Retirement Income Inadequacy Increases Significantly after $150,000
By: Carl Rosen
In a Study for the Institute for Research on Public Policy, No. 17, April 2011, ‘Projecting the Adequacy of Canadians’ Retirement Income,’ Michael C. Wolfson found that “about half of the late baby boom generation with mid-level earnings in working years can expect at least a 25 per cent drop in their living standards by age 70 taking account not only of the public pension system, but also private retirement savings in RRSPs and workplace pensions, and accumulated equity in owner-occupied housing.”
Women especially can expect a further drop when they reach age 80. The study was based on post retirement income replacement rates and average consumption rates utilizing the Statistics Canada Life Path micro simulation model (statistically representative samples numbering in the millions of complete socioeconomic biographies of individuals generating a complete set of overlapping birth cohorts from 1971, onwards which are also used to analyze government policies). The study distinguished between income replacement rates based on the total or gross income before or after retirement where the normal standard is an equivalent income replacement rate of 70 per cent of gross income and the study’s preferred focus on “consumption possibilities of net income where the income equivalency replacement rate is 100 per cent.”
The study found that gross income replacement rates are poor proxies for the replacement adequacy of actual retirement income. A study of the connection between gross and net replacement rates of income at age 70 for the 1960-65 birth cohorts found that “gross replacement rates in the presumed target of 65 to 70 per cent range in reality can be expected to correspond to net replacement rates in the 55 per cent to 100 per cent range.” The study also noted that there was no public policy concern for supplementing retirement incomes for persons earning above $80,000 per year.
The inadequacy of retirement income increased as income increased. The study found that for the 1960-65 birth cohort (currently age 46-51) average declines in net income at age 70 (2030-35) would be 60 per cent or a retirement income replacement rate of net income of only 40 per cent at an average level of $150,000.
Our examination of the income replacement rates of gross income also shows the inadequacy of retirement income replacement rates at annual incomes of $150,000 and above. The inadequacy of retirement income replacement rates for individuals earning $150,000 and above (where the OAS is clawed back) is established by the caps on Defined Benefit pension payments at retirement of approximately $89,000 per year plus the maximum CPP payment of approximately $10,000 per year which would provide a 66 per cent rate of income replacement of a $150,000 income, but only a 33 per cent rate of income replacement at $300,000 of annual income with smaller replacement rates at higher income levels. As the Defined Contribution and RRSP contribution rates are established presumably to result in retirement payments similar to the DB payments, declining retirement income replacement percentage can only be offset by corporations establishing Supplemental Executive Retirement Plans (SERPs) funded and secured utilizing Retirement Compensation Arrangement (RCA) provisions under the Income Tax Act or the individual utilizing income from investments or the proceeds of the sale of investments, other assets, or the family home.
Carl Rosen, BA, B.Litt, LL.B, JD, is vice-chairman of Retirement Compensation Funding Inc.