Securing a comfortable retirement is going to take Canadian employees longer — more than eight years longer — according to a Towers Watson report looking at the effect of changes in capital market returns and annuity purchase prices.
If a 60-year old member of a defined contribution (DC) pension plan wanted to match the retirement benefits of a benchmark DC member in 2007 who retired at 60, after 20 years of contributing, this plan member would need to work until the age of 68 and a half, according to the Defined Contribution (DC) Retirement Age Index.
“It’s not suggesting everybody’s got to work until 68. It’s just it’s going to take a lot more effort — the equivalent of 8.5 years of contributing contributions and continuing investment returns to do as well as the retiree in ’07,” said Michelle Loder, Canadian DC business leader at Towers Watson in Toronto.
The plan member who retired at age 60 in 2007 experienced an annualized average investment return of 7.2 per cent, said Towers Watson. In contrast, a plan member with the same length of contribution history, but who retired in 2012, experienced an average return of 6.3 per cent.
“0.9 per cent may not sound like much but it actually can translate into tens of thousands of dollars that will not be available to the second plan member to secure in retirement income through an annuity,” said Loder. “That means the plan member needs to work longer to make up the difference, contribute more during that delay or be satisfied with less income than their counterpart who retired in 2007.”
It’s about assets and liabilities, said Claude Leblanc, a group benefits and retirement services consultant in Montreal. The stock market is giving roughly a four per cent return, two per cent more than inflation, while low interest rates are having an impact.
“If you are expecting to earn an eight per cent return on a portion of the plan and you are getting only four, you will require almost 50 per cent more money to be able to cover your liabilities,” he said.
“The time, the rate savings and the rate of return — if one of those elements shrinks or changes, you need to adjust the other ones. And most of the employer programs in Canada, sadly, did not adjust the contribution rate and people will have a gap in their expected return over time.”
Plan members are also underestimating what they’ll need, said Leblanc.
“People are not taking time to really understand their situation, even the ones that are under the defined benefit (plan) because they need a significant number of years of service to earn pension income.”
The average Canadian isn’t really aware of what retirement will look like for them, financially or emotionally, said Greg Pallone, managing director of group benefits at TRG, a group benefits provider based in Vancouver.
“It’s kind of an age-old problem that hasn’t really changed because of the financial crisis. All that we’ve really done since 2008 is create more of a concern in the average Canadian’s minds,” he said. “Even members that were on defined benefit plans who knew what their payment would be at their normal retirement age still had no idea what impact that would have on their lifestyle.”
Many people aren’t even aware they need to plan for retirement, said Pallone.
“Most people assume the government will look after them, or the savings they do have will be enough,” he said. “The real concern in Canada is that our debt loads aren’t reducing as we approach retirement. We’ve abused a lower interest rate environment to leverage our lifestyle, forgetting that, at some point, you will retire and if you retire with a debt load of any kind, that’s really the biggest factor that pushes you into basically a sustenance level of income.”
Many plan members don’t know how to make the calculations, said Loder.
“In DC plans, RSPs (retirement savings plans), most people are focused on whether they made or lost money on their investments, which is one tree of the forest but not the whole forest,” she said. “They’re only looking at the movement of the account balance up and down, so they’re not asking themselves the question every year of ‘Am I contributing enough?’”
There’s also the issue of longevity, as people retiring at 60 today could have 25 years of retirement, if not more.
“That’s a lot of continuing management of assets for 25 years, to manage the withdrawals because you have to be able to support your lifestyle but not deplete your assets so quickly that you run out,” said Loder. “In 25 years, the variability of returns can be high and a long-term rate-of-return assumption on that 25-year period doesn’t necessarily equal the last 25-year period rate of return.”
How employers are combating the confusion
In the United States, auto-escalation is helping people better prepare for retirement, but this hasn’t really come to Canada yet, said Pallone. Many employers are waiting to see what changes are made to the Canada Pension Plan (CPP) and pooled registered pension plans (PRPPs).
“We like the fact there’s a lot of dialogue but we’re getting mixed messages and it’s hard to advise plan sponsors on what to do,” he said. “PRPP is going to be a waste of time in terms of better preparing someone for retirement... They’re already underutilizing the RRSP so by putting in another voluntary pooled arrangement, simply because it has lower fees, isn’t going to solve the problem.”
And while there has been greater interest and activity in the use of retirement income projections on pension statements, these can be tricky, according to Pallone.
“When you’re doing projections based on capital accumulations, there’s so many variables at play, you have to make sure the employee understands it’s really just a projection, not a guarantee — not even a really good estimate sometimes — and you counter that with being conservative with the rates of return.”
In the last few years, custodians and insurers have also been customizing employee statements but the disclaimers and footnotes can make some employees gloss over it, said Pallone. Some of the bigger providers are also providing member portals that allow people to do their own projections and include assets that are not in the pension plan.
“If we had a 10 per cent uptake five years ago from an employee group onto an administrator’s portal, that’s doubled in the last couple of years because employees are more engaged now and they want the tools. So they’re out there — employers just have to promote them a little bit better,” he said.
Generally, employers provide more of a tactical type of education rather than a strategic one, said Loder, and sponsors often pay the most attention to investments, with very little focus on contributions or goals.
“It’s kind of backwards and not in the right proportions.”
Part of rethinking plan design could include making the completion of a retirement projection tool part of the enrolment process, said Loder.
“It’s a difficult struggle because financial literacy levels are very low.”
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