Retirement hurdles hurting Canadians

We probably all think about retirement throughout our working years. But when do we really take retirement planning more seriously?

Dr. David Foote, author of the demographics best-seller ‘Boom, Bust, & Echo’, spoke at a Russell Investments-sponsored presentation for advisors not long ago and described how the average Canadian saves for retirement. According to Dr. Foote, Canadians are making ends meet in their 20s, saving for their first down payment on a house and having kids (not cheap) in their 30s, paying off debt in their 40s and unfortunately, not really saving for retirement until their 50s.

Based on my experience so far, I would have to agree with Dr. Foote’s prognosis, although I may be a bit ahead of the curve. At 40, retirement has been top of mind lately. However, my anxiety towards retirement was not brought on by age, but rather by the current trends and policies that seem to be making it more and more difficult for us to invest in our future.

Retirees are actually doing quite well. Recent research conducted by Harris Decima on behalf of Russell revealed that only one-quarter of retirees who have been retired for five to ten years are concerned about outliving their money. However, I believe the current saving structure will start to show serious cracks over the coming decades and decrease the percentage of retirees feeling good about their income in retirement. The largest challenges include:

The transition from defined benefit (DB) plans to RSPs and defined contribution (DC) plans; The current RRSP limits.

Pension problems loom

I’m sure we still all have an uncle or aunt with a great pension from their 35 years of service at one company. They seem to have little stress and enjoy their retirement years with passion. But that Cadillac retirement plan will become an increasingly rare situation going forward.

Only three decades ago, almost one in two Canadians in the workforce was covered by a DB plan. Today, that number is one in four and trending downwards. The new vehicle, as we all know, is the DC plan. With DB plans, there is substantial flexibility on funding the plan; with DC plans, there was a limit of $22,000 in 2009. DB plans are managed by professionals who are unemotional about the risks they need to take to meet their goals. With DC plans, employers wash their hands of the investing responsibility, post their contribution and tell their employees – many with no financial education – they will have to manage their own retirement. Investing for retirement has essentially been transitioned from experienced professionals who understand funding, securities, risk and asset allocation to Mr. and Mrs. Smith doing everything themselves.

There are many news stories explaining the unfunded status of pension plans globally. These stories will decline as those covered by DB plans pass on. How are younger Canadians or those not covered by DB plans providing for their retirement? Not too well, according to Statistics Canada. Barely a third of Canadians who were entitled to make an RRSP contribution in 2008 did so, and the total amount contributed was only 6% of what it could have been. These numbers were basically unchanged from 2006 and 2007. The median RRSP contribution in 2007 was $2,780.

Not only are contribution rates less flexible under DC plans, but risk is also limited. A client may tell you they want conservative assets with no risk, but you know if they choose to invest primarily in GICs and government bonds they will not reach their goals. On the other hand, pension managers are only concerned with the assets and liabilities of the plan, and target an asset allocation based on what they need to achieve, not based on an investor’s preference.

The potential penalty an advisor or investment counsellor would face in a case where a client proved the investment professional did not follow their preferences can be significant. The penalty for clients who resist education and advice regarding their needs for their retirement portfolio can be far harsher if they fall well short of their income needs in retirement.

There are solutions to this downloading of responsibility. For instance, the Australian system is the next generation of the DC system I believe we need to look at in Canada. In Australia, an employer makes a contribution to a fund, and the fund’s investment earnings are taxed at 15% (a favoured rate compared to personal income tax rates). The benefit is tax-free if taken at age 60 or later.

Employer contributions can be topped up by employees to a limit of $50,000 a year via a pretax salary sacrifice. After-tax contributions can be added to a limit of a further $150,000. There are also benefits for low-income workers, where the government will match up to 150% of an individual’s contribution to a maximum of $1,500/year to encourage individuals to save. The government provides public pension funds to manage the assets and carry 80% or higher weightings to equities to meet the needs of plan participants.

RRSP limits

Employees in Australia are also allowed to top up their contribution level to $50,000 a year. In Canada, we are allowed half that amount. Is it less expensive to retire in Canada than Australia?

If you read a recent research piece by former Bank of Canada Governor David Dodge, the maximum RRSP contribution levels do not allow higher-income earners to save enough to replace 70% of their incomes in retirement. Let’s take an example of an individual with annual income of $250,000. A $22,000 RRSP contribution rate equates to 8.8% of the individual’s income. According to Dodge, individuals need to save 10%-21% of their pretax incomes each year if they want to replace 70% of their income.

The study compares different replacement ratios and retirement ages. For those who want to retire at age 63 and generate a 70% replacement ratio, any individual who makes over $61,270 will require annual savings of greater than 19%, or 1% higher than the current RSP maximum. For those who make over $150,000, 25% in annual savings is required to replace 70% of income at age 63, or 17% annual savings to replace 60% of income at age 65.

These calculations assume the individuals save consistently for 35 years, which we already know is rare. Individual pension plans (IPPs) may be a possible solution, allowing tax-preferred contributions to fund a plan based on the income requirements of the plan holder(s). This focus on income instead of contribution rates makes far more sense as it factors in the realities of investment returns we all deal with.

If the IPP does not have enough money in it to fund the liability due to poor investment returns, the individual can top up the plan with the required amount of contribution and get a tax credit for the entire amount. Contributors to RRSPs have no such flexibility. The problem is IPPs are not viable for the majority of Canadians and can be expensive to set up depending on the province the individual lives in. Greater flexibility of contribution rates and more focus on retirement income versus contribution rates will move policy in the right direction to ensure successful retirements for Canadians.

It feels a bit better getting some frustrations and ideas about our retirement structure off my chest. Hopefully, this won’t be a futile rant, as I believe the more vocal we are about the issues, the better chance we have of achieving improvements and finding alternative solutions. Now is the time to do whatever we can to spare our clients from what could become a taxing situation for years to come. Speaking of such, don’t even get me started on the HST (Harmonized Sales Tax) – that deserves an entire rant of its own.

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Keith Pangretitsch is the director of private client services at Russell Investments Canada.

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Keith Pangretitsch