That's right. The pension plans Delica-driving lefties drool over and Trump-loving deplorables love to hate are really not an outsized deal. Mediocre returns, high administration costs, bad investment strategies, political dabbling, I don't know... but when I do the math the numbers tell the same story over and over. I would be MUCH better off investing on my own in a matching contribution based plan than contributing to my supposedly gold-plated, defined-benefit government pension plan.
How Government Pensions Work
Periodically, government pension authorities evaluate the sustainability of their pension plan and set contribution rates. These rates fall into two main categories: 1) a certain rate for employees and employers up to the CPP contribution limit [called YMPE - Yearly Maximum Pensionable Earnings], and 2) a higher rate for employees and employers above the YMPE limit. The CPP limit -- or YMPE -- is taken into account because once you turn 65, your pension benefits will be lowered according to your estimated CPP payments. For example if the plan calculates you will earn $1,000 a month from CPP, they will reduce your monthly pension benefit by about $1,000.
Government pension plans -- or at least the ones that MSM tell you are so brutally unfair -- are defined-benefit plans. Basically you and your employer pay into the plan according to advanced calculations, but no matter how the plan performs you get a guaranteed pension benefit that's based on your income and years of service.
In my pension, one can retire and collect a benefit as early as 55 years old as long as they meet the "85 factor" (age + years of service > 85). This means you would have to start your career contributing to the pension plan at 25 years old to get the full benefit at 55 years old.
My Future Pension Estimate
My pension benefit calculation goes like this: Average of Best 5 Years Salary x 2% x Years of Service = Best Annual Benefit.
At age 65 this is changed to a two part calculation for the CPP adjustment: YMPE x 1.4% x Years of Service PLUS Balance of Salary x 2% x Years of Service.
Assuming my salary goes up with inflation (as it generally does), at age 55 I will get a taxable benefit worth about $53,000 in today's dollars. After paying taxes at 19%, my net income will be around $42,900 if I retire in Alberta. At age 65 when I get CPP, the pension benefit will be adjusted down to $23,219 PLUS $20,560 for a total taxable benefit of $43,679 in today's dollars. I should note once I start collecting my pension the benefit only increases each year by 60% of the posted inflation rate so over time my real purchasing power goes down. Also, when I die my wife only gets 2/3rds of the benefit for the rest of her life. Our estate gets zilch when we both die.
Not bad at first glance considering I earn around $85,000 a year before a bit of overtime. However, I should point out the benefit is fully taxable as regular income and I have zero control over my income mix, tax saving strategies, or coordinating my withdrawals with my actual expenses.
What If I Invested Myself?
The contribution rates to my pension are pretty high. About $420 biweekly comes from me plus $455 biweekly from my employer. If I invested through Questrade according to my RM Balanced Portfolio -- which should return 6% annually after inflation over the long term -- after 31 years my portion of contributions would be worth about $970,000 and my employer's contributions would be about $1,050,000 for a total value of a bit more than $2,000,000.
Following my 25x Rule (which gives me more than 92% chance of success when retiring at 55 years old) I would be able to withdraw $80,000 in my first year of retirement and adjust up each following year at the full rate of inflation, not just 60% of inflation. Plus I get no clawback at 65 years old for CPP. My wife would still get the full amount when I die. Plus our estate would get the total value of the portfolio which is very likely to be worth more than $2 million.
I also am able to tax-optimize my portfolio. Drawing some fully taxable income from RRSPs, tax advantaged Canadian dividend income from my Cash/Margin Account, tax advantaged capital gains income from my Cash/Margin Account, and non-declarable income from my TFSA. I could realistically pay a blended tax rate of 16% (or less) for a net income of $67,300.
Although my pension is pretty much guaranteed, it certainly isn't as lucrative as many believe it to be. To me a 92% guarantee with full adjustment for inflation and no CPP clawback is about as valuable as the 99% guarantee the government pension gives with only 60% inflation adjustment. Using the same contribution rates in a self-managed, low-fee, index based RM Balanced Portfolio, I would realistically be able to achieve almost 60% higher net income in retirement.
If the pension plan was able to follow the 25X Rule, the total value of my pension at age 55 should be $1.325 million ($53,000 x 25). The administrators should be able to achieve that with total biweekly contribution of $600 over 31 years instead of the current $875.
I realize it's definitely a controversial topic, especially considering many Canadians are about as financially literate as my fluffy and ever-so-cute pooch. But I for one would not be upset if "the swamp was drained" and my fallaciously esteemed government pension was changed to a contribution based indexing plan open to all working Canadians. One can only dream.
Despite the large contributions I make to my government pension plan, which ultimately shrink my paycheque, I don't add my pension value in our Net Worth Updates. I feel it would throw off our true accomplishment: building a great investment portfolio out of what's left of our paycheques after taxes and those massive contributions.
Thanks for reading! If you have complainypants friends who quiver angrily or drool jealously at the mention of government pensions, please share this.