Retirement crisis overblown: Hamilton

“If you look below the headlines, there is a lot that we can be proud of,” he said, speaking at the 19th annual Mercer Fearless Forecast symposium. “We have virtually no poverty among senior citizens in Canada — virtually none; a big change from 40 years ago when we started to develop the system that we now have.”

For the broadly defined middle class — those earning between $25,000 and $125,000 per annum — Statistics Canada reports an income replacement ratio of 50%.

“Is 50% replacement a sign of success or is it a sign of failure? We’re mostly taught that at 50% replacement, seniors should be disappointed, disgruntled and will be living miserably. I think that’s a wrong conclusion; I think 50% largely suffices.”

He points out Canadian seniors are, on average, retiring voluntarily before age 65, indicating they’re content with anticipated income levels Interestingly, they continue to save money, despite halving their income.

“When they’re surveyed, 95% of them say they’re happy. That’s a higher percentage than is found among working Canadians,” he points out. “When they’re asked if their standard of living deteriorated or improved upon retirement, 80% say their standard of living is as good, if not better.”

Government programs provide a solid floor for retirement income, but benefits are hardly rich. Fortunately, individual Canadians have stepped up to the plate, tripling retirement savings in real terms over the past 20 years, to about $2 trillion.

“We obsess about any reduction in standard of living when people retire,” he said. “The major reduction in standard of living in Canada doesn’t happen when people retire; it happens much earlier in life when they have children and buy a home.”

Mercer’s own Global Pension Index ranks Canada fourth, behind the Netherlands, Australia and Sweden — countries Hamilton describes as the poster children for defined benefit, defined contribution and state pension plans.

“Then we had Canada, the poster child for the mixed-model, chaotic pension system,” he said. “Given the difficulty in understanding Canada’s retirement system, it said a lot that we managed to come in the top tier.”

While there is much to be proud of, there is always room for improvement for the retirement system, and Hamilton said media pressure will force politicians to enact fresh reforms.

“Before we start any reform in this country, we need to do so with a clear view of what can be achieved, and what can’t be achieved,” Hamilton said.

What Canadians won’t see, he said, is a system that offers large, affordable, secure pensions at stable prices.

“What can be achieved is a system that tries to do that, as best it can, through diversified strategies and takes burdens that arise and distributes those equitably.”

Hamilton points out the current retirement system poses problems for a very small number of Canadians — those in the private sector, middle aged, and with above-average incomes. Reforms to Canada’s pension system need to focus on these affected groups, as broad-based reforms are neither needed nor affordable.

Financial innovation has provided the retirement system with all the tools it needs, he said. What Canadians now are new institutions, which can provide workers with affordable advice on which of these tools is right for them.

At the same time, there needs to be a complementary focus on debt management.

“We need to treat seniors like adults,” said Hamilton. “During my life we’ve tended to pamper seniors. When I was young, we indexed all the government programs because seniors shouldn’t be on fixed income. Thirty years later, I’m reading that we need to give seniors money because they’re all on fixed income. None of them are on fixed income. They’re happy and they’re capable of bearing risk, dealing with disappointment, and are frugal as the day is long. If we’re going to be an older population, we need the older part of that population to be pulling its weight.”

Bad ideas
Hamilton warns reforms cannot be based on an expansion of CPP that’s funded by intergenerational transfers, as this would compound the severity of existing problems.

“Transferring this burden to the small, not terribly wealthy generation following the boomers is not a viable strategy,” he said. A proposal that the CPP be doubled, with those retiring in seven years getting the full benefit while paying almost none of the cost, is “just an embarrassment.”

Reforms that would force poor or younger workers to save more should also be avoided, he said.

Canada’s working poor often find themselves in better financial shape when they retire, thanks to the Canada Pension Plan, Old Age Security and the Guaranteed Income Supplement. A worker earning less than $25,000 per annum before retirement can expect to replace 120% of that income in retirement.

“For them, retirement is the best of times,” Hamilton said.

Forcing younger workers to save more would also be a mistake, as they should be encouraged to pay down debt.

The real problem with retirement planning in Canada, he said, is not on the asset side of the spreadsheet, but on liabilities. The 50% income replacement rate will suffice for most retirees, but only if they retire debt free. Carrying a mortgage on 50% of pre-retirement income is a recipe for misery.

Boomers benefited from the period of high inflation and interest rates, because it let them buy homes at suppressed values while inflation doubled incomes over ten years.

By contrast, young Canadians are taking on massive debt loads at extremely low interest rates. Any increase in those rates will eat into their net worth. Meanwhile, the Bank of Canada has an avowed inflation target of just 2%, which means wages are not likely to skyrocket as they did for boomers.

The upshot of this is the danger of retiring with debt is much higher for today’s 30-year-olds.

Delay benefits ?
Extending the age at which government benefits are available would also be a mistake, but could be considered as reform of last resort.

Tax subsidies for union-sponsored DB plans would create an unfair situation, in which taxpayers would be on the hook for private pensions, while employer-sponsored plans would receive no such guaranteed support.

(01/12/10)