The C.D. Howe Pension Papers Advisory Board just published its latest paper, The Piggy Bank Index: Matching Canadians’ Savings Rates to Their Dreams. The paper, which was co-authored by David Dodge, warns that Canadians need to save 10% to 21% of pay for 35 years if they “wish to provide for adequate and assured retirement incomes”.
The message is not new and in fact, the paper itself adds little that is new. The authors have based their conclusions on a set of pension projections using smoothed economic assumptions. Similar projections have been done many times before.
The basic message—that most Canadians need to save much more—needs to be taken with a grain of salt. While the paper shows the required savings rate assuming three retirement targets—50%, 60%, and 70% of final pay (pre-tax)—the emphasis is clearly on the 70% scenario. The 70% target has been bandied about for decades but users rarely attempt to substantiate it with hard research. This paper is no different. Anyone who is interested in a more scientific analysis of adequate replacement ratios should read the papers by Baker & Milligan, Horner and Whitehouse (all papers are cited in Jack Mintz’s Summary Report on Retirement Income Adequacy Research found at www.fin.gc.ca). Based on these other papers, the true target ratio varies by income level, ranging from over 90% of final earnings for very low income Canadians to about 50% for earners in the highest decile.
The Dodge paper does raise one very interesting implication: the only way for a high earner to achieve a 70% income target after retirement is to forgo a comfortable lifestyle before retirement. For example, an individual (we will call him Jack) earning $95,000 near retirement would need to save 22% of earnings for 35 years to achieve a 70% income target at age 63. Not only is such a savings rate high, it would be irrational for Jack to try to achieve it. Here is why:
A – He would incur a number of employment-related expenses (C/QPP, EI, life & health insurance, commuting costs, daycare etc.) totaling roughly 10% of pay.
B – Jack also faces costs related to raising children and mortgage payments which add up to another 10% to 40% of pay (we will say 18% to 23% for this exercise).
C – Based on the above, disposable income before retirement is 45% to 50% of earnings.
D – By retirement, the expenses set out in A of B are virtually nil.
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Thus, in order to achieve retirement income equal to 70% of earnings, Jack must live on just 45% to 50% of his earnings for the 35 years preceding retirement. (If we factor in the lighter tax load after retirement, the gap is even bigger.) Clearly, few Canadians would agree with this savings strategy. If one could live on 45%, why save for 70%? It’s time to go back to the drawing board.
Fred Vettese is chief actuary with Morneau Sobeco.
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