Capital accumulation plan (CAP) sponsors and members continue to wrestle with the concept of “adequate” retirement income.
Industry experts frequently cite 60% to 80% as an appropriate rule of thumb for gross income replacement. On this basis, Eckler’s Capital Accumulation Plan Income Tracker (CAPit) remains on the low end of this range, at 60.4% in the first quarter of 2015, due to ongoing low interest rates.
However, rules of thumb can be misleading and unhelpful in determining the retirement readiness of CAP members. Recognizing that a single ratio may not be a meaningful measure of retirement income adequacy for all individuals, Eckler worked with Bonnie-Jeanne MacDonald, postdoctoral fellow at Dalhousie University, to adopt her living standard replacement ratio (LSRR) to the CAP world.
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The LSRR measures an individual’s consumption income during different life phases. It does this by closely examining unique economic and personal factors—including family income, marital status, number of children, province of residence, housing costs and healthcare coverage—both before and after retirement. “Consumption income” is the income that is left over for goods and services after taxes, savings, housing costs and insurance premiums are deducted.
“Individuals who retire with an unchanged standard of living are generally content with that outcome. Measuring how consumption income is expected to differ before and after retirement allows plan sponsors to
better understand each employee’s retirement readiness,” says Janice Holman, principal in Eckler’s Toronto office.
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Personal factors have a significant impact on consumption income. For this reason, two different defined contribution plan participants can contribute the same amount to their plan, but have significantly different
LSRR outcomes. The examples below both start with a 10% contribution rate, and identical investment earnings and salary. However, personal factors differ as follows:
- Participant 1 is married with four children, living in rural Nova Scotia, and contributing 100% of healthcare plan premium;
- Participant 2 is single, living in Toronto, and contributing 50% of healthcare plan premium.
The sufficiency of the 60% gross income replacement ratio produced by CAPit as of March 2015 depends on personal factors.
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For the married Nova Scotian, it actually equates to a better living standard in retirement (124% LSRR). But it won’t be enough for the single Torontonian (80% LSRR), who will have a choice of working (and saving) longer, or facing a reduced standard of living.
“With a better understanding of the retirement readiness of their employees, plan sponsors can create targeted, more effective interventions where needed, to better manage their workforce and allow for on-time retirements,” says Holman.