Published in the Financial Post on June 4, 2015
By Malcolm Hamilton
Malcolm Hamilton is a senior fellow at the C.D. Howe Institute and a former partner with Mercer. His paper, Do Canadians Save Too Little?, is published by the Institute.
Canadians frequently read that they borrow too much, spend too much, save too little, retire too early and live too long. The drumbeat intensifies during RRSP season but it is always there in the background, and has been for decades. I cannot remember a time when Canadians were thought to be saving enough.
Our undersaving problem is attributed to many things: financial illiteracy, personal irresponsibility, a lack of foresight and insufficient self-control, to name just a few. The young are accused of being less frugal than their parents, just as their parents were accused of being less frugal than their parents. And so it goes.
The province of Ontario recently cited undersaving as the prime motivation for the Ontario Retirement Pension Plan (ORPP). The province’s concern rests, in part, on two assumptions. First, the household saving rate reported by Statistics Canada, a rate that has plunged from 20% in 1980 to 5% today, is a useful measure of the amount that Canadians set aside each year for retirement. The second is that Canadians need to replace 70% of their employment income to retire with a decent standard of living. Neither assumption is correct.
The household saving rate is not a measure of retirement saving, it is a measure of total saving. The rate takes into account not just the amounts Canadian workers set aside for retirement, but also the amounts withdrawn from retirement accounts by Canadian pensioners and the investment income earned on our accumulated savings.
Between 1990 and 2012, as the household saving rate headed sharply lower, the amounts contributed to retirement savings plans as a percentage of employment earnings headed sharply higher. Contributions are not 4 percent or 5 percent of earnings – they are 14 percent of earnings. They are not falling – they are rising.
The reduction in the household saving rate was caused by:
a significant reduction in saving unrelated to retirement,
a significant increase in withdrawals (mostly pensions paid to retired Canadians) from pension plans and RRSPs, and
a significant reduction in the rate of return on retirement savings (excluding capital gains and losses), from 9.0 percent in 1990 to 3.6 percent in 2012.
If anyone is to be blamed for this it should logically be elderly Canadians for collecting their pensions and central bankers for vanquishing inflation and championing ultra-low interest rates.
As for the 70% income replacement target, it is a reasonable target for those who are prepared to save heavily throughout their working lives to preserve, after retirement, the very high standard of living they briefly enjoy in the years immediately preceding retirement, after their children leave home and their debts are discharged. Those who can live with something closer to the standard of living they enjoyed during most of their working life can retire in comfort on much less.
Even if one believes that Canadians are saving too little for retirement, the ORPP is an ineffective remedy. The cost is too low to make a meaningful difference and the benefits are badly targeted.
For example, with respect to costs, the Ontario Teachers’ Pension Plan (OTPP) currently collects $3.1 billion per annum to provide pensions to 180,000 Ontario teachers – $17,000 per member. The ORPP will collect about $3.5 billion per annum to support 3 million private sector workers– $1,200 per member. The disparity is smaller expressed as a percent of pay – 24 percent for the OTPP versus 3.5 percent for the ORPP – but it is still hard to see how 3.5 percent is going to make a meaningful difference for private sector workers when it takes seven times as much to do the job in the public sector.
Regarding the targeting of benefits, none of the studies mentioned by the province concluded that low-income Canadians are saving too little for retirement. The under-saving problem, to the extent that there is one, is supposed to be for middle-to-high-income workers in the private sector. Yet according to the province’s estimates, one-third of ORPP participants will make less than $15,000 per annum and almost one-half of these will be under the age of 25. The province points out that most of these workers will earn better incomes in the future, but why should workers save for retirement when they are young and poor? Wouldn’t it make more sense for them to save when they are older and better able to afford it?
I believe that Canadians are reasonably well prepared for retirement. Most save more than the 5 percent household saving rate. Most can retire comfortably on less than the traditional 70 percent replacement target. The greatest challenges come early in their adult lives when the burdens of acquiring a home and supporting young children strain the family budget. After that, things get easier.
As studies of our retirement system become more sophisticated, we focus more on the distribution of outcomes and less on the averages. We inevitably discover that while many appear to be saving too much relative to the arbitrary thresholds chosen for these studies, others appear to be saving too little. The size of the group that appears to be “at risk” cannot be accurately determined nor can the attributes of its members be usefully described.
How should we fill the “gaps” identified by these studies? The Canada and Quebec Pension Plans are effective ways to increase the post-retirement incomes of all working Canadians. They are ineffective ways to increase the post-retirement incomes of hard-to-identify minorities who are thought to be saving too little. Their strength is their reach – they can efficiently move everyone to a common goal. But what if there is no common goal? What if there are only individual goals dictated by personal circumstances and priorities?
When studies conclude that gross replacement targets are unreliable measures of retirement income adequacy due to the diversity of our population, they are also concluding that programs like the Canada and Quebec Pension Plans can go only so far in addressing our retirement needs. They can establish a lowest common denominator – a replacement target that all Canadians should strive to equal or exceed. Beyond that, we need bett
