Retirement Income Adequacy:
A conversation for Canadians
GO with Eckler: Engaging insights about financial wellness in the workplace
Recent research shows that Canadians are thinking about their retirement – more specifically, not having enough money for retirement – a lot! More than half of Canadians say they don’t know how much they need to save for retirement and nearly two-thirds of working Canadians worry about running out of money during retirement.
Against this backdrop, we thought the time was right for a special edition of GO with Eckler. We are delighted that Bonnie-Jeanne MacDonald, PhD, FCIA, FSA, Eckler’s Resident Scholar and Director of Financial Security Research at the National Institute on Ageing, and Janice Holman CFA, CFP, Eckler Principal and financial wellness practice leader, recently had the opportunity to share insights on the current state of retirement income adequacy in Canada.
Janice: Bonnie-Jeanne, thank you for sharing your time and insights with us! Can you provide our readers with a bit of background on the work you’ve been doing on retirement income adequacy?
Bonnie-Jeanne: Thank you, Janice. Retirement income adequacy brings together my work as both a pension actuary and an academic focused on the financial and health aspects of Canada’s ageing population.
At a basic level, people need to know if they’re saving enough for retirement. The longstanding goal we’ve come to depend on to determine how much is “enough” retirement income is a gross earnings replacement rate of 70%. It’s used by actuaries, financial advisers, academics, and public policy analysts across Canada and worldwide. But is it accurate? In 2009 my colleagues and I studied over 100 articles and research papers but could not find a single empirical study (that’s a study that uses actual, real-life data) proving that the 70% final earnings replacement rate is a valid measure. So, we tested it ourselves and discovered that, in the real world, people who were able to maintain their standard of living had a vast range of replacement rates – anywhere from 10% to 200%. What that means is that not only is the 70% a scientifically invalid measure – it’s dangerous because it’s most likely wrong, which could lead to harmful decisions.
Janice: That’s a significant finding, especially when we consider that for the first time in our history, there are more people over the age of 65 than there are under the age of 15. That’s a lot of people for whom retirement income adequacy is currently, or will soon become, a critical question. It seems that using the 70% rule could lead many to a retirement that was not what they had hoped for. Canadians need a way to correctly determine what an adequate retirement income means for their individual situation. Can you share with us the work you have done on this?
Bonnie-Jeanne: Once we realized that the usual 70% rule of thumb was invalid, my next question was to ask, is there an alternative, more accurate way to help people measure their retirement income adequacy – that is, how well will their living standards be sustained in retirement? Your living standard is personal and is based on your specific life characteristics, such as your cost of housing, marital status, how many dependents you support, where you live etc. Each of these factors has a major impact so pretending that these other factors don’t exist (or don’t matter) is where the 70% rule has gone dangerously wrong. With that in mind, we proposed the Living Standards Replacement Rate (or LSRR for short), a more accurate and scientifically robust alternative measure that answers the most fundamental question: How much will I need?
Janice: How do you calculate your LSRR?
Bonnie-Jeanne: The LSRR determines how well a person’s living standards will be maintained after retirement. Traditionally, if a person wanted to measure the cost of their living standards, they would need to go about the arduous bottom-up task of collecting all of their receipts, credit or bank statements then determine if they would have enough money to finance this living standard once in retirement. With the LSRR, we take a top-down shortcut by estimating how much you spend to support your living standard. We look at your gross employment income, deduct your major income drains such as taxes, mortgage payments, retirement savings and then adjust to recognize any partners and dependents you’re supporting.
That gives a good estimate of the income that you’re spending on yourself to support your living standards (your “spendable income”) while working. We then do the same thing for retirement, adjusting to reflect that stage of life: your anticipated income and taxes. Keep in mind there are no longer required savings after retirement and likely no more dependents).
Comparing the two will answer the big question: Are you on track to have the same amount of spendable income in retirement? In other words, will you have the funds to maintain your standard of living?
Janice: Comparing how much money someone has available to support their standard of living before and after retirement makes a lot of sense. What if someone wanted a different lifestyle, such as staying home and gardening or taking care of grandchildren? Or maybe they want to travel and eat out more. How would they use the LSRR to plan for retirement?
Bonnie-Jeanne: That’s the beauty of this approach – it’s understandable, and when something is understandable, it’s easier to make the necessary adjustments. If you want a better living standard, then you know that you’re saving towards more spendable income than you currently need – and vice versa. When people can truly understand how much they’re spending on their current living standard today, and how much of that current lifestyle they can expect in retirement, it’s very empowering. They can implement strategies to improve their LSRR, such as saving more, adjusting their retirement date, or re-evaluating their retirement lifestyle goals.
Janice: Government retirement benefits, and when to take them, also play a key role in retirement income adequacy. When to claim the Canada Pension Plan (CPP) or the Quebec Pension Plan (QPP), is an important financial decision for most Canadians, yet it is hard for many Canadians to know when the right time is. In less than 10 years, one-quarter of Canada’s population will be aged 65 years or older – making us one of the world’s few super-aged countries. Given our demographics, it’s really important that people understand how to get the most from the CPP or QPP. What has your research shown on the best time to take CPP/QPP?
Bonnie-Jeanne: While each person’s situation will be unique to them, Canadians in reasonable health who can afford to wait and want to optimize the amount of CPP/QPP benefits they get should consider delaying the start of their benefits for as long as possible. However, fewer than 1% of Canadians choose to delay benefits to age 70. Most Canadians take their CPP/QPP benefits as soon as they are eligible at age 60, likely without considering that they may be giving up substantial lifetime income and valuable protection against financial market risks, high inflation, or the potential for outliving retirement income. Taking CPP/QPP too early can mean forfeiting important financial security at older ages.
Janice: This seems like a significant problem that could affect everyone – from employers who have workers that don’t know how and when to comfortably retire, to all Canadians if retirees run out of money later in life. In your view, how can these challenges be addressed?
Bonnie-Jeanne: It comes down to Canadians receiving the information and support they need – in the right way at the right time – so they can make these critical decisions. At a minimum, the industry needs to move away from outdated, invalid, and often harmful rules of thumb. Beyond this, Canadians should be provided basic, unbiased education so they can make more informed decisions. Even better is to have personalized financial assessments together with guidance on the implications of an individual’s current savings patterns and how to reach their goals, along with expert, unbiased support to help navigate them through their decision-making process.
Janice: I agree; people go from having a single paycheque, or maybe two in a family, to retirement where they could be receiving up to a dozen sources of income. We are asking the average Canadian to forecast what their expenses will look like and how to create an optimal income stream that will last for life. It is almost an impossible task! Your approach of making the math easier and finding ways of creating secure lifetime income is what we need to provide the retirements people hope for.
What about workplace retirement plans – can you talk a bit about what’s on the horizon?
Bonnie-Jeanne: Workplace retirement plans contribute greatly to a person’s retirement income. However, over the past several decades, there has been a decline in traditional workplace defined benefit (DB) pension plans that promise lifetime pension income after retirement. In Canada, only 1 in 10 Canadians will receive income from a workplace DB pension. In response, Canadians have contributed nearly $1.5 trillion to RRSPs and defined contribution pension plans. While this is encouraging news, the missing piece is the actual “pension” that will help replace employment wages in retirement.
What Canadians need most of all is an affordable, readily available option to convert retirement savings into affordable monthly lifetime income.
Motivated by this gap in the Canadian retirement income system that I believed would increasingly lead to financial insecurity among Canada’s ageing population, we at the NIA formed a coalition of leading pension experts, organizations and industry stakeholders to ask the federal government to change tax and pension legislation to allow for a “shared risk” decumulation option, called Dynamic Pension Pools (DP pools), that would let Canadians combine their registered savings at retirement and generate lifetime pension income less expensively than with a traditional annuity.
In the last budget, the Federal government continued to move forward with its promise to make DP pools (or Variable Payment Life Annuities) a reality in Canada.
Janice: It sounds like if we can tackle these items – how much to save, when to take CPP, and access to retirement vehicles that provide lifetime income – we’ll be a long way down the path to improved retirements for both employees and employers. This is excellent work you have done!
Bonnie-Jeanne: Thank you, Janice. That’s very kind. The challenge now is that there’s a lot left to do and that’s because it’s really up to those with direct access to Canadians who can turn this hard work into reality.
The big obstacle to implementing better retirement financial planning practices is a psychological one: workers are being asked to look beyond their best financial interests today and instead prepare for their older, more vulnerable selves in the far-off future. This task is further complicated by the fact that the economics of ageing will look very different in the years to come. We all know that secure pension income is going down, but it’s less known that retirement costs will go up – and potentially by a lot. That is because not only are people living longer than ever before, but the baby boomers had far fewer children than previous generations did. Adult children have traditionally provided most of the care for seniors in their homes and, without that support, retiring Canadians will need to finance a longer retirement time period with less money and higher expenses.
While online calculators and educational resources do an excellent job of providing Canadians with data and information, more tools are needed to put the numbers into a personal context, to enhance deeper understanding and motivate action. Employers are uniquely positioned to support this more personalized approach to retirement planning. They can directly communicate appropriate retirement financial planning to large groups of Canadians and, most of all, their members trust them and consider them a source of unbiased information. Leveraging these unique strengths and fostering more informed retirement financial decisions among members is good for employees – and for their employers.
To continue the conversation, please reach out to Janice and Bonnie-Jeanne directly.
GO with Eckler is a quarterly newsletter to help employers and plan sponsors support financial wellness for their employees and plan members.
Please contact your Eckler consultant if you would like to learn more about supporting finances.
