Friday, 29 October 2010

Pension Income Shortfall a Problem for Only a Few - Is That So?

Some pundits and politicians like Alberta's Finance Minister Ted Morton oppose the expansion of CPP to give a bigger assured retirement income to Canadians on the basis that it isn't a big problem because it is "... limited to a small sector of the Canadian workforce ..." (as quoted in this News 95.7 report from June this year).

Perhaps he was looking at data such as that in the Retirement Income Adequacy Research Report of December 2009 which was commissioned by the federal and provincial finance ministers. Tables 2 and 3 cite research showing that retired 70-72 year old men and women in 2006 had average income replacement levels from about 70% on up across every single income level. Looks good doesn't it since 70% replacement is the common rule of thumb for maintaining a standard of living. Furthermore, that result holds whether or not the retiree had been a member of a Registered Pension Plan or not and to complete the picture, in all but the highest income quintile, the non-RPP retirees had higher incomes than the RPPs. That's true even when the employment earnings of the non-RPPs (since non-RPPs, unsurprisingly, still are working and have much higher employment earnings) are subtracted. Got that? Retirees without a pension plan had higher incomes. Shocker! What retirement income problem?

As report author Jack Mintz writes, "The results are thus quite striking but need to be interpreted with care." Enter the nit picking detail. Note the word average in the above paragraph. Consider this dumb statement - if you have one foot in the freezer and the other in the oven, then on average your feet are a comfortable temperature. The Stats Can researchers Yuri Ostrovsky and Grant Schellenberg who put together the original data in Pension Coverage, Retirement Status, and Earnings Replacement Rates Among a Cohort of Canadian Seniors realized the hidden danger of using an average and have since done a revealing follow-up in A Note on Pension Coverage and Earnings Replacement Rates of Retired Men: A Closer Look at Distributions (no, they did not look at the detail for women) of July 2010. By looking at the breakdown of replacement income percentage, they found that the non-RRPs had a much higher concentration of men at the low end of the income replacement scale. The RPPs are clumped in the middle of the replacement spectrum. The average came out the same because of an offsetting bunch of non-RPPs at the highest end of the scale. A few rich people counterbalance a bunch of poor people and the average looks the same. The graph below from the study shows this for the middle income group ($45,700 to $58,200 / quintile 3).

If one cares to look, the phenomenon is the same in all three middle income quintiles, covering income of $32,800 to $76,100. In every income group except the very lowest (where OAS and GIS ensure that the bulk of men have pretty close to or more than their pre-retirement income) about half fall below 50% replacement rate of income. 50% replacement must be about the minimum for anyone to maintain a standard of living no matter how modest and probably it isn't near enough at lower income levels. Conclusion: pretty darn close to half the Canadian retired population of men must be unable to maintain their standard of living in retirement. A small sector of the workforce indeed, Minister Morton!

5 comments:

Michael James said...

I don't see why the government should be in the business of paying retirees enough to maintain their lifestyles. It makes more sense for government to focus on guaranteeing a minimum income, which has nothing to do with the retirees' working income. Paying people significantly more than this creates a huge tax burden for those who work.

Anonymous said...

Retirement income "replacement rates" are meaningless, because they only look at income - assets and expenses are not included at all.

If somebody retires with a million dollars in the bank, a brand-new paid-for car, a fully paid-for and well-maintained home, they would have an income of under $20k if the million dollars is earning meager interest in a bank account. By most official measures, that person would be "poor". If their pre-retirement income was $100k/y, the post-retirement "replacement ratio" would be a paltry 20%, and the government would be thinking of him/her as a pauper.

That person, however, would have a good standard of living because ongoing expenses would be quite low. Food, utilities, and shelter costs for a single person can be as low as $10k a year if they own a modest home and prepare their own meals. That leaves around $10k a year for travelling, hobbies, or other "luxuries".

Income doesn't matter. Income "replacement ratios" don't matter. What matters are the expenses relative to the income level.

larry macdonald said...

Agree with Michael James. There are opporunity costs. Benefits here seem rather small compared to benefits that could be realized in healthcare, education etc.

CanadianInvestor said...

MJ & LM, rather than a "government payout" scheme, I view a target income replacement policy, with source deductions to fully fund it, as a method of enforced savings. The reason to have enforced savings, as opposed to voluntary savings, is that only a small minority actually end up doing the saving required to have a good enough standard of living throughout retirement. Taxpayers would not want, I dare say, to be obliged to support later on those who did not save and who chose to live better / consume more early in life.

Anon, what you say about a really low replacement rate is probably achievable, the only thing is it is likely only a small minority who might be in that situation.

Financial Cents said...

Good post. I have to agree with MJ and LM - you need a minimum social safety net and that's it.

My generation, mid-30s now, is going to be in a mess if we are obliged to pay for those who did not save, given the demographics shift. Kinda scary actually...

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