Required savings rate to finance retirement
The C. D. Howe Institute published a research paper to address the issue of what fraction of earnings must be saved to provide for an adequate retirement income. In this column I have decided to provide a summary of the report.
The Institute estimated required savings rates for workers at different levels of income and found that: To sustain a 70 per cent replacement of earnings after retirement, high-income earners (annual earnings in excess of $150,000) who plan to retire at age 65 will need to save 21 per centof their gross earnings. This required savings rates does not take into account any CPP premiums paid. The required savings rate will drop to 17 per cent if retirement is postponed to age 67 (due to the higher number of savings years and lower number of retirement years). Conversely, the required savings rate will climb to 25 per cent if retirement is accelerated to age 63. Reduction of the target replacement ratio from 70 per cent to 60 per cent will significantly reduce the required savings rate, but higher income earners still need to save more than lower income earners. The estimated required savings rates at this target replacement ratio level, for retirement commencing at age 67, 65 and 63 respectively, are 14 per cent, 17 per cent and 21per cent. The lower your preretirement earnings level, the lower your required savings rate. For a worker whose earnings level does not exceed $21,056, there is essentially no savings requirement at either the 60 per cent or 70per cent target replacement ratio. (Public government based pensions will take care of the retirement need). For a worker whose earnings level is $51,381 and seeking a 60 per cent target replacement ratio, the estimated required savings rates are only 7 per cent, 10 per cent and 13 per cent for retirement commencing at age 67, 65 and 63 respectively. The three points to remember in this study were firstly the return on investment is assumed to be 3 per cent. The Institute acknowledged that this is a very conservative assumption, given that total real returns (i.e. after inflation) over very long periods is around 4 per cent for a prudent portfolio (60 per cent equity and 40 per cent fixed income). However, they preferred to adhere to this assumption — which may have the effect of biasing upward the required savings rates — to offset possible downward biasing that is inherent in other assumptions.
Secondly the age of retirement and the number of savings years were used in the study. Savings is assumed to begin at age 30, so for retirement at ages 67, 65 and 63 respectively, the number of savings years are 37, 35 and 33. Accordingly, those who start saving later in life will therefore need to save a much higher percentage of their earnings.
Finally, public government based pensions are assumed to continue in their present structure. Thus, CPP/ QPP, OAS and GIS are assumed to continue to provide for an important part (and for lower income workers, even all) of the income needed to meet retirement needs.
Overall, the Institute concluded that, especially for high-income earners, the required savings rates far exceed what individuals actually save in their registered retirement savings plans (RSPs) or what employers contribute to pension plans. Income Tax Act restrictions also mean that the amount that high-income earners may accumulate in their RSPs or in pension plans fall short of the amount required to replace 70 per cent of their working income.
In general, you must find a certified financial planner (CFP) that specializes in retirement planning discussions and prepares various retirement projections. This is particularly important for people who plan to retire early, or clients who seek to preserve their pre-retirement lifestyle and may need to replace more than 70 per cent of their working income. Further discussions can be had with a CFP advisor to augment your retirement nest egg (such as the use of additional savings vehicles like the TFSA and the tax efficient allocation of their investments) in order to help you achieve peace of mind.
For a further discussion around your investment and estate planning issues, contact Neil Mardian, M.Sc. (Mgmt) CFP at 403-504-3026 or neil.mardian@td.com