High mutual fund fees could cause Canadians to delay their retirement by as much as 11 years or else leave them with 40 per cent less money for their retirement, says a report from the Canadian Centre for Policy Alternatives.
The think-tank published the report as Canadians were going through their annual tradition of trying to decide where to invest money before the RRSP deadline on March 2.
Since their creation several decades ago, RRSPs have become a major element in retirement planning. But that growth in importance has been accompanied by a decline in workplace pension plans. In 1997, about 43 per cent of workers were covered by some sort of pension plan. Today, that figure has fallen to 27 per cent.
RRSP’s have helped bridge that gap, but there’s a growing body of evidence that they don’t provide nearly the same level of blanket coverage. Citing Statistics Canada data, the Canadian Centre for Policy Alternatives report notes that almost a third of households with someone between the age 45 and 64 don’t have an RRSP, and that’s a demographic group that would presumably make retirement planning a much bigger priority than someone younger.
The biggest single asset in most Canadians’ RRSPs is mutual funds, which are groups of stocks or bonds bundled together and overseen by a fund manager. That manager is paid a fee measured as a management expense ratio or MER that comes out of the fund’s revenues. This limits the amount the fund can invest and is paid regardless of performance.
According to the report, the average Canadian mutual fund charged 2.1 per cent in fees last year. That sounds like a tiny amount, but with compound interest it adds up over time. Many of those fees have declined in recent years in the face of public pressure, but “even these much lower fees are still two to three times higher than pension fund fees,” said the Canadian Centre for Policy Alternatives’ senior economist David Macdonald.
Mutual fund managers ostensibly do the same job as pension fund managers, but at a much higher cost. Consider that “the average workplace pension plan withdrew only 0.38 per cent of all its assets in 2014 to pay its managers,” the report says. “At 2.1 per cent of assets, the average mutual fund withdrew much more for the same task in 2014.”
Test case: Raj vs. Susan
Some simple number crunching shows why fund fees are eating into Canadians’ retirements by lowering returns. The report gives the theoretical example of a young worker named Raj, who contributes five per cent of his salary starting at age 25 to the pension plan where he works. His employer matches that contribution, and after 40 years, Raj and his employer have contributed $240,000 to his retirement. But his pension is worth $780,000.
Raj’s story is contrasted with that of Susan, another young worker who doesn’t have a pension. She’s the same age and earns the same salary and contributes five per cent of her salary every year to an RRSP, which is matched by her employer. But in part because of management fees, Susan’s retirement account is worth $540,000 at 65, even though she contributed the same amount as Raj and made the same annual gains in her mutual funds.
She would have to work another seven years, until she’s 72, to have the same amount as Raj did at 65, the report notes. And while not all mutual funds are created equal, the picture looks even worse for some.
The report tabulates what it calls asset weighted fees for many equity funds in Canada, and found they ranged from a high of 2.9 per cent at some fund companies to a low of 1.1 per cent at others.
“The average equity fund investor [paying 2.9 per cent] would have to keep working and contributing until age 76 to save as much as they would have with identical contributions to the average pension plan,” the report says. “Alternatively, that investor could retire at 65, but would do so with 41 per cent less than they would have had with identical contributions to the average pension plan.”
Even someone lucky enough to be invested in one of the cheapest equity funds, charging 1.1 per cent, “would have to work until age 68, or retire at age 65 with 16 per cent smaller savings compared to a pension plan.”
Compared to mutual funds, the report argues, pensions are a much cheaper option for everyone. And even there, not all are created equal. Defined benefit plans, which are becoming more and more scarce in Canada, have even lower fees, withdrawing an average of 0.36 per cent of assets to pay their expenses in 2012, the most recent year for which data is available.
Defined contribution plans charged more than double that in 2012, or an average of 0.69 per cent.
Index funds and exchange traded funds offer lower fees, the report says, but “occupy a very small proportion of Canadians’ managed fund holdings.”
The report says most people don’t have much power to change their retirement options: they either sign up for a workplace pension plan if it’s offered, or go it alone with RRSPs if they aren’t. Instead, the group aims to put pressure on policymakers to come up with better retirement options than those currently on offer.
“It is not in most people’s power to reduce mutual fund fees, expand the Canada Pension Plan or start a company pension plan,” the report says. “But policymakers have more options; their choices could help everyone retire more comfortably.”