The ‘Perfect” Canada Pension Plan Client

What would you think of the Financial Advisor who sets you up in a financial product that works like this?
• You invest $4,700/year into this plan-up to your age 65. Contributions are mandatory. And while the contributions are tax deductible all benefits received are fully taxable.
• These contributions must be made beginning the year you start working full time (you might be age 19 out of high school or perhaps older after University).
• If you die as a single person (non married, no children) say, 5 or 10 or 20 years later there is a death benefit of $2,500 (maximum) payable to your estate. Nothing else is payable from your contributions.
• If you die and you are married and you do have one or more children the $2,500 death benefit is payable and there is also a maximum (it could be less or much less) monthly pension of about $555/month payable to your surviving spouse and additional $228 per month (maximum) for each of the dependent children while they are dependent.
• If you become severely disabled you might qualify for a disability benefit. In order to qualify the disability must be both ‘severe’ and ‘prolonged’. The definitions are: Severe means that you have a mental or physical disability that regularly stops you from doing any type of substantially gainful work. Prolonged means that your disability is long-term and of indefinite duration or is likely to result in death. The maximum disability benefit is about $1,213/month to age 65.
• At retirement (age 65) you will receive a monthly pension of about $1,012/month from this product—and you will receive it as long as you live.
• But here is a catch—if you and your spouse are both retired each receiving the maximum pension (keeping in mind you have each contributed over the past 40+ years while working) and one of you dies—even if this is just a few days after retirement—the benefit payable to your surviving spouse is limited to the Death Benefit of $2,500 (maximum) –which is taxable. In other words you have contributed $4,700/year for over 40 years, you die one month into retirement and your contributions of over $188,000 over the years will provide a benefit to your surviving spouse of only $2,500.
Is this a good deal?
I would suggest you would be quite concerned (or even upset) about a Financial Advisor who put you into a plan that required you to deposit $4,700/year for, say, 40 years (over $188,000 in total contributions) that provided you with a pension of only about $12,000/year—and no value other than a $2,500 death benefit to your surviving spouse or estate upon your death during retirement.
What I have just described above is a simplified version of the Canada Pension Plan. Some will note that the individual’s annual maximum contribution is only one half of the $4,700 I quoted above—this is because your employer must make a contribution equal to your contribution—so there is, in fact, $4,700/year going into the CPP on your behalf.
Some will also argue that you must allocate some cost for the premature death and disability benefits that are payable under the CPP. This is a valid argument but even after you take these costs into account—is it a ‘good deal’ for the surviving retired spouse to receive absolutely nothing (other than the $2,500 death benefit) from his/her deceased’s pension?
And others may point out that the CPP benefits are indexed—but then, so are the contributions each year.
The title of this article is the ‘PERFECT’ Canada Pension Plan client. The ‘perfect’ Canada Pension Plan client (from the government’s point of view) is the person who is working and contributing to the CPP beginning in their 20’s, never has a CPP disability claim and lives to ‘retirement age’ (early pension available as early as age 60) and then dies after receiving one monthly CPP pension cheque. Total contributions over, say, 40 years would be almost $190,000 (ignoring inflationary increases) and the total benefits paid would be one month of pension ($1,012) plus the $2,500 death benefit. Is this a good deal? For whom?
At the time of this writing (November 2013) there are ongoing discussions and political posturing to ‘enhance’ the Canada Pension Plan by increasing contribution levels (and the so called ‘benefits’). Would this be a ‘good deal’ in the eyes of most Canadian taxpayers? I suspect that most people do not fully understand the workings of the Canada Pension Plan. And I would suggest many (most?) politicians don’t understand either-but it makes for good political noise.
As a professional I cannot imagine how I could possibly justify recommending a financial product that works like this—that would require thousands and thousands of dollars contributions for a pension benefit that may end up being worth less than the first year’s contributions.