Are you one of the 3.5 million Canadians in for an unpleasant retirement surprise?
Not only has the financial crisis pummelled retirement portfolios, but it turns out that millions of Canadians were making a hash of their retirement planning even before their investments in Chrysler and Lehman Brothers blew up.
The Canadian retirement system—which compares well to many other countries—has three pillars: Old Age Security (OAS), the Canada Pension Plan (CPP), and retirement savings (workplace pensions and RRSPs). OAS is paid for by taxes, while CPP and retirement savings are paid for by employers and workers.
Canada’s ministers of finance, including the Yukon’s premier, met last week to discuss the topic. The good news is that, despite a huge deficit, the government is highly likely to be able to continue paying OAS. Ministers also issued a reassuring press release saying that while the CPP’s investment portfolio has been hit hard in the markets, we can still be confident that it will pay us each a maximum of $909 per month when the time comes.
The news was not so good on the third pillar, workplace pensions and RRSPs. In fact, it was so alarming that the finance ministers punted, asking a gloomy committee of actuaries and economists to study the problem and report back later.
The question is, how many of the roughly 15 million workers in Canada will have an adequate retirement income? And by “adequate,” we mean only 30-50 per cent below the income of the median working person. This is not the comfortable senior lifestyle pictured in insurance company television advertisements involving matching sweater sets and golf vacations with smiling grandchildren.
C.D. Howe Institute research indicates there are four big groups of Canadians, each with a different approach to retirement savings.
The first is the wealthy. About a million Canadians are either rich or have diligently contributed to their RRSPs over the years and are in good shape.
The second group is low-income earners. There are about 5 million workers who earn less than $30,000 per year and have neither a pension nor personal retirement savings. Thanks to OAS and CPP however, these workers will receive a regular income in retirement. The average for a couple is about $28,000 per year. It is tough to make ends meet on $28,000, but in the harsh world of retirement economics this is considered “adequate.” Many of these workers will have retirement incomes that are not dramatically below their working incomes.
Next come the nine million “middle class” workers. Of these, about 5.5 million have workplace pensions. These are mostly government employees, since the number of workers offered pensions in the private sector has been steadily falling since 1991. Fewer companies offer generous “defined benefit” pensions, where employees contribute but the employer takes on the risk of providing a certain level of benefits in retirement no matter what happens with inflation or the stock market. Which leaves 3.5 million Canadians, mostly in the private sector, who rely on RRSPs for their retirement.
The difference between these two groups is surprisingly stark. Canadian pension expert James Pierlot compared two hypothetical middle class couples. Angie and Brad work for the government while Courtney and Dave work in the private sector. All four are the same age, started work at age 28 and earned $50,000 at retirement. Angie and Brad worked 30 years while Courtney and Dave worked four extra years, typical for private sector workers.
At retirement, a typical government pension will give Angie and Brad a nest egg worth $1.2 million, yielding an income of over $50,000 per year for 27 years. Courtney and Dave, representing the average private sector working couple, have only $245,000 in RRSPs yielding $12,000 a year for 23 years.
Clearly, Courtney and Dave are going to suffer a dramatic income reduction when they retire. And the news gets worse. According to Statistics Canada, one- quarter of Canadians in the 55-64 age group headed for retirement are still renting their homes. Of home-owners in this age bracket, about 40 per cent still have mortgages. Rent or mortgage payments will take a big bite out of $12,000 a year.
This underlines the attractiveness of a government job with an old-fashioned pension.
Some people argue that a government pension makes up for the lower salaries in the public sector. Interestingly, however, a Treasury Board of Canada study found that salaries for comparable work were similar in the public and private sectors in 2003, and since then public sector salaries have risen faster than private sector ones.
It also raises the contrast between a paternalistic pension system and the freedom given to Courtney and Dave to decide how much to save for retirement. Behavioural economists have studied how real-world people differ from the rational decision-makers in economic theory; they are overconfident, hesitant about grappling with tough financial issues, and inconsistent in saving even when they have finally made a financial plan.
So what should you do? The first thing to do is a financial plan, assessing your desired income in retirement, your current savings and your age. It will likely involve starting retirement saving sooner, saving more and spending less. It may also mean being smarter about the investments you do have. Statistics Canada says that more than half of RRSPs are invested in mutual funds and income trusts, which often have high fees of two per cent per year or worse.
The gap between Angie and Brad versus Courtney and Dave, however, is too large to be filled in a few years. Courtney and Dave, and quite a few of the 3.5 million middle class private-sector workers, may find themselves working longer and retiring later.
And while our ministers of finance punted on the issue last week, they did make one low-profile technical change to CPP. They added incentives for Courtney and Dave to keep working past age 65.
Keith Halliday is a Yukon economist and author of the Aurore of the Yukon series of historical children’s adventure novels. His next book Game
On Yukon! appears shortly.