Planning for Retirement with Reasonable Targets FCAC-OECD Conference on Financial Literacy

Jack M. Mintz Palmer Chair of Public Policy School of Public Policy The University of Calgary What is the Problem?

 Canadian net wealth has almost returned to the 2007 peak.

 Canada has one of the lowest poverty rates for seniors in the world.

 Retirement is supported by  government transfers,  CPP, pensions and RRSPs (TFSAs): $1.9 trillion  home equity: $1.9 trillion  other net financial assets: $2.2 trillion.  Current Canadians do not have much debt at retirement.

 On average Canadians in most income classes have done reasonably well so far with a set back in 2008/9 especially hurting people with DC arrangements. Income replacement needed is lower than 70 percent for most households.

 Most important concern with the 20% or so minority of $30-50k Canadians having adequate retirement income below 60% replacement of working income.

 Is it an under-saving or lifetime income problem? No one really knows.

Planning for retirement May 26, 2011 2 Long-Run Factors May Change Affecting Retirement Income Costs

 Real returns could be higher or lower after this decade. One never knows.  Potential changes to retirement age – people work longer since they expect to live longer but some might want to retire earlier if incomes grow.  Importance of worker productivity increases as capital grows relative to labour. Canada’s recent increase in incomes per capita has improved from 1990s (about 2% of GDP) but this is due to better employment and income gains from terms of trade improvements rather than worker productivity gains (still 1 percent of GDP).  Changes in family structure – more single individuals who will have different lifetime requirement for income and savings.

Planning for retirement May 26, 2011 3 Real Returns on Bonds/Stocks 20

15

10

5

0

1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

-5

-10

Marketable Bonds (1-3yr. Avg) TSE Index (Yearly % change)

Planning for retirement May 26, 2011 4 Defined Contribution Plans leave a lot risk to the individuals – income replacement ratios can vary widely.

Source: Morneau Shepell 50%

50/50 asset mix over 30 yrs, 50% indexing of annuity 45%

40%

35%

30%

DC Pension (% Pension (% of DC Final Pay) 25%

20%

15%

10% 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003 2007

Year of Retirement

Planning for retirement May 26, 2011 5 Risk hurts defined benefit plans too. Changes in the financial situation of pension plans (since December 31th, 2005) Source: Morneau Shepell

135

130

125

120

115

110 Millions of dollards ($M) dollards of Millions

105

100

95

90

Asset ($M) Solvency liability ($M)

Planning for retirement May 26, 2011 6 Equities, per cent of total portfolio 75 Ireland United United States Kingdom

Australia Japan Canada Denmark, 50 Sweden Austria Netherlands Norway Iceland Poland Germany Switzerland Portugal 25 Spain Hungary Mexico Slovak R Czech R 0 -40 -30 -20 -10 0 Real investment return in 2008 (%) Planning for retirement May 26, 2011 7 Risk and The Cost of Pensions

 To avoid risk, one could hold fewer less risky assets as in some countries.  Invest in less risky assets (such as Government of Canada Bonds) but with lower returns.  Make higher contributions and/or accept lower promised benefits. For example,  Normal cost for a DB Plan with reasonable inflation protection would increase by 50% to 70% (cost would be about 30% of payroll for public sector plans).  Liability increases by around 50% depending on maturity of plan (more for active members and less for retirees).  Pensions to achieve targetted replacement incomes simply won’t be as cheap with less risky investments.  But maybe that is okay – replacement income at 70% of final working year income is perhaps beyond what is necessary for many.

8 What Governments Will Worry About

 People having adequate retirement income:  Currently low-income taken care of but some with modest incomes are a concern (10 percent of middle income group once accounting for all net assets held by households).  Pressures to fund health care costs for aging population.  Potential loss of risk-pooling across and within generations with disappearance of defined benefit programs.  Oncoming labour shortages – effect of pension costs on top of rising wage costs. Need for flexible labour markets.  Productivity – future fiscal gaps from public spending related to age and declining tax/GDP ratio with more retired workers.  Competitiveness of Canadian businesses needs capital and skilled labour – impact of taxes on labour costs.

Planning for retirement May 26, 2011 9 Reforms: DC +DB Approaches

 Regulatory  Multi-employer pooled RPP with expanded definition of issue of employer monitoring and contracting arrangements.  Equal tax treatment of Group RRSPs and DC plans.  Others not recommended – pension guarantee funds, public insurance schemes, government-sponsored DC plans.  CPP as a defined benefit plan:  CPP increase – replacement ratio or maximum earnings.  Fully funded approach to avoid intergenerational transfers (benefits match contributions made by employees and employers). Payroll taxes would first rise.

Planning for retirement May 26, 2011 10