C.D. Howe study sets high retirement savings bar

April 06, 2010

James Daw

There's no "gold standard" retirement before age 60 when David Dodge estimates how much people without civil service pensions need to save.

The former Bank of Canada governor estimates few young workers earning more than $60,000 a year can expect to collect 70 per cent of pre-retirement earnings by 63.

Not under current rules.

Federal civil servants can collect that much after 35 years of work, regardless of how many job promotions they've received. But most high-wage earners outside the inner circle of government are simply shut out by registered retirement savings plan rules.

Dodge and two policy analysts conclude in a paper for the C.D. Howe Institute that Canadians earning more than about $60,000 would need to save more than the 18 per cent of pay per year allowed for RRSPs. That's if they start at age 30 and remain in the same income range through their career.

Yes, they could receive pay hikes slightly higher than the cost of living. But, if they enjoyed big job promotions, their savings rate would have to rise even more outside the 18 per cent RRSP limit.

Dodge, Alexandre Laurin and Colin Busby base their calculations on conservative investment return assumptions: An average of 5 per cent a year, or 3 percentage points more than they expect consumer prices will rise.

They chose a somewhat lower average return than the 4.2 per cent in excess of price inflation over the past 50 years for a portfolio holding 60 per cent stocks, 20 per cent longbonds and 20 per cent short-term treasury bills.

The 3 per cent real return was chosen to compensate for other assumptions that might be overly optimistic. The lower return also allows for the reality that the public pay fees on investments.

The authors also assume that the future retiree would buy a life annuity that would increase his or her annual income by 2 per cent a year.

"Our calculated indicative savings rates rise sharply with income level and (far) exceed what most individuals actually save or what employers contribute to defined-contribution plans," they write.

Actuary Malcolm Hamilton has long argued that a 70 per cent retirement income is an overly ambitious target for most Canadians.

Most will live on much less while they work to raise children, buy a house, contribute to the Canada Pension Plan and to Employment Insurance and save for retirement.

Hamilton argues that 50 per cent is a more realistic income target for retirement. Many Canadians with above-average earnings may not be saving enough to achieve that level of income by age 65.

For example, someone with an income of about $96,000 a year would have to save 11 per cent, age 30 to 65, to enjoy half that income in retirement

"Different Canadians will legitimately make different choices (about how much to save and when to retire)," the commentators write. "But to make smart choices, Canadians – employers, employees and the self-employed – need both adequate information and, most importantly, appropriate vehicles to provide efficient risk-adjusted management of their savings both during working years and retirement."

The analysis of savings rates should serve as a wake-up call for working Canadians. They should not be lulled into saving less, or retiring early, by unrealistic expectations about investment returns.

You may need more to pay future medical and energy expenses.

Policy-makers should consider the data in debating whether Canada needs new options for those with no pensions. They should not assume everything's fine as it is.