No retirement crisis in Canada

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posted December 11, 2013

The upcoming meeting of federal and provincial finance ministers will touch on what's become a politically charged debate about expanding the Canada Pension Plan (CPP). Proponents have tried to convince Canadians they are not saving sufficiently for retirement with some even suggesting we are on the brink of a retirement crisis. These views simply do not reconcile with the available empirical evidence. Thankfully, there's no retirement crisis in Canada.

It's important to clarify how we should think about retirement adequacy before determining whether a problem exists. Indeed, measuring the adequacy of Canada's retirement system can be complicated by divergent definitions and how different sources of income are accounted for.

The income level in retirement needed to maintain living standards is typically lower than one's pre-retirement income. The reasons are complex and precise replacement rates depend on individual circumstances and pre-retirement earnings. Income replacement rates can be as low as 50 to 60 per cent but the rule of thumb among financial planners is between 70 and 80 per cent.

People can maintain their consumption in retirement with less income partly because they spend less on commuting, raising children, and work-related expenses; certain taxes also fall in retirement years (think: payroll taxes). An analysis of adequate replacement rates must therefore reflect these realities.

In this regard, Canada's retirement system is generally achieving adequate replacement rates. In fact, that was the conclusion from an extensive probe the federal and provincial finance ministers commissioned back in 2009. The summary report found: Overall, the Canadian retirement-income system is performing well, providing Canadians with an adequate standard of living upon retirement.

Canada's retirement system consists of three main pillars: government income support programs like Old Age Security and Guaranteed Income Supplement that are paid to eligible seniors regardless of their employment history (pillar one), the CPP (or QPP in Quebec) which is a government-administered pension based on contributions from one's employment (pillar two), and other savings including Registered Pension Plans, RRSPs, and Tax-Free Savings Accounts (pillar three).

Thanks in large part to a generous pillar one, eligible low-income seniors experience relatively high replacement rates of income in retirement. And this pillar partly explains why Canada has one of the lowest rates of senior poverty in the developed world. Let's be clear: expanding the CPP won't help low-income seniors over a replacement rate hurdle.

To the extent that other Canadians are deemed to have lower than desired replacement rates, a key problem is the failure to take a comprehensive view of the resources available to them in retirement. Failing to do so overlooks large forms of savings such as real estate, equity in a business, and financial assets held outside of tax-preferred accounts. Critically, these assets can help supplement income as people downsize their family home, collect investment property income, or sell their businesses.

According to data from the federal Department of Finance, real estate assets (net of mortgages) and other non-financial and financial assets (less consumer debt) account for more than two-thirds of the aggregate assets held by Canadians. Any analysis that ignores these assets misses the lion's share of Canadians' savings.

A recent Statistics Canada study that accounted for the potential income Canadians could derive from such assets found that senior-led households are actually better off than those headed by younger adults. And calculations by actuary Fred Vettese suggest that virtually all Canadian households will achieve adequate replacement rates when these assets are considered. Canadians are clearly more prudent and prepared for retirement than bigger CPP advocates give them credit.

However, to the extent that a small group of Canadians with modest incomes have inadequate retirement income, more research is required to better understand who these individuals are and the factors that contribute to their circumstances. But expanding the CPP is a blunt instrument that would affect all working Canadians. And it would be illogical to impose a compulsory increase to the CPP when the current retirement income system is serving the great majority.

So what problem are CPP proponents trying to fix? The current mix of public programs, employment-based pensions, tax benefits for private savings, and other assets appear to be helping the vast majority of Canadians achieve reasonable living standards in retirement. To the extent that certain cohorts may be saving inadequately, the policy debate should be about targeted measures to address the problem not a one-size-fits-all reform.

As finance ministers prepare to meet to discuss a CPP expansion, they should consult the available evidence which does not support claims of a retirement crisis. Finance ministers should exercise caution and resist pressure to act.

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