Is there any point in saving?

A recent report prepared for the Department of Finance by Keith Horner came to a optimistic conclusion about Canadians' savings levels:

Overall, it appears that about 69% of Canadian households saved in RPPs and RRSPs at rates sufficient to fully maintain their consumption levels in retirement (100% replacement rate). About 78% of households met a lower target consistent with a 10% reduction in consumption at retirement (90% replacement rate).

I read this and was stunned - if you'd asked me to guess the percentage of households that were saving enough for retirement, I would have given a number half the size of Horner's estimates, or less.

But digging deeper, it's possible to find out what is driving these results. It turns out that Canada's retirement system is generous enough that low income Canadians shouldn't bother to save for retirement - they can expect to enjoy as high a standard of living as they have now. This is especially true for parents, whose bills for food and shoes and hot water shrink when kids leave home, so less income is needed to achieve the same standard of living.

According to Horner, any parent earning less than $40,000 does not need to save at all to be as well off when retired as they are at present. Here are his estimates of the percentage of income a two-parent family needs to save in order to maintain their current standard of living upon retirement. The horizontal axis measures household income, the vertical the percentage of earnings that need to be saved:

Target Savings Rate, 1- and 2-earner Family
RPP/RRSP Contribution Rate as a per cent of Earnings Source: Horner, 2009, http://www.fin.gc.ca/activty/pubs/pension/ref-bib/horner-eng.asp

According to Horner (Table 4.3), half of single-earner two-parent families have earnings below $40,000 per year. And even if they're not saving at all, they're saving enough. When they retire, Canada Pension Plan, Old Age Security and Guaranteed Income Supplement will provide a higher standard of living than they enjoy at present.

Comments

[Adam P]

This is a great post, makes me want to move back home.

[Nick Rowe]

Yep. It's paying off the kids and the mortgage. When you get rid of them, life gets a lot easier!

Adam: but will your parents *let* you move back home ;-)

[Andrew F]

I'm not sure what to make of this. David Dodge just finished presenting a report suggesting that Canadians need to save upwards of 15% to maintain their standard of living in retirement. How do we square these? Was Dodge not including the value of the safety net, or not excluding the expenses retirees can avoid, such as mortgage payments and university tuition?

And if we accept the latter methodology, does it make sense to keep your adjusted standard of living the same in retirement? Yes, you don't have mortgage payments, but uninsured medical costs also rise, and that will take a big bite out of your pre-retirement standard of living.

Colour me skeptical... but then, I'm also saving close to an order of magnitude more than I need to be according to the chart.

[Frances Woolley]

Andrew F, I think you're wise to be highly skeptical of most things you read on this subject. I wrote this post in part to show what assumptions underlie some of the more rosy views on Canada's retirement situation, e.g. '69% of Canadians are saving enough'.

On saving more than you need - to be fair, this diagram just shows savings in registered plans (RPPs and RRSPs), and if you're a serious saver you can run out of registered room surprisingly quickly, and if you have kids part of your savings is probably in RESPs also.

The Dodge paper that you mention is available from the CD Howe Institute. This is what the paper actually says:

**Except for the working poor,** Canadians must save a
very high fraction of pre-retirement earnings every year – either through employer plans
or private saving – to provide for reasonably adequate and assured retirement incomes.
􀂄 We estimate that most Canadians, should they wish to retire at age 65 and replace
70 percent of their working incomes, will need to save from 10 to 21 percent of their
pre-tax earnings every year, if they save for 35 years.

So the numbers aren't that different, except that this post makes the point that there are a lot of Canadians who fall into the category of 'working poor.'

The other difference is that the Dodge paper doesn't account for reductions in cost of living when you have kids. Though, to be fair, I don't know if the Horner paper takes into account Canada Child Tax Benefit, which substantially offsets the costs of kids for low income households.

Adam, Nick - childless couples earning below $30,000 also needn't bother to save. Horner reports that 58% of one-earner childless couples earn less than $40K, but not the % earning less than $30K.

[Patrick]

Frances always depresses me.

And After reading Adam's latest blog posts I have to wonder what we'd do with all those savings if people did as Dodge suggests. And I have to wonder what would happen to demand? Presumably, all that money would have to be invested in something, but where? And in what? Money is already pretty cheap, and there's all kinds of idle capacity laying around. There are lots of poor places in the world that need investment and capital, but that has always been true, and little has changed over the decades in places like, oh, the entire continent of Africa. And the Chinese seem hell bent on preventing foreign investment in anything other than export capacity. I can see us all sitting around our chests full of gold, starving and freezing.

[Andrew F]

Patrick: isn't that what Japan is?

[Jeff Gingerich]

Depending on your time horizon, I think it risky to assume the retirement benefits will be as generous or that inflation will remain benign. I plan to save to mitigate the risk.

[Frances Woolley]

Jeff - I agree that its risky to assume the retirement benefits will be as generous. Canada's labour force has become massively polarized over the past 3 decades or so, with many more people who are 'working poor'. When the late boomers retire, a relatively high percentage will have experienced single parenthood, divorce or low wages - so not only will there be lots of retirees, there will be lots of vulnerable retirees eligible for GIS etc.

Saving more is a good idea to mitigate the risk of decreased benefits, but if you're serious about inflation, perhaps you want to run up a whole lot of nominal debts for inflation to wipe out, much like the US government?

Patrick, sorry for depressing you, and I imagine this response hasn't helped. I have a more cheerful post planned, but it may take a few weeks.

[Determinant]

Frances, how much of an issue do you see this polarization of the labour force becoming?

It's not only poor wages, it's poor benefits as well. Companies in the "poor wages" category will at best offer a Group RRSP or Defined-Contribution RPP. In either case the contribution rate is poor and the mutual funds used to implement these plans are often terrible performers. Plus the fact that the funds themselves are poorly sold to "clients" (I hate to call them that, because the workers aren't the real client).

The result is terrible investment performance.

[Jon]

Saving more is a good idea to mitigate the risk of decreased benefits, but if you're serious about inflation, perhaps you want to run up a whole lot of nominal debts for inflation to wipe out, much like the US government?

If people believe that, we're in serious trouble. This really is the dark ages of economic thought; all that hard won knowledge lost.

[Greg]

This is a great question Nick. You ask a lot of good ones with your posts

I think we expect too much from saving. I think we, in our efforts to reward savers "properly" are killing current producers and consumers. My feeling on savers has changed a lot in the last year or so.

Why should anyone expect that whatever consumption they forgo today will be available tomorrow?? It seems its quite easy to show the irrationality of this view. If you want something get it today, there are no guarantees it will be available for tomorrow. Now this is not to suggest that one should never save for future consumption, only that there is a point where the excessive savings become a burden and irrationally putting the concerns of "savers" over current consumers and producers lead to deflationary biases on the economy. The primary argument against any kind of inflationary policy is "It punishes savers!!!! ". GOOD, I say!! Lets get the savers off their butts.

[larry macdonald]

Frances
It seems to me the Horner study suggests the current concern about people not saving enough for retirement is misplaced. Here the retirement and policy wonks are currently beavering away with proposals to increase retirement benefits (e.g. increased CPP premiums) but it all appears rather unnecessary or worse, likely to add to unintended consequences.

[Frances Woolley]

Larry, I personally share Jeff and Andrew F's pessimism, but as Patrick points out, I tend to have a glass-half-empty, pessimistic view of the world. Your interpretation is one that a lot of people would put on the study.

Perhaps where you and I might agree is that the people who are struggling to save enough are not the people at the very low or the very high end of the income distribution but the people in the middle - all those families in Vancouver who are the targets of the radio ads "cash in on the value of your home."

I also really don't know about the proposal to increase CPP premiums.

Determinant, you asked about the income distribution. David Green and Jon Kesselman have a book out from UBC Press on this, but here's a story that gives you a flavour of what's happened in the Canadian economy. When I started work at Carleton in 1990, all of the maintenance was done by unionized employees of Carleton U. Sometime in the mid-90s (I think) maintenance was contracted out. Now they didn't fire the old workers - they kept their unionized jobs until they retired, looking after a smaller and smaller portion of the campus. But any new workers were hired by the outside contractors, with non-union or not-as-generous-union contracts, less security, etc.

This is all a familiar story, but people don't always recognize that it was the younger workers in the 1980s and 1990s who really got hit with the brunt of the economic change, and when those workers hit retirement they'll be the 'working poor' that I've been talking about.

[Roland]

Those workers entering the workforce in the 1980's and 90's also had to participate in a "credentials arms race" in order to obtain sorts of employment which hitherto had not demanded much formal accreditation. This ramped up student debt as these workers paid for their bouts of "lifelong learning" (sort of like tertian malaria.)

Housing prices in major urban areas skyrocketed over the period. Later entrants were penalized.

High divorce rates split young households, in many cases increasing overall living costs--no shared efficiencies).

Having few kids will make members of that generation relatively more dependent on state provision in old age--plus they will have to purchase housekeeping and nursing services hitherto often provided by children for their ailing elderly parents.

To some extent, the financial and property legacies of their prosperous elders will enable that generation to get a foothold in expensive urban housing markets and pay off debts.

However, where such inheritances are lacking, these people will form be the nucleus of a classic proletariat.

[Mick Marrs]

As a Carleton graduate from the early 90s, this is all very depressing.
The dismal science :-). I'm going for a latte at Starbucks ....
Wait, on second thought I better invest that money into my company sponsored Defined Contribution Pension Plan.

BTW, in all seriousness, the percentage of my co-workers that don't understand that there are no guarantees with DCPP is extremely worrying. I don't know if it is pure ignorance or just "hiding their heads in the sand".

We need a better system to manage these company sponsored plans.