C.D. Howe Institute COMMENTARY...Independent • Reasoned † Relevant C.D. Howe Institute The authors wish to thank Keith Horner, Keith Ambachtsheer, Malcolm Hamilton, Steve Bonnar,

C.D. Howe Institute

COMMENTARY

Canada’s Looming Retirement Challenge:Will Future Retirees Be Able to Maintain Their Living Standards upon Retirement?

Kevin D. MooreWilliam Robson

Alexandre Laurin

In this issue...The authors provide insights into Canadians' state of retirementpreparedness, not only across income groups, but also within them.

NO. 317, DECEMBER 2010

PENSION PAPERS

A key question in Canada’s pensions debate is whether Canadians will be able to maintaintheir living standards in retirement, and if policy needs to respond to the risk that some willexperience painful declines.

To date, it has been very difficult to estimate how current trends might affect variousmembers of the population in the long run. In this study, we used LifePaths – a sophisticatedsimulation tool developed at Statistics Canada which integrates a large amount of data on thesocio-economic experience of Canadians – to project consumption before and afterretirement for Canadians who have not yet reached retirement age. In addition to incomefrom public pension programs, LifePaths integrates saving in and income from registeredpension plans (RPPs) and registered retirement savings plans (RRSPs), and also tracks theaccumulation of equity in housing and its support for consumption later in life.

What makes LifePaths particularly valuable is its ability to model time-varying demographicand socio-economic patterns on diversified and representative people of various ages overtime. This study focuses on future retirees’ ability to maintain their pre-retirementconsumption after they cease working – benchmarking each individual’s living standards afterretirement to their situation before it – taking into account the diversity and variability ofincome, taxation, saving, employment, and family situations over a lifetime. Importantly, it gives insights in to state of retirement preparedness, not only across income groups, but also within them.

Consistent with other research, the study finds that Canada’s retirement system has supportedpost-retirement consumption relatively well, especially for lower-income individuals andthose who reached retirement age in the last twenty years. If ongoing behavior and economiccircumstances were to persist indefinitely, however, more Canadians may find maintainingtheir working-life consumption in retirement more difficult. While only about 16 percent ofrecent retirees are in circumstances that imply a substantial reduction in consumption post-retirement, the persistence of recent trends would raise this number over time: 44 percent ofcurrent 25- to 30-year-olds – and a substantial majority of those in the two upper incomequintiles – would risk a marked reduction in their standard of living after retirement. Keyfactors behind this projected increase in risk are the fact that Old Age Security benefits, beingindexed to inflation, are projected to lag productivity-driven increases in earnings and thedeclining share of private-sector workers participating in RPPs. This trend is robust todiffering assumptions within reasonable ranges for future real wage growth, inflation, rates ofreturn, RPP coverage and saving rates.

In short, if existing trends and behavior continue, the number of working Canadians at riskof a significant drop in their living standards in retirement will rise over time. Since, theprojection results vary substantially among generations, earnings groups, and sources ofincome, however, policymakers need to assess how the retirement prospects of various groupswould change in response to reforms that seek to mitigate that risk.

ABOUT THE INSTITUTE

The C.D. Howe Institute is a leading independent, economic and social policy research institution. TheInstitute promotes sound policies in these fields for all Canadians through its research andcommunications. Its nationwide activities include regular policy roundtables and presentations by policystaff in major regional centres, as well as before parliamentary committees. The Institute’s individual andcorporate members are drawn from business, universities and the professions across the country.

INDEPENDENT • REASONED • RELEVANT

THE AUTHORS

OF THIS ISSUE

KEVIN D. MOORE is asenior researcher withStatistics Canada'sModelling Division.

WILLIAM ROBSON isPresident and CEO, andALEXANDRE LAURINis a Associate Director ofResearch at theC.D.Howe Institute.

Rigorous external review of every major policy study,undertaken by academics and outside experts, helpsensure the quality,integrity and objectivity of the Institute’s research.

$12.00ISBN 978-0-88806-824-8ISSN 0824-8001 (print);ISSN 1703-0765 (online)

THE STUDY IN BRIEF

Commentary 317 | 1

Whether Canadians are on apath to maintain theirliving standards in

retirement – taking into accountpublic-pension benefits, benefitaccruals in registered pension plans,and purely individual saving – is thelargely unanswered question inCanada’s pensions debate.

By international standards and, notwithstandingthe recent financial crisis, compared to the past,Canada’s stock of tax-deferred saving in registeredpension plans (RPPs) and registered retirementsavings plans (RRSPs) is large. Whether, incombination with other sources of retirementincome, it is large enough to satisfy Canadians’expectations for living standards in retirement ishard to say, however. Even if we knew what thoseexpectations are, we have typically been forced torely on aggregate, average assumptions aboutpeople’s future employment and earningstrajectories, saving rates, rates of return, andpotential withdrawals to judge what individual oraggregate stocks of assets will be when the timecomes to begin drawing them down.

The uncertainties involved in assessingaggregate retirement savings are an order ofmagnitude worse when it comes to assessing theprospects for subsets of the Canadian population.Statistics Canada’s Survey of Financial Security hasprovided two snapshots in the last 25 years – in1999 and 2005 – of the retirement saving andpension entitlements of people of various ages andincomes. Regular surveys of this type, with largeenough samples, especially if linked to data onindividual earnings histories, would go a long wayto providing the information necessary to evaluatethe adequacy of Canadians’ retirement saving with

more confidence, including that of particularsubpopulations. Unfortunately, no suchinformation exists.

This ignorance matters enormously. There iswidespread concern that Canadians are not savingenough and that their standards of living maydrop significantly in retirement. If rates of returnremain at levels such as we have recently seen onyields on high-quality debt securities, the savingrates needed to achieve standard benchmarks forincome replacement will indeed be very high.1

Yet the aptness of these standard benchmarks ingeneral, or for specific groups, is doubtful, andpolicies to respond to this concern need a betterknowledge base.

This paper employs a new tool – StatisticsCanada’s LifePaths model – to simulate thecareers, lifetime saving, and retirement income ofCanada’s population with a high degree of detailand to project potential consumption possibilitiesfor future retirees. Its focus is on people’s ability toconsume in retirement compared to their actualconsumption during their working lives – thus itis a relative measure that takes each individual’spre-retirement consumption as the standard. Itfinds that, while only about 16 percent of recentretirees are in circumstances that imply asubstantial reduction in their standard of livingafter retirement, the persistence of some recenttrends into the future could result in sizeabledeclines in consumption possibilities as time goesby; in fact, fully 44 percent of current 25- to 30-year-olds are on track to experience a markedreduction in their standard of living afterretirement. The most prominent factors for thisprojected declining trend are the failure of OASbenefits to follow the growth of householdearnings, plus an ongoing trend of fewer privatesector workers enjoying coverage under registeredpension plans.

Independent • Reasoned • Relevant C.D. Howe Institute

The authors wish to thank Keith Horner, Keith Ambachtsheer, Malcolm Hamilton, Steve Bonnar, James Pierlot, Ian Markham, BruceGordon, Jeffrey Orr, and Terri Troy for helpful comments on earlier drafts of this paper. Special thanks also go to Xiaofen Lin, Laurie Plager,Martin Spielauer, Geoff Rowe, and Steve Gribble of Statistics Canada’s Modelling Division and to Michael Wolfson for their contributionsto this line of research; and to Human Resources and Skills Development Canada for its ongoing support of LifePaths’ development. Theviews expressed here are those of the authors. They are not the opinions of Statistics Canada and are not necessarily shared by the C.D.Howe Institute’s members or Board of Directors. The authors from the C.D. Howe Institute take full responsibility for the assumptionsunderlying the central projection scenario used in this study.

1 Dodge, Laurin, and Busby (2010) estimated that most Canadians, should they wish to retire at age 65 and replace 70 percent of theirworking incomes, will need to save from 10 to 21 percent of their pre-tax earnings every year if they save for 35 years.

| 2 Commentary 317

Because Old Age Security (OAS) and theGuaranteed Income Supplement (GIS), alongwith the C/QPP, protect lower-income Canadiansfrom substantial declines in their standards ofliving in retirement,2 the people these trendshighlight as most at risk of sizeable declines inconsumption after they finish work are thosemiddle- to high-income individuals who rely onvoluntary savings to the greatest extent. It alsoturns out, however, that many at the lower end ofthe income spectrum could also be at risk:although the proportion of newly retired seniorsin the lowest pre-retirement earnings quintile whohave consumption-replacement rates of less than75 percent is currently almost nil, theseprojections show that proportion approaching 20percent by 2050.

The sensitivity of projections this far into thefuture to assumptions inevitably makes theseconclusions somewhat speculative. The principalfinding of this study, however – that is, a projectedgradual increase in the proportion of futureretirees likely to experience a significant decline intheir standard of living upon retirement – persistseven with differing assumptions for future realwage growth, inflation, rates of return, RPPcoverage, and future saving rates.

If policymakers judge that risks of large dropsin living standards for various groups in thepopulation constitute a public-policy problem,reforms should address behaviour and outcomesacross much of the earnings spectrum.

Pre- and Post-Work Living Standardsof Currently Retired Canadians

A review of what we know about the relativeliving standards of Canadians who retired in thepast is a reasonable starting point for exploringwhat may happen to currently working Canadians

when they leave employment. In aggregate, thepicture is bright for current retirees.

The incidence of low-income among Canadianseniors is low – some 4 percent of retirees,compared to 13 percent among OECD countrieson average. In addition, the average disposableincome of the Canada’s elderly population is 91percent of that of the total population, which isamong the highest in OECD countries (OECD 2009).

While these measures do not speak to whetherCanadian retirees have been able to maintain theirstandard of living in retirement, a relatively brightpicture also emerges from a recent statisticalanalysis of post- versus pre-retirement incomes ofCanadian families. Using a rich database ofindividuals tracked over a period of 20 years,LaRochelle-Côté, Myles, and Picot (2008) showedthat, on average, lower-income people experiencedlittle change in disposable income as they movedinto retirement. Middle-income individuals wereable to replace about 70 percent of peak after-taxworking-age income, while top earners replacedabout 60 percent on average. Looking at familyincomes, which is appropriate if consumption isshared among household members, they foundthat replacement rates were generally 10percentage points higher.

This same study, however, noted considerablevariation in the retirement income of retirees withsimilar working-life disposable incomes. Amongindividual retirees aged 69–71 with above-averageworking-life income, more than a quarter hadreplacement rates lower than 60 percent. Thoseable to achieve higher replacement rates usuallyrelied on some employment earnings early inretirement (and that raises obvious questionsabout what retirement actually means for suchpeople), supplemented by investment income and,in later retirement, income from private pensions.

That finding highlights another importantdifference in the postwork circumstances ofCanadians with different sources of income.

C.D. Howe Institute

2 We should note that the fact that low-income workers are generally able to replace a high proportion of their working-life consumption inretirement does not imply their standards of living in retirement are any more adequate to their needs than they were in the course of theirworking lives.

Commentary 317 | 3

Ostrovsky and Schellenberg (2009) found that, onaverage, people with no or low RPP coverage werelikely to more than make up for that lack withearnings from employment or self-employmentand with income from non-registered financialinvestments. But these findings demonstrate therisk of relying on average measures when there is alot of variation around the average and thedistribution is not symmetrical. Subsequentresearch (Ostrovsky and Schellenberg 2010),which examined distributions of replacementrates, showed that the typical experience, that is,the median replacement rate, of people with RPPcoverage was significantly better than of thosewithout it.

Is the experience of current retirees a reliableguide to the future? Horner (2009) looked atcurrent saving patterns to estimate what futureincomes in retirement may look like, and hefound that about 30 percent of modest- to high-income households are not likely saving enough toavoid a significant drop3 in their standards ofliving in retirement. While Horner’s work lookedat home equity, small-business equity, and non-registered savings assets, each of which isimportant for some retired individuals (Brown,Hou, and Lafrance 2010; Ostrovsky andSchellenberg 2009), the available data make itdifficult to draw strong conclusions about these factors.

Since Horner’s study relied on a single year ofcross-sectional tax data, it required strongassumptions about the rest of an individual’scareer, both the past and the future; essentially itassumed that an individual’s earnings, RPPcoverage, contributions to RRSPs, and familydemographics in 2006 are fully representative ofhis or her entire career. But one year’s data cannotproperly capture the dynamics and diversity of aperson’s actual life course. Actual retirementincome is a cumulative function of an individual’semployment, earnings, RPP coverage, and

individual savings over an entire career, and thereis often tremendous variability in each of these factors.

Not enough is known about Canadian workers’cumulative retirement saving to date, but theirfuture saving behaviour is even more uncertain. Itis often assumed that current behaviour willcontinue. However, in order to make projectionsof future retirement saving and its adequacy, it iscritical to have an appreciation of the underlyingcohort trends relating to employment, earnings,and saving in various forms; simply extrapolatingcurrent saving outcomes may not be appropriate.

The declining trend in RPP coverage and theshift from defined-benefit to defined-contributionor hybrid plans for those with coverage, forexample, may mean that pensions are more fullyfunded and thus likelier to be paid; however, fromthe individual retiree’s point of view, they makefuture retirement income (rather thancontributions from current workers) sensitive tofinancial-market volatility and investment returns.The recent advent of TFSAs will also very likelyplay an increasingly important role in shaping thesaving behaviour of working Canadians. That isbecause, for many taxpayers, TFSAs are a moretax-efficient retirement-saving vehicle thantraditional tax-deferred accounts (Laurin andPoschmann 2010).

In addition to the deficiencies in our knowledgeabout the existing retirement savings of Canadianworkers, and the uncertainties associated withprojecting their future saving, there are broaduncertainties about the future of the economy,such as wage growth, rates of return, and inflation,as well as uncertainties about future government policy.

Many economists expect that as populationaging restrains the growth of labour supply inyears ahead, GDP growth will be slower than inrecent decades. The demographic shift may alsodepress rates of return on real and financial assets.Firstly, returns on investments are in the long term


3 Defined as the proportion of households likely unable to replace, in retirement, at least 90 percent of estimated consumption pre-retirement(Horner 2009, see Table 4.5).

| 4 Commentary 317

dependent on real economic activity, which againis likely to grow at a slower pace with an ageingworkforce. Secondly, an ageing population alsomeans that the pool of individuals living onretirement income – and thus, on average, netsellers of assets – will expand at a faster pace thanthe pool of younger workers, who are net buyersof assets. This demographic effect on asset marketsmay dampen future rates of return (Takáts 2010).

The LifePaths Model

Statistics Canada’s LifePaths microsimulationmodel provides important insights into thisresearch question and overcomes many limitationsof the existing research. LifePaths can robustlyproject the retirement incomes from public andregistered sources, and home equity, for past and

future retirees and can identify individuals likelyto experience a significant decline in theirstandard of living after retirement. It is also apowerful tool for evaluating the importance of keyrisks and uncertainties.4

LifePaths is a publicly available microsimulationmodel of individuals and families, designedprimarily for analysis and development ofgovernment policies that have a longitudinaldimension. It creates detailed individual lifehistories by using behavioural equations estimatedfrom a wide variety of household survey andadministrative data (described in Box 1). Theresulting synthetic population is representative ofCanada’s population and its historical evolution, isconsistent with available microdata, and has beenconstructed to adequately reproduce aggregatepopulation statistics.

C.D. Howe Institute

4 LifePaths can also explore the impact of various policy changes, including the marginal impact after interactions with the rest of the tax andtransfer system.

LifePaths integrates a tremendous amount of microdata andaggregate data on the socioeconomic experience of Canadians. Key data sources used to develop the model are historicaldemographic estimates of population, immigration, emigration,fertility, and mortality, census microdata from 1971 to 2006,longitudinal Labour Force Survey data from 1976 to 2005, FamilyHistory surveys from 1984 to 2001, administrative data onpostsecondary education, the 1999 and 2005 Survey of FinancialSecurity (SFS), and longitudinal and/or cross-sectional taxation datafrom 1980 to 2007. Many other data sources have also been used toa lesser degree.

For the simulation of retirement income and the determinationof consumption replacement outcomes, an individual’s earningshistory is particularly important. The streams of lifetime saving andthe corresponding accumulation of wealth in an individual's RRSPsand/or RPPs and in the form of home equity are also crucialcomponents of such an evaluation. The key data underlying theequations that produce individual earnings histories in LifePaths area longitudinal version of the 1976-2004 Labour Force Surveys, andcensus data from 1981 to 2001. The resulting earnings historieshave been calibrated and validated using various longitudinal taxdata sources.

The likelihood that a simulated individual accrues benefits in anRPP during his or her lifetime, and the size and characteristics ofthose benefits, are modelled from a number of data sources.

Equations linking the socioeconomic characteristics of individualsand their likelihood and type of RPP coverage have been estimatedfrom the 1999 SFS. The number of individuals accruing an RPPbenefit in a given year, broken out according to birth cohort, age,and earnings, has been established from taxation microdata from1991 to 2006, supplemented by data from the Pension Plans inCanada Survey from 1977 to 2007 The 1971 to 1996 censuses havebeen used to infer trends in RPP coverage for older cohorts.

LifePaths’ modelling of RRSP saving and accumulation relies onlongitudinal tax microdata on RRSP contributions and withdrawalsfrom 1990 to 2001 and on cross-sectional tax microdata from 1968to 2007. Gross market rates of return to various asset classes havebeen taken or derived from Statistics Canada’s CANSIM database,Tables 176-0041 and 176-0043, “Financial Market Statistics.”Differences between gross market rates of return and those actuallyreceived by individuals have been estimated by roughly calibratingaggregate RRSP stocks to be consistent with the SFS for 1999 and2005. The distributions of household RRSP wealth produced byLifePaths have been validated using data from the 1999 and 2005 SFS.

The retirement income received by individuals from RPPs andRRSPs in LifePaths’ simulations has been validated with taxationdata from 1990 to 2006.

LifePaths' modelling of home ownership and home equity relieson 1981 to 2006 census data, linked longitudinal income-tax andproperty-tax assessment data, and the 1999 and 2005 SFS.

Box 1. Data Sources for LifePaths

Sources: Statistics Canada LifePaths Model and authors’ calculations.

Commentary 317 | 5

LifePaths models individual-level fertility,mortality, family demographics, education,employment, earnings, most taxes and transfers(including public pensions), savings in RRSPs andRPPs, and the accumulation of equity in owner-occupied homes. Rather than merely producingaverage results, therefore, it generates a range ordistribution of individual outcomes.

LifePaths models individuals’ retirement incomeand ability to maintain pre-retirement livingstandards for historical retirement cohorts byusing socioeconomic parameters and behaviouralequations estimated from several data sources.These successfully reproduce the actual historicalexperience of individual Canadians in detail andtypically include cohort and period effects. Manyassumptions underlie a projection scenario. Exceptwhere specific alternative assumptions are made, ithas been generally assumed that futuresocioeconomic outcomes are consistent with thecohort trends visible in the most recent data.

LifePaths incorporates considerable detail onthe historical evolution of various retirement-income programs and the income and payroll taxsystems. For these projections, it is assumed thatpublic pensions, and the income-tax and payrolltax systems, including the provisions for RPPs andRRSPs, will remain as currently legislated. Public-pension benefits and many elements of federal andprovincial income taxes (tax brackets, tax credits,etc.) remain indexed to the consumer price index(CPI). The yearly maximum limit for pensionableearnings under the CPP and QPP (YMPE)continues to be indexed to the growth of theaverage industrial wage.

The following assumptions in the projectionscenario chosen for this study are of particular note:

• Real wages will grow at 1.3 percent annually (theassumption for real wage growth made by theChief Actuary of Canada in the most recentActuarial Report of the Canada Pension Plan)(Canada 2010).

• CPI inflation will be 2 percent annually (reflectingthe Bank of Canada’s target).

• There will be a trend to lower private-sector RPPcoverage and a continuing movement fromdefined-benefit to defined-contribution plans inthe private sector.

• Future real-market rates of return of the variousasset classes held by RRSPs and defined-contribution RPPs are based, as a starting point,on their historical averages over the last 72 years –roughly 4 percent in aggregate. In LifePaths,individuals receive a reduced rate of return,reflecting investment-management and other costsand individual-level performance penalties that arenot well understood but are implied by theaggregate data on RRSP pre - retirement tax flows,market rates of return and RRSP wealth in the1999 and 2005 Survey of Financial Security. Thebase assumption is that the net real rate of returnreceived by individuals in the future is roughly 1percent for RRSPs and 2.5 percent for defined-contribution RPPs.5 Note that these are aggregaterates of return: LifePaths actually models portfoliocomposition and rates of return stochastically atthe level of the individual.

• Individuals’ homes appreciate at 2.65 percent(nominal) per year in the future, the midpointbetween the assumptions for nominal inflationand nominal wage growth.

• Most homeowners will reach retirement agehaving largely paid off their mortgages (consistentwith the distribution of home-equity ratios at age65 in the 1999 and 2005 Survey of FinancialSecurity).

We stress that these assumptions produce a conditional projection. If the futuresocioeconomic behaviour of younger workers,including their saving rates, is substantiallydifferent from that implied by historical andcurrent trends, the results could be quite differentfrom those projected in this study. For example,individuals’ saving rates may change as peopleupdate their projections about their ownretirement. We discuss the impact of some


5 LifePaths takes flows of RRSP contributions and withdrawals from longitudinal tax data prior to age 71 and applies net market rates ofreturn to stylized RRSP portfolios to produce aggregate RRSP stocks. Reconciling the resulting RRSP stocks with those in the 1999 and2005 Surveys of Financial Security suggested that rates of return within actual RRSP portfolios were lower than those on the assets of thestylized portfolios. The reasons for this gap are unclear.

| 6 Commentary 317

alternative assumptions, including those for saving behaviour, at the end of the study, under “Sensitivities.”

We should also note limitations with respect tothe treatment of defined-benefit pension plans,including defined-benefit RPPs and the C/QPP.The funding status of these plans is not modelledin LifePaths. Our projections assume that futureemployee contributions and benefit levels willfollow their historical trends and that any changesin employer contributions required to reconcilecontributions and benefits will not affect currentcompensation or income growth. If rates of returnstay persistently low, however, defined-benefitplans, including the C/QPP, would experiencefunding deficiencies. In that case, benefits wouldbe lower than projected, thus loweringconsumption in retirement, and/or contributionswould be higher than projected, which mightreduce pre-retirement consumption.

Benchmarking Living Standards inRetirement

Most discussions of living standards in retirementcompared to those enjoyed during working liferefer to gross earnings replacement. Onecommonly used rule of thumb is that a grossretirement income equal to roughly 70 percent ofgross pre-retirement earnings allows individuals tomaintain their standard of living after retirement.This rule is arbitrary and ignores the substantialdifferences among individuals in the relationshipbetween gross income and consumption. LifePathsfacilitates an attempt to measure individuals’consumption-replacement rates more directly.More specifically, consumption-replacement rateshave been estimated in the following manner.

Consumption-replacement rate=Potential retirement consumption Proxy for actual pre-retirement consumption

Potential retirement consumption is anindividual’s after-tax income, at age 70, fromOAS, C/QPP, the GIS, RPPs, and RRSPs, plusthe “imputed rent” from home ownership and theamortization of 50 percent of an individual’shome equity. It does not include income fromwork: while employment income does support theconsumption of many Canadian seniors, theexplicit focus on living standards after work ceasesprecludes it as an income source. AlthoughLifePaths does not model the timing of retirementper se, underlying trends produce increasinglabour force participation after traditionalretirement age in the future.

Proxy for actual pre-retirement consumption isgross earnings plus imputed rent, less payroll andincome taxes, less net retirement saving in RPPsand RRSPs, less payments of mortgage principal.This is a “prime working age” measure ofconsumption; it averages each individual’s “best”15 years between ages 35 and 60 and is indexedfor inflation.

As noted, both the replacement-rate numeratorand denominator include a measure for imputedrent. People with equity in their homes enjoy aflow of income or consumption services, usuallyreferred to as imputed rent, that should berecognized and included as a source of income orconsumption; this study relies on the approachused by Brown, Hou, and Lafrance (2010) toestimate it. The amount of imputed rent receivedby an individual is a function of the size of his orher home equity; the 50 percent of home equitythat is not already being amortized in thenumerator provides a flow of imputed rent.

Both the numerator and denominator arecalculated on a single-adult-equivalent basis bysumming the values for the two spouses, whereapplicable, and then using an equivalency scale toadjust for family size (spouses plus dependent children).

Under “Sensitivities” we discuss theconsumption-replacement-rate methodologyfurther; we test the sensitivity of the findings tosome alternative choices and assess the omission of

C.D. Howe Institute

Commentary 317 | 7

some elements of saving and net worth from thecalculation of replacement rates.

The use of a proxy for pre-retirementconsumption allows a straightforward target forindividuals to avoid a reduction in their standardof living after retirement, that is, a consumption-replacement rate of 100 percent. Other studieshave typically used thresholds of 100 percent or90 percent in their analysis (Munnell, Webb, andDelorme 2006; Horner 2009). Some wouldconsider full replacement of consumption inretirement from public pensions, registeredsources and home equity as an overambitious goal.Cessation of work ends some expenses, and someargue that, whereas some costs increase with age,the net costs of many activities tend to decline.Moreover, some analyses of the CPI (for example,Rossiter 2005), which we use to convert nominaldollar amounts into real-consumptionpossibilities, suggest that it overstates increases inthe cost of living, which would also justify using amore conservative replacement ratio. The use of amore conservative 75 percent replacementthreshold also provides a counterbalance to thefact that some forms of saving are not explicitlyincorporated into the analysis. Theseconsiderations, plus a sense that declines in livingstandards in retirement need to be significant toraise public policy concerns, leads us to use aconsumption-replacement threshold of 75 percentas a benchmark for potentially disruptive declinesin living standards in retirement.

The next section of the study evaluates theconsumption-replacement outcomes of theCanadian retirement-income system by usingLifePaths. We present results first for recentretirees, that is, those reaching retirement agebetween 2006 and 2010. Then the timeframeexpands to encompass persons reaching retirementage between 1966 and 2050 in order to examinethe historical and projected future evolution ofpotential consumption replacement in retirement.

We look at various consumption-replacementmeasures: average replacement rates, both byspecific source of retirement consumption and

overall, as well as entire distributions ofreplacement rates and the proportion ofindividuals below certain replacement thresholds,with particular emphasis on those with less than75 percent replacement. An examination of thedistribution of replacement rates allows a focus onsubgroups of particular interest – in this case,those individuals at risk of low consumptionreplacement in retirement.

The Projections and Simulations

The 2006-2010 Retirement Cohort

Figure 1 shows the stacked average consumption-replacement rates by source and by pre-retirementearnings decile for recently retired workers, that is,those reaching age 66 between 2006 and 2010.Average total replacement rates for the bottomseven deciles of this cohort equal or exceed 100percent. Average total replacement rates decline aspre-retirement earnings increase; they are well over100 percent for the bottom deciles but fall to 77percent for the top decile. Only average RPPreplacement rates increase with earnings.Interestingly, average RRSP replacement rates arevery flat across most of the pre-retirement earningsdistribution. All public sources of retirementincome and home equity provide replacementrates that fall with pre-retirement earnings.

As noted, average replacement rates obscure theunderlying variability in the replacement rates ofindividuals. This is particularly true for singlesources of retirement income. Figure 2 shows thedistribution of replacement rates from RPPs forrecent retirees with pre-retirement earningsbetween the 60th and 80th percentiles.

Fewer than a fifth of these individuals have RPPreplacement rates of 50 percent or greater. Some 8percent have no family income from RPPs, andthe RPP replacement rates of the remainingindividuals are widely distributed, most fallingbetween 10 and 50 percent.


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C.D. Howe Institute

Pre-retirement Earnings by Decile

Housing Equity RRSP RPP GIS/SPA C/QPP OAS

0-10

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.1-10 10-20 20-30 30-40 40-50 50-60 60-70 70-80 80-90 90-100 100+

Figure1: Stacked Average Replacement Rates by Component and Pre-Retirement Earnings (2006-2010 Retirement Cohort)


Figure 2: Distribution of RPP Replacement Rates by Size (60th-to-80th percentile, 2006-2010 retirement cohort)


Commentary 317 | 9

Figure 3 moves to the distribution of totalreplacement rates for all recent retirees. As onemight expect, individual total replacement ratesare somewhat less variable than those from singlesources of retirement income since one sourceoften offsets others. Nevertheless, significantvariability remains.

More than half of recent retirees appear to becapable of maintaining their consumption afterretirement, and a further sizeable minority areexperiencing only a fairly modest reduction.Overall, roughly five in six individuals appear tohave consumption possibilities of at least 75percent, and four in five of at least 80 percent.6

Cohorts Retiring from 1966 to 2050

Average Replacement Rates

We now turn to historical and projected futuretrends in rates of consumption replacementprovided by retirement income from publicpensions, registered sources and home equity.Figure 4 shows the trends in the average

replacement received from public pensions,broken out by retirement cohort and component.The vertical dotted line divides historical andfuture retirement cohorts. The averagereplacement rate from “all public pensions”increased steadily across cohorts reaching normalretirement age from 1966 to 1988 and peaked in1988 at about 57 percent. It has since declined to46 percent for recent retirees and is projected tocontinue declining for future retirees.

The dominant reason for the downward trendin the “all public pensions” replacement rate is thesteadily declining replacement provided by OASbenefits. The pre-retirement consumption of thesecohorts has increased steadily in real terms overthe past 50 years, a trend that is projected tocontinue (albeit more modestly) thanks toincreasing labour-market participation by womenand assumptions of future wage growth thatoutpaces inflation.

The other trend of particular note is thesubstantial increases in average rates ofreplacement provided by C/QPP for cohortsreaching retirement age from 1966 to 1988;


Perc

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30

20

25

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0under 40 40-50 50-60 60-70 70-80 80-90 80-90 100-125 125-150 150

Figure 3: Distribution of Total Replacement Rates by Size (2006-2010 Retirement Cohort)


6 This finding seems reasonably consistent with those of other studies for recent retirees, notably LaRochelle-Côté, Myles, and Picot (2008)after adjusting for the different replacement measures (i.e., after-tax income replacement versus consumption replacement).

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for these cohorts, this trend more than offset thedeclining OAS replacement rates and producedincreasing “all public pension” replacement rates.This increase in C/QPP replacement rates acrossthese cohorts was caused by the phase-in of fullCPP benefits during the plan’s first decade ofoperation and the equivalent for QPP benefitsover two decades, in combination with rapidexpansions of the YMPE between 1974 and 1986.But for cohorts reaching retirement age since1988, the average C/QPP replacement rate hasbeen gradually declining, a trend which appears toreflect the fact that individuals are entering theworkforce later than previously and leaving itearlier. Average C/QPP replacement rates areprojected to continue declining modestly forcohorts retiring over the next 20 years. Theforthcoming changes in the actuarial adjustmentsfor early or late take-up of C/QPP benefits havenot been modelled.

Similar measures are shown in Figure 5 for theother components of the retirement-incomesystem modelled in LifePaths: RPPs, RRSPs, andhome equity. It should be recalled that thereplacement rate from home equity includes boththe stream of consumption or “imputed rent”received by homeowners and the assumed

drawdown of 50 percent of a homeowner’s equity,amortized over the course of his or her retirement.

Average combined consumption replacementfrom these sources increased steadily over thehistorical period, from a low of some 35 percentfor the earliest retirement cohorts shown to arecent high of 56 percent. However, this trend isprojected to reverse for all future retirementcohorts, with combined replacement ratesdropping steadily and reaching 45 percent forindividuals who reach retirement age in 2050.

Several factors underlie this projected decline.Average RPP replacement rates rose steadily acrosshistorical retirement cohorts, peaking at 30percent for the 2001-5 cohort; they declinemodestly for the most recent retirement cohortand are projected to continue declining for futurecohorts and to reach a floor at roughly 20 percentfor cohorts reaching retirement age after 2040.These trends reflect the observed expansion andthen contraction of RPP coverage of the labourforce over the historical period, as well as theassumption that future private-sector RPPcoverage will continue to decline moderately.

The historical and projected trends in home-equity replacement rates reflect historical trendsand future assumptions for home ownership,home prices, and mortgage debt at retirement.

C.D. Howe Institute

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Commentary 317 | 11

It has been assumed that home-ownership rateswill remain at recent levels, that home prices willincrease annually by the midpoint of inflation (2.0 percent) and nominal wage growth (3.3 percent),and that the majority of homeowners in futureretirement cohorts will reach retirement with littleor no remaining mortgage debt (as did retiredindividuals in the 1999 and 2005 Survey ofFinancial Security).

In part, the historical trend of increasingaverage RRSP replacement rates is due to theongoing maturation of this program after itsintroduction in 1957. Successive retirementcohorts have access to RRSP saving overprogressively larger portions of their careers. Inaddition, annual RRSP participation ratesincreased steadily after the introduction of theprogram, especially in the early to mid-1990s,following a comprehensive reform of RRSP limits.The flattening of average RRSP replacement ratesfor recent and future retirees reflects themoderation in RRSP saving observed in the pastdecade; these projections assume that these recentlevels of RRSP participation will continue into the future.

The average replacement rates from all theseseparate components are stacked in Figure 6 toprovide a comprehensive picture of the trends intotal replacement rates and their composition.

Average total replacement rates increased steadilyacross cohorts retiring in the historical period,peaking at roughly 105 percent for the 2001-5cohort. The average total replacement ratedeclined slightly for the most recent retirees.Integrating existing data on current workers’socioeconomic experience to the present withprojections of the remainder of their lifecourses,based on historical and current trends, yieldssteady and substantial declines in replacementrates for future retirement cohorts, falling toroughly 75 percent for individuals reachingretirement age in 2050.

Distribution of Replacement Rates

Figure 7 compares the distribution of totalreplacement rates for the 2006-2010 retirementcohort with that projected for the 2046-50cohort. The contrast is stark. Only 25 percent ofthe 2046-50 retirement cohort are projected tohave replacement rates from public pensions,registered sources, and home equity of 100percent or greater, compared to 55 percent of the2006-10 retirement cohort. Making reference toour 75-percent benchmark for potentialconsumption replacement from these sources,more than four in ten individuals in the 2046-50


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| 12 Commentary 317

retirement cohort are projected to experience adrop in consumption possibilities larger than 25percent, compared to only about one in sixindividuals in the 2006-10 cohort.

This analysis is extended across all retirementcohorts in Figure 8. Since it is difficult to showthe complete distribution of replacement rates

across many cohorts, we show more summarymeasures, namely, the proportions of individualswith a total replacement rate under three differentthresholds – 100 percent, 75 percent, and 50 percent.

Since, for the reasons elaborated above, aconsumption-replacement rate of less than 100percent does not necessarily indicate a meaningful

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Figure 7: Distribution of Total Replacement Rates by Size and Retirement Cohort


Commentary 317 | 13

fall in living standards, we include this thresholdprimarily as a reference point. As previouslynoted, we see individuals with a consumption-replacement rate under 75 percent as at risk of asignificant decline in their standard of living afterretirement. Individuals with a replacement rate ofless than 50 percent would seem likely toexperience a very substantial drop in theirstandard of living.

For recent retirees, the proportion of individualswith replacement rates under 100 percent isroughly 44 percent. The proportion with less than75 percent consumption replacement is muchsmaller, however, at about 16 percent, and veryfew recent retirees, fewer than 3 percent, havereplacement rates under 50 percent.

The trends in these measures are similar,differing mainly in degree, and they correspond tothe opposite trends seen in average totalreplacement rates in Figure 6. Over most of thehistorical period, as average replacement rates forretiring cohorts were increasing, the proportion ofthese cohorts with replacement rates under thesethresholds fell. For recent retirees, this trend hasstarted to reverse. The proportion of individualsnot meeting a given replacement thresholdincreases markedly across future retirement

cohorts (Figure 8) and at a greater rate than thedecline in average total replacement rates.

The proportion of individuals who appear likelyto experience less than 75 percent consumptionreplacement in retirement is shown broken out bypre-retirement-earnings quintile in Figure 9. Theproportion of individuals below this thresholdincreases substantially as pre-retirement earnings increase.

This finding is not surprising because the publicpension system, which is mandatory and hasnearly universal coverage, provides high levels ofconsumption replacement to individuals with lowpre-retirement earnings. The higher a person’searnings, the more voluntary saving by theindividual (and/or his or her employer) throughRPPs, RRSPs, home equity, or other instrumentsis needed to replace consumption in retirement.

The projected trend of large increases in theproportion of future retirement cohorts with lowreplacement rates holds across the entire pre-retirement earnings spectrum. Over time, the pre-retirement consumption of all cohorts is projectedto rise in real terms, supported by risinghousehold earnings - although they are projectedto increase at a slower pace than in the past 40years. These higher living standards duringworking life will be, on average, more difficult to


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| 14 Commentary 317

replace in retirement. While almost no one in thebottom quintile of the most recent retirementcohort has replacement rates below 75 percent, itis projected that almost 20 percent of the bottomquintile of the 2050 retirement cohort will.

Sensitivities

How sensitive are these findings to some of themethodological choices made and to some of themore significant assumptions made about futuresocioeconomic parameters? Clearly, very largedifferences in methods and assumptions could

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Figure 10: Proportion of Population with Total Replacement Rate <75% by Pre-Retirement Earnings Quintile

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Commentary 317 | 15

produce quite different results. The principalfinding of this analysis – that is, the projection ofsubstantial increases in the proportion of futureretirees with low levels of consumptionreplacement – persists, even with alternativemethodologies and assumptions.

Pre-retirement Standard of Living

A critical methodological issue in designing areplacement-rate measure is the choice of a periodto benchmark pre-retirement living standards.Annual pre-retirement consumption tends to beconsiderably more stable than annual earnings,but it still varies significantly over the life course.Should the retirement-income system be evaluatedby whether it replaces an individual’s peak life-course consumption? This is the standard impliedby many defined-benefit RPPs, which providepensions based on final average earnings. Analternative is to calculate a broader, “career-average” standard for pre-retirement consumption.The approach taken in this study has been toaverage each individual’s best 15 years ofconsumption between ages 35 and 60. Thisexcludes the early portion of individuals’ careers,when their consumption is often much lower thantheir “prime-working-age” consumption, and italso avoids “cherry picking” a small number of anindividual’s years of highest consumption.

Figure 10 tests the sensitivity of the results tothe choice of measurement period for pre-retirement consumption, comparing a narrower“peak- career” measure (best 5 out of the final 10years before retirement) and a broader career-average measure (best 25 out of the final 40 yearsbefore retirement) to the base specification.

Not surprisingly, the incidence of replacementrates below 75 percent is very sensitive to themeasurement period used for pre-retirementconsumption, particularly for cohorts thatexperienced, or are projected to experience,substantial growth in average real wages over thecourse of their careers. By contrast, the trends inhistorical and projected replacement rates are notparticularly sensitive to this methodological

choice. The projected future trend of substantialincreases in the prevalence of replacement ratesbelow 75 percent is not sensitive to differentmeasurement periods for pre-retirement consumption.

Home Equity and Other Non-Registered Wealth

Another critical issue is the treatment of homeequity. In general, there is little controversy over amethodology that expects a retired individual todraw down his or her assets over the course ofretirement, transforming them into streams ofconsumption. There seems also to be littledisagreement that the flow of housing services thathomeowners receive from their homes (imputedrent) should be included in measures of theirconsumption. However, many argue that homesare special, and that it is not appropriate toassume that retirees will sell their homes orotherwise deplete their home equity.

Our consumption-replacement measure reflectsa compromise. We include imputed rent in bothpre-retirement and potential retirementconsumption, and we include the amortization of50 percent of an individual’s home equity in themeasurement of potential retirementconsumption. Figure 11 illustrates the sensitivityof replacement rates to the treatment of homeequity. Clearly, different treatments of homeequity change the overall levels of consumptionreplacement. The trends, both historical andfuture, however, remain intact. (For a discussionof other assets and liabilities that might affect thecalculations, see Box 2.)

For a minority of individuals, inheritances are asignificant source of consumption. Since our focusis on consumption financed by current and pastindividual earnings, we would prefer to removeinheritances from consideration. However, theexisting data do not generally allow us todistinguish between assets funded by saving asopposed to inheritances. LifePaths’ estimates ofassets, particularly housing equity, will partiallyreflect the receipt of inheritances, which may biasour replacement rates upwards.


| 16 Commentary 317

C.D. Howe Institute

Real-Wage Growth and Inflation

We explore the sensitivity of the results toassumptions for the future growth of real wages inFigure 12. The base assumption is that, after atransition period, real wages increase by 1.3 percenta year. This is the base assumption of the ChiefActuary of Canada in his latest report on the CPP(Canada 2010).

We test the importance of this assumption byrunning alternatives with markedly different real-wage growth rates: 0.5 percent and 1.9 percent.Since we are comparing individuals’ consumptionpossibilities in retirement to their actualconsumption during their working years,consumption-replacement outcomes are onlymodestly sensitive to assumptions for real-wagegrowth, especially in the longer term. The trend of asubstantially increasing incidence of replacementrates under 75 percent persists regardless of theassumptions about future changes in real wages.

Because inflation has broadly similar impacts onwages, rates of return, and public pensions,

variations in the assumptions for inflation make verylittle difference to the results. We experimented withinflation rates of 0 percent and 4 percent annually;the impacts were too small to show graphically.

Rates of Return on Saving

We show the sensitivity of future consumptionreplacement in retirement to assumptions aboutfuture rates of return in Figure 13.

The base assumption is that, in aggregate, thefuture real market rate of return for the various assetclasses held by RRSPs and defined-contributionRPPs will be roughly 4 percent. This has been thehistorical average over the past 72 years. Afteraccounting for investment costs, and the individual-level performance penalties implied by the aggregatedata on RRSP wealth in the 1999 and 2005 Surveyof Financial Security, the base assumption is that thenet real rate of return received by individuals in thefuture will be roughly, in aggregate, 1 percent forRRSPs and 2.5 percent for defined-contribution


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Figure 11: Proportion of Population with Total Replacement Rate < 75% by Treatment of Housing Equity and Retirement Cohort


Commentary 317 | 17

RPPs. Individuals do not all receive theseaggregate net rates of return; LifePaths models anumber of sources of individual variation in ratesof return, including differences in portfoliocomposition.

Sensitivity analysis was performed by bothincreasing and decreasing the net rates of returnthat individuals receive by 150 basis points. Notethat this could represent differences in overall

market rates of return, costs, astuteness ininvesting, or combinations thereof.

Not surprisingly, consumption replacement issensitive to the net returns that individuals receiveon their retirement saving, especially in the longerterm (see Figure 13).

Alternative assumptions about future net realrates of return have the effect of altering thesteepness of the projected increases in the


LifePaths does not currently model some components of savings and net worth that would ideally be incorporated into consumption-replacement rates. Elements that are missing include savings and financial assets other than RPPs and RRSPs; non-mortgage debt; and realassets other than owner-occupied homes, such as business equity and recreational real estate.

These missing components will be added to LifePaths as resources permit. In the meantime, their absence is not considered particularlyconsequential. Like the addition of home equity to the analysis in Figure 11, their inclusion will reduce the proportion of individuals in allretirement cohorts with low replacement rates. However, it should do so to a much lesser extent than housing equity, because manyindividuals have significant home equity at retirement, whereas far fewer have substantial assets in these other, omitted sources.Furthermore, initial exploration suggests that projected replacement rates from these sources will decline across future retirement cohorts;their eventual inclusion in the analysis is expected to reinforce, rather than challenge, the findings presented here, namely, the projection thatthe incidence of low consumption-replacement rates for future retirees will increase substantially.

It should be noted that LifePaths does not currently model Tax Free Savings Accounts (TFSAs), a new tax-preferred savings vehicle thathas recently been introduced in Canada. At this point, there are not enough data to support the modelling of TFSAs or to make informedjudgments about their likely long-term impact on future consumption replacement in retirement. TFSAs have the potential to improve thereplacement rates of future retirement cohorts, especially if they motivate significant new saving, rather than merely serving as a substitutefor other forms of saving.

Box 2. Other Assets and Liabilities Potentially Affecting Consumption Replacement in Retirement


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Figure 12: Proportion of Population with Total Replacement Rate < 75% by Future Real Wage Growth and Retirement Cohort


| 18 Commentary 317

incidence of replacement rates under 75 percent,suggesting that retirement-income reforms thatincrease the net return individuals receive canbrighten Canadians’ retirement prospects. Evenrelatively large increases in future net rates ofreturn, however, such as 150 basis points, do notsignificantly reduce the likelihood of lowreplacement rates for future retirees.

Future RPP Coverage

Although the specific results are not presentedhere, future consumption replacement outcomeswere found to be quite insensitive to assumptionsregarding future private-sector RPP coverage.

That variations involving more or less futureRPP coverage in the private sector producedresults similar to those in the base case reflects therelatively low level of RPP coverage in privatesector currently, and the fact that there is anintegrated limit for RPP saving and RRSP saving.

It also reflects the relative inertia of RPP coverage;if, as assumed, decreases in RPP coverageprimarily affect new membership in RPPs, ratherthan existing RPP members, it will take forty yearsor more to be fully-realized in replacement rates.

Future Retirement Saving

The base projections assume that the futureretirement saving of workers will be consistentwith the outcomes and trends in retirement savingobserved in historical data, especially over the lastdecade. The persistence of historical behaviour ina population of workers that, as in ourprojections, looks ahead and sees difficultiesmaintaining their living standards in retirement isopen to question. We therefore tested thesensitivity of our results to some differentassumptions about saving. For simplicity, weexplored scenarios in which, starting in 2011, allindividuals who currently save in RRSPs and

C.D. Howe Institute

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Commentary 317 | 19

contribute to defined-contribution RPPs increasetheir annual contributions by 25 percent, 50percent, or 100 percent.

Higher saving affects both the numerator andthe denominator of our consumption-replacementmeasure, since it lowers consumption duringworking life and raises the income from which tocover consumption in retirement. These impactscombine to produce the results in Figure 14,which shows a modest reduction in the proportion of retirees at risk of seeing a substantial drop inliving standards in retirement with the 25 percentincrease in these forms of saving, and moresubstantial impacts with the 50 and 100 percentincreases. This last – and admittedly less thanrealistic - scenario reduces the share of thepopulation that will have less than 75-percentconsumption replacement by our measuresconsiderably below the base case, but does notstop it from rising relative to the current situation.

Concluding RemarksIn recent years, factors such as declining privateoccupational pension-plan coverage, the financialcrisis, low household saving rates, lower long-termreal rates of return, the aging of the population,and higher life expectancies have raised questionsabout how well Canada’s current and futureworkers will be able to maintain their livingstandards in retirement.

To date, it has been very difficult to estimatehow current trends might affect Canada’s diversepopulation in the long run. In this study, we usedLifePaths – a sophisticated simulation modeldeveloped by Statistics Canada which integrates atremendous amount of data on the socioeconomicexperience of Canadians – to project consumptionbefore and after retirement for Canadians whohave not yet reached retirement age.

Before discussing our main findings, it is worthreiterating a few elements that distinguishLifePaths from alternative methods of analysis.



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Accurately projecting over very long periods oftime – some 40 years in this study – is inevitablyconditional upon the realization of keyassumptions about socioeconomic anddemographic trends. LifePaths is no exception,but what makes LifePaths particularly valuable –and useful in testing the importance of thoseassumptions – is its ability to model time-varyingdemographic and socioeconomic patterns ondiversified and representative samples ofpopulation cohorts over time.

LifePaths also allows the modelling of familyconsumption on an individual basis, reflecting thediversity and variability of income, saving,employment, and family situations over a lifetime.While it does not encompass all non-registeredforms of saving, LifePaths does permit theintegration of housing equity, a key form of wealthfor the majority of Canadians, into the analysis.

Like Mintz (2009), Baldwin (2009), andLaRochelle-Côté, Myles, and Picot (2008), wefind that Canada’s retirement system hassupported post-retirement consumption relativelywell, especially for individuals reaching retirementage in the last 20 years. Since the 1980s, morethan half of retirees may even have seen theirstandards of living go up in retirement – that is,their consumption-replacement rate is higher than100 percent (Figure 8). On average, publicpensions, registered forms of saving, and homeequity would appear to have allowed recentretirees to maintain their average work-lifestandards of living once they retire, and very few modest-income retirees have experienced asignificant drop.

A look at the future, on the other hand, shows a different trajectory. After four decades ofimprovement, the proportion of newly retiredindividuals unable to replace at least three-quartersof their average pre-retirement consumption fromthe sources we model is projected to nearly tripleover the next 40 years (see Figure 9). If currenttrends persist, by the 2046-50 period, about 45percent of workers currently aged between 25 and30 years would not meet our 75-percentthreshold – a jump of nearly 30 percentage points

from those who reached retirement in the last fiveyears. For many Canadians, while this decline inthe proportion of retirees reaching the 75-percentconsumption-replacement threshold does notnecessarily imply an absolute drop in their post-retirement living standards compared to currentretirees – our projections assume generally risingwages and living standards throughout the period– it seems fair to characterise it as a painfuldownward adjustment.

This decline in potential consumptionreplacement would be felt across the entireearnings distribution, including the bottom 20percent, for almost all of whom it has beenstandard practice to assume full consumptionreplacement. In our base case, by 2046-50, nearlyone in five newly retired seniors in the lowestearnings quintile does not meet a consumptionreplacement threshold of 75 percent.

At the upper end of the earnings spectrum - thetop 20 percent – the proportion of earners whomight not achieve our 75-percent benchmark isvery high, exceeding 50 percent for those retiringafter 2025 and reaching nearly 70 percent forthose retiring in 2050.

These findings reflect the fact that, unlike thesituation experienced by cohorts retiring overmost of the past 40 years, when the sources ofsupport for retirement consumption we modelwere becoming stronger, total retirementconsumption possibilities are projected to growvery modestly, and to lag behind the futuregrowth in household earnings.

These numbers are large enough to justify aconclusion that in order to maintain theirstandard of living in retirement, many workersmay require a better balance betweenconsumption before and after retirement. Howthey might achieve that, and how policy mightsupport them, is beyond the scope of this study.We do observe, however, that since the prospect oflow replacement rates increases with eachsuccessive retirement cohort, those currently intheir late 20s and early 30s have the greatest needsin this regard. We also note that, since theprojection results vary substantially among

C.D. Howe Institute

Commentary 317 | 21

generations, earnings groups, and sources ofincome, no one reform option would likely beable to address every situation efficiently. Care isneeded in assessing how the retirement prospectsof various groups, including the time at whichpeople cease work, are likely to change in responseto various policy-reform scenarios.

In short, our results point to an often claimed –but up to now largely unsubstantiated – problem.The level of retirement preparedness of a large

number of working Canadians, particularly in theyounger generations, exposes them to a significantrisk of lower living standards in retirement.Policymakers and private pension providers alikeshould direct their attention to reforms that canmitigate this risk.


| 22 Commentary 317

References

Baldwin, Bob. 2009. “Research Study on the CanadianRetirement Income System.” Prepared for the Ministryof Finance (Ontario). November.

Brown, W. Mark, Feng Hou, and Amélie Lafrance. 2010.“Incomes of Retirement-Age and Working-AgeCanadians: Accounting for Home Ownership.”Statistics Canada Economic Analysis Research PaperSeries. Ottawa. July.

Canada. 2010. Office of the Chief Actuary. “ActuarialReport (25th) on the Canada Pension Plan, as at 31December 2009.” Ottawa: Office of the Superintendentof Financial Institutions Canada.

Dodge, David A., Alexandre Laurin, and Colin Busby.2010. “The Piggy Bank Index: Matching Canadians’Saving Rates to Their Retirement Dreams.” C.D. HoweInstitute e-brief No. 95. March.

Horner, Keith. 2009. “Retirement Saving by CanadianHouseholds.” Report for theResearch Working Groupon Retirement Income Adequacy. December.

LaRochelle-Côté, Sébastien, John Myles, and Garnett Picot.2008. “Income Security and Stability duringRetirement in Canada.” Statistics Canada AnalyticalStudies Branch Research Paper Series. Ottawa. March.

Laurin, Alexandre, and Finn Poschmann. 2010. “Saver’sChoice: Comparing the Marginal Effective Tax Burdenson RRSPs and TFSAs.” C.D. Howe Institute e-briefNo. 91. January.

Mintz, Jack M. 2009. “Summary Report on RetirementIncome Adequacy Research.” Summary report for theResearch Working Group on Retirement IncomeAdequacy. December.

Munnell Alicia, Anthony Webb, and Luke Delorme. 2006.“A New National Retirement Risk Index.” ChestnutHill, MA: Center for Retirement Research at BostonCollege.

Organisation for Economic Co-operation andDevelopment. 2009. “Pensions at a Glance 2009:Retirement Income Systems in OECD Countries.”Paris: OECD.

Ostrovsky, Yuri, and Grant Schellenberg. 2009. “PensionCoverage, Retirement Status, and EarningsReplacement Rates among a Cohort of CanadianSeniors.” Statistics Canada Analytical Studies BranchResearch Paper Series. Ottawa. December.

_____. 2010. “Pension Coverage and Earnings ReplacementRates among Canadian Couples.” Statistics CanadaAnalytical Studies Branch Research Paper Series.Ottawa: July.

Rossiter, James. 2005. “Measurement Bias in the CanadianConsumer Price Index.” Working Paper 2005-39.Ottawa: Bank of Canada.

Statistics Canada. Survey of Financial Security. Variousyears. Ottawa: Statistics Canada.

Takáts, Elöd. 2010. “Ageing and Asset Prices.” Bank forInternational Settlements Working Papers No. 318.Basel: Bank for International Settlements.

C.D. Howe Institute

C.D. Howe Institute Commentary© is a periodic analysis of, and commentary on, current public policy issues. Freya Godard and James Fleming edited the manuscript; Bryant Sinanan and Yang Zhao prepared it for publication. As with all Institute publications, the viewsexpressed here are those of the author and do not necessarily reflect the opinions of the Institute’s members or Board of Directors. Quotationwith appropriate credit is permissible.

To order this publication please contact: Renouf Publishing Company Limited, 5369 Canotek Road, Ottawa, Ontario K1J 9J3; or the C.D. Howe Institute, 67 Yonge St., Suite 300, Toronto, Ontario M5E 1J8. The full text of this publication is also available on the Institute’swebsite at www.cdhowe.org.

Commentary 317 | 23

THE PENSION PAPERS PROGRAM

The C.D. Howe Institute launched the Pension Papers in May 2007 to address key challenges facing Canada’ssystem of retirement saving, assess current developments, identify regulatory strengths and shortfalls, and makerecommendations to ensure the integrity of pension earnings for the growing number of Canadians approachingretirement. The Institute gratefully acknowledges the participation of the advisory panel for the program.

AA DD VV II SS OO RR YY PP AA NN EE LL CCoo--cchhaaiirrss:: Claude LamoureuxFormer President & CEO of the Ontario Teachers’ Pension Plan

Nick Le PanFormer Superintendent of Financial Institutions, Canada

Members:

Keith Ambachtsheer;

Bob Baldwin;

Leo de BeverAlberta Investment Management Corporation (AIMCo);

Steve Bonnar;

Elizabeth Brown,Hicks Morley Hamilton Stewart Storie LLP;

Peter Drake,Fidelity Investments;

Brian FitzGerald,Capital G Consulting Inc.;

Bruce Gordon,Manulife Financial Canada;

Malcolm Hamilton,Mercer Human Resource Consulting Limited;

Bryan Hocking,Association of Canadian Pension Management;

Bill Kyle,The Great-West Life Assurance Company;

Ian Markham,Towers Watson;

Bernard Morency, Caisse de depot et placement du Québec;

Michael Nobrega,Ontario Municipal Employees’ Retirement System;

Jim Pesando,University of Toronto;

James Pierlot;

John Por, Cortex Applied Research;

Tom Reid,Sun Life Financial Inc.;

Jeremy Rudin,Department of Finance, Canada;

Tammy Schirle,Wilfrid Laurier University;

Terri Troy;

Fred Vettese,Morneau Sobeco;

François Weldon,Human Resources and Social Development Canada;

Barbara Zvan,Ontario Teachers’ Pension Plan.

| 24 Commentary 317

NOTES


| 25 Commentary 317

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