The article “100 Is The New 80 And Your Financial Plan Needs To Reflect That” was originally published on Financial Post on October 3, 2017.
Time to face the fact that Canadians are living longer. Can you afford it?
Canadians are living longer. In fact, half of Canadian babies born in 2007 are predicted to still be alive at age 104 according to the World Economic Forum (WEF). Even a 65-year old couple has a 10 per cent chance of one of the two spouses reaching 100 and a 50 per cent chance that one will live to at least age 94.
In the olden days, parents used to just save for university for their kids. Now they are saving for their home down payments. Arguably, they should start saving for their children’s retirement.
Many of my clients roll their eyes or make a joke when I model their retirement plans to age 100. But it is a reality that many Canadians need to plan for and a concern that is a global one.
The World Economic Form released a white paper this summer entitled “We’ll Live to 100 — How Can We Afford It?” They highlighted the challenges to financial security in an ageing society and I will highlight four of the primary challenges identified by the WEF.
The first challenge is increased life expectancies combined with lower birth rates. Today, there are eight workers per retiree, but that number is expected to be cut in half to four working age people per retiree by 2050. A smaller tax base and more people who require government resources like health care is a bad combination.
The solution to me is two-fold and requires individual and government intervention.
On a personal level, Canadians need to acknowledge the statistics that suggest that many of us will live to 100. Cheating the facts is kind of like cheating on a diet. You are probably the only one who is going to lose (or gain, as the case may be). Financially, you should plan for a long life expectancy by proactively engaging in retirement planning and by consciously ensuring you save enough for your future.
Federal and provincial governments also need to encourage policies that encourage young immigrants to come to Canada, encourage Canadians to have children and encourage all of us to save for retirement.
The second challenge highlighted by the WEF is a lack of easy access to pensions. In Canada, nearly three-quarters of employees between 25 and 54 have no company pension. Even if a Canadian receives the maximum Canada Pension Plan (CPP) and Old Age Security (OAS), these government pensions would total $20,375 currently and the average combined pension is less than three-quarters of the maximum — just $14,732.
If we look abroad, there are lessons to be learned from countries like the United States and the United Kingdom.
In the U.S., two-thirds of workers were enrolled in defined contribution pension plans in 2016, compared to about one-third of Canadian workers in any type of registered pension plan (defined benefit or defined contribution). U.S. Social Security also pays up to $31,668 U.S. per year — nearly double the maximum combined CPP and OAS pensions of a Canadian retiree factoring in foreign exchange.
In the U.K., nearly half a million employers have signed up for the National Employment Savings Trust (NEST), a mandatory workplace pension scheme that has been set up by the government. Plan members pay a fee of 1.8 per cent on their incoming contributions plus an additional 0.3 per cent management fee for their invested funds, such that combined fees are generally 0.5 per cent or less. This compares to the average balanced mutual fund management expense ratio (MER) in Canada of 1.82 per cent, which is how many Canadians without pensions would have their retirement funds invested.
Obviously, Canada cannot play catch-up overnight. But we may be falling behind other industrialized countries.
The third challenge is a long-term low-growth environment. The WEF pegs expected future stock returns at five per cent and bonds at three per cent — well below long-term averages. A balanced portfolio has returned eight to nine per cent over the past 30 years, but may only return four to five per cent over the next 30 years. They also reference high fees negating investment growth as a risk and Canada has long had amongst the highest investment fees in the world.
Canadian investors need a healthy stock exposure to avoid outliving their savings and reasonable expectations about investment returns. Having too much money invested too conservatively or having too much faith in high future returns are both risky retirement strategies.
The investment industry needs to continue to find ways to offer low-fee products, particularly to those with smaller investment portfolios. Canadian robo-advisers have done a great job in this regard and fin-tech innovation needs to be encouraged.
The fourth WEF challenge is an inadequate savings rate. DC plan contributions frequently fall short of required annual savings, which they peg at 10 to 15 per cent of income. The household savings rate in Canada has averaged about 7.5 per cent since 1981 and was most recently 4.6 per cent in the second quarter of 2017 according to Statistics Canada.
The WEF estimates that the Canadian retirement savings gap will increase from $3 trillion in 2015 to $13 trillion by 2050. That’s a 5 per cent annualized increase in the gap. The interesting thing about the Canadian savings shortfall is that individual savings and unfunded corporate pension promises are not highlighted as the main contributors to the gap. In fact, more than 90 per cent of the shortfall is identified as being unfunded government and public employee pension promises.
This means OAS, an unfunded government pension plan, could become very costly for future governments or even just outright unsustainable. Stephen Harper’s Conservatives had followed a global trend with government pensions and implemented a phased-in delay in OAS eligibility to age 67. Justin Trudeau’s Liberals promptly cancelled this upon taking office and have left OAS pension eligibility at age 65.
Government employee pensions are going to be a problem as well. If the cost of funding these pensions has been underestimated, as the WEF suggests, something has got to give. Either future taxpayers and governments are going to bear a huge burden to pay civil servant retirees who live to 100 or government employee pensions need to be reformed now to reflect the fact that retirees are living longer. When pension promises that were meant to make 20 years of payments need to sustain 40 years instead, formulas and contributions may need to be revisited.
Canadian centenarians who live to or beyond age 100 will become more common in the future. If we are going to successfully ensure that we and our children can be financially independent to a ripe old age, we need to consider factors that tilt the scales in our favour. This will require both personal and government initiative. And much like compound interest can benefit savers, a lack of interest in our increasing longevity can compound in a negative way if we don’t start planning for it.
Jason Heath is a fee-only Certified Financial Planner (CFP) and income tax professional for Objective Financial Partners Inc. in Toronto, Ontario.