While one expert says replacement rates vary with income and age, another argues the longstanding 70 per cent benchmark doesn’t actually work.
Bonnie-Jeanne MacDonald, director of financial security research for the National Institute on Ageing at Toronto Metropolitan University
Retirement financial security has become critically important with population ageing — now, more than ever, is the time to adopt better measures of how much people need to retire, whether it’s to help people financially plan or evaluate our retirement income systems.
The final earnings replacement rate, usually targeted at 70 per cent, is a longstanding international benchmark. After an extensive literature review funded by the Society of Actuaries in 2009, I couldn’t locate any empirical evidence that it works. That’s to say, there’s no study that shows that, for a sufficient sample of workers who hit the 70 per cent target, living standards are, in fact, approximately maintained after retirement.
So we decided to test it ourselves. Unfortunately, we found this metric to have no predictive power — it didn’t signal better or worse living standards relative to the working life. It doesn’t tell us anything about retirement income adequacy. It’s a superficial metric that never had any empirical evidence and is standing in the way of sound decision-making.
But we still need a way to measure retirement income adequacy. Although my research had established the invalidity of the traditional replacement rate, it wasn’t enough and I was committed to proposing an alternative.
Building from best academic practices, I developed the Living Standards Replacement Rate, which is an evidence-based metric that determines how well a worker’s living standards will be maintained after retirement by calculating how much money they have while they’re still working, compared to how much they’re expected to have to spend in retirement. The LSRR provides a more scientifically valid, robust and understandable answer to the question of retirement income adequacy.
Philip Cross, senior fellow at the Fraser Institute
Most Canadians successfully manage retirement without an income goal because only they know their individual circumstances, which are too diverse for one number to capture.
While the typical recommendation is replacing 70 per cent of pre-retirement income, these rates vary with income and age. Low-income retirees see incomes rise on average due to old-age security and the guaranteed income supplement, while higher-income retirees can thrive on pensions that replace less than half of their income. Income needs also change with age. While spending is often high early in retirement due to travel or other indulgences, most pensioners over age 80 have more frugal lifestyles.
Canadians are demonstrably capable of making good decisions about retirement based on their personal circumstances. They reduce their own savings when governments promise more funding of pensions. They lower spending and raise savings as infirmity increases with age. They have saved more in personal accounts as corporate defined benefit plans virtually disappeared. Some sacrifice pension income to retire early, while growing numbers work past the traditional retirement age of 65. These decisions were made by individuals based on calculations of their own circumstances, not retirement income goals dictated by elaborate models that gloss over diverse individual preferences.
Individual Canadians taking more control over their retirement decisions has generally accompanied higher incomes, lower poverty rates, longer life expectancy and increasing life satisfaction.
Governments and the financial industry actively encourage Canadians to save too much. This is why most Canadians die with too much money in the bank, according to pension expert Malcolm Hamilton.