5.8 million working Canadians will see 20% drop in income in Retirement

Almost 6-million working Canadians risk losing the “retirement of their dreams,” according to a CIBC report getting lots of attention today at the Globe & Mail website. CIBC deputy chief economist Benjamin Tal (pictured) says some 5.8 million working-age Canadians will suffer at least a 20% drop in their standard of living once they leave the full-time work force.

The short article is listed as one of the most popular today on the site and has attracted dozens of comments and social media mentions.

Stop me if you think you’ve heard this before but it seems the bank believes the country’s retirement system needs to be reformed as quickly as possible. The most recent move in this direction came from an apparent about-face by the Conservative Government, whose apparent refusal to consider an expanded or “Big” CPP motivated the Ontario government to launch a new retirement system of its own, the ORPP or Ontario Retirement Pension Plan. Then last week, Finance Minister Joe Oliver floated a trial balloon for a “voluntary” expansion of the CPP, which the Hub reprised on the weekend.

Younger middle-income workers with no DB plans at risk

Mr. Tal told the Globe that “it’s not just CPP,” but expressed concern that Canadians still aren’t saving enough money. While many Canadians close to the traditional retirement age of 65 are “on a path to the retirement of their dreams,” Tal’s data also shows millions others, especially younger workers in the middle-income brackets, “are headed for a steep decline in living standards in the decades ahead.”

Tal feels the leading edge of the Baby Boomers are well positioned for retirement but their children may not be, “given the current trend towards lower savings rates and reduced private pension coverage.”  He estimates that for those born in the 1980s, the so-called “Replacement Rate” will be only 0.7. This supposedly implies a “30% drop in their standard of living,” although many financial planners have often argued that it’s only necessary to “replace” 70% of working income to achieve a comparable standard of living once you’re retired.

70% Replacement Ratio may suffice, or 50% for those with lower working incomes

That’s because retirees typically no longer have to pay home mortgages, raise and educate children, pay the costs of commuting or indeed put away large sums into retirement savings itself. Once you stop earning the big bucks you also stop paying the big taxes. In fact, retired actuary Malcolm Hamilton has often argued that a 50% replacement ratio may be sufficient in retirement once those expenses have disappeared, since working Canadians spent so many decades being accustomed to living on relatively little disposable income while bearing all those expenses.

One strange aspect of the Canadian retirement system is that those with relatively low incomes in their working years can easily replace most of that income through Government retirement income programs like Old Age Security and the Guaranteed Income Supplement to the OAS, as well as CPP for those who contributed to it.

High-income earners who spent their careers with employers who sponsored Defined Benefit pensions also have little trouble funding a dream retirement. In my own circle of Boomers in their early 60s, practically the only ones who have fully retired enjoy such DB plans.

Higher-income earners lacking DB plans at risk

Where there’s potential shortfalls are middle-to-high and high-income earners who lack employer DB plans and who are attempting to create their own pensions by converting large RRSPs, Defined Contribution plans, non-registered savings and eventually TFSAs into guaranteed streams of income in old age — generally through purchasing life annuities from an insurance company.

This is the thrust of Moshe Milevsky’s new (international) second edition of Pensionize Your Nest Egg, co-authored with certified financial planner Alexandra MacQueen. It should be required reading for any government or financial types who are considering tinkering further with Canada’s retirement income system: the book’s focus is on what and what does not constitute a “Real” pension, and how those without “real” pensions (i.e. DB plans) can in effect build their own from capital appreciation plans like RRSPs, TFSAs and even employer-sponsored DC pensions.

We at the Hub don’t think we need more DC-like plans like Ottawa’s new PRPPs (Pooled Registered Pension Plans), nor will an expanded CPP be particularly useful if it behaves like another DC plan or RRSP. But if it can act like a real DB plan and provide a guaranteed income for life (as today’s CPP/QPP more or less accomplishes), then it’s certainly a reform we believe should be explored.

More on this in a guest blog later this week.