Putting a number on retirement dreams

(November 2007) In my last column, I went outside of my economist background and training into some new areas for me, including extolling the virtues of creating a vision for retirement. While I firmly believe in creating a vision and having dreams for retirement, the economist in me always wants to put a number on everything. So this month I’m going back within the comfortable confines of what this column is all about — explaining the economics of retirement.

Putting a number on retirement dreams provides a basis for what is probably the question most often asked of a financial advisor: How much do I need for retirement? If this isn’t the most often asked question, then it must be a close second. Years ago, the magic answer to this question was $1 million. If you could save $1 million, you would be able to lead a great life in retirement. While this was the appropriate amount for some Canadians, the $1 million idea became so pervasive that it ended up as the be-all and end-all for many Canadians planning for retirement.

In an attempt to answer this question, Fidelity decided to take a different approach. Instead of arbitrarily choosing a number for retirement savings for everyone to work toward, we decided to base our research on where Canadians are today to help us understand where they are going. This research formed the basis of the Fidelity Retirement Index, which is the first quantitative measure in Canada of how well Canadians are prepared for retirement. By understanding where you are today in your retirement preparation, you can understand what sort of lifestyle you are on track to have in retirement. And, hopefully, you can take action to improve your preparations.

The index is based on real financial data from more than 2,200 working Canadian households. “Real financial data” means information about current income, pension plan membership, retirement savings, contributions to retirement savings each month and expected date of retirement. The data for each recipient, along with relevant economic and financial market assumptions, was projected to provide estimates of both pre- and post-retirement income, including CPP/QPP and Old Age Security/GIS. The results for each individual were aggregated to produce a national index score and provincial scores for B.C., Alberta, Ontario and Quebec. Regional scores were calculated for Saskatchewan and Manitoba combined and the Atlantic provinces, while city scores were calculated for Vancouver, Calgary, Toronto and Montreal.

So what did the index results show? The index revealed that Canadians are not well prepared at all, with the median Canadian on track to replace just 50% of pre-retirement income. In other words, retirement will mean a 50% pay cut. For some Canadians, this could mean a significant reduction in their planned retirement lifestyle. We know, however, that many Canadians are not planning to downsize their lifestyle in retirement. Even those who aspire to maintain their current lifestyle in retirement will need to replace a significant portion of their pre-retirement income.

Before I cover the index in greater detail, I’ll remind you about the benchmark data on retirement income replacement rates discussed in this column a few months ago. Our research on retirement income replacement rates was prompted by the increasing evidence that many Canadians have no intention of downsizing their lifestyle in retirement. The research concluded that these people will need to replace between 75% and 85% of their pre-retirement income, depending on whether they are single or have a partner, how much of their salaries they save for retirement during their working years and the extent to which they make use of tax-efficient retirement income strategies. The benchmark is in stark contrast to the reality that the median Canadian is on track to replace just half of his or her pre-retirement income.

Looking deeper into the index data, we find some surprising results. The fact that Alberta recorded the lowest provincial/regional score shows that a booming economy and high personal income levels don’t necessarily translate into a high level of retirement readiness.

A second surprise was the high incidence of respondents who plan to use home equity to fund their retirement and who plan to rely on inheritances. The expected reliance on home equity is higher than we have seen in other survey work we have done, and raises the question of whether those expecting to sell their homes have considered their attachment to the neighbourhood and community. Regarding the expected role of inheritances in retirement income, even those with the least financial education might have considered that inheritances can be a risky bet.

The third surprise was the Fidelity Canadian Retirement Index score was significantly lower than that of the Fidelity U.S. Retirement Index, whose most recent score was 58%. While there are many possible reasons, I do believe that Canadians are more complacent in their retirement planning because of the sense that they will be taken care of by government programs. Breaking Canadians of this inertia is a critical step toward increasing Canadians’ preparations for retirement.

One part of the index results was positive for financial advisors. In every age category, Canadians who get financial advice are better prepared than those who do not. Nationally, those who don’t use a financial advisor had index scores of 46%, below the national index score of 50%. Canadians who use a financial advisor had average index scores of 56%, meaning they are relatively more prepared than other Canadians, especially those who do not use an advisor. While it is good to see that Canadians who use a financial advisor are benefiting from advice, an index score of 56% means that there is still work to be done in ensuring Canadians are better prepared for the future.

The Fidelity Retirement Index and the benchmark retirement income replacement data paint a clear picture. Most Canadians are simply not saving enough for retirement. It is our hope that the release of the Fidelity Retirement Index will get Canadians thinking about their retirement and talking with their financial advisors. If enough of them do, the result will be higher scores when Fidelity releases its Retirement Index results next year.

Peter Drake is vice-president, retirement & economic research, for Fidelity Investments Canada. With over 35 years’ experience as an economist, he leads Fidelity’s research efforts in retirement in Canada today. He can be reached at peter.drake@fmr.com.

(11/13/07)