1.9% through their employer) in order to replace 14.24% of their income in retirement;

- under the CPP, workers contribute 9.9% of their earnings in order to replace 25% of their income in retirement.

In order words, for the ORPP to replace 25% of income, workers would only have to pay 3.8%*(25/14.24) = 6.67% of their income rather than 9.9%. Why?

- Part of the reason is that, while neither plans requires contributions on earnings up to $3,500/year and both still pay benefits on those earnings, the ORPP has a higher ceiling ($90,000) than the CPP (around $55,000 next year). But this difference is rather minor: with the same ceiling as the CPP, ORPP could still replace 25% of pensionable earnings with a contribution rate of 6.8-6.9%. There may be other minor design differences (I haven't done a full comparison), but it's pretty safe to say that ORPP could have the same design and pay the same benefits as the CPP with a contribution rate of around 7%.

- So why could ORPP offer the same benefit as the CPP with only 70% as much contributions? The answer is buried in the CPP actuarial report: even while (real) investment returns are assumed to be 4% going forward, the actual return for those born after 1970 is only 2%. This is because CPP contributions were too low for earlier cohorts as a result of inaccurate projections. Thus, younger workers are heavily subsidizing older workers and retirees: since contributions made to the CPP are withdrawn, on average, about 20 years after they are made, that 2% difference per year means that young workers have to pay 40-50% more than what they would pay if they didn't have to subsidize older workers. Lo and behold, that's roughly what you'd tack onto ORPP contribution rates to get to the CPP contribution rates.

In short, roughly 70% of the CPP contributions are actually retirement savings; the remaining 30% is a tax that makes up for insufficient contributions before 2000 - a tax of up to roughly $1,500 per worker each year. By contrast, because the ORPP isn't saddled with past mistakes, it is 100% retirement savings. Therefore, it is highly ironic that Stephen Harper is characterizing ORPP as a tax while doing nothing about the CPP.

No comments: