Trends in Personal Finance
The following trends illustrate how serious the problem of lack of saving for the future has become.
A study prepared by the University of Waterloo claims that two-thirds of households appear not to be saving enough to cover basic expenses in 2030.
In 1999 a study prepared by two Statistics Canada analysts, Maser and Dufour, concluded that 33% of the near elderly would not be able to generate total requirement income equivalent to 67% of their working income.
In a study for the Ministry of Finance in the Province of Ontario prepared by Bob Baldwin it was observed in a study by the Chief Actuary (OCA, 2008) that both men and women are working later and later in life. By 2030 it is expected that 14% of women and 25% of men ages 65 to 69 will be engaged in paid work.
Trends in pension plan coverage
Statcan surveys reveal that over the past two decades the percentage of Canadians covered by employer pension plans has fallen. As of 2008 the percentage of the population covered by defined benefit pension plans had dropped to 29% from 38% in 1992. There has been a marked shift away from defined benefit plans and toward defined contribution plans.
The graphs below show the trend in pension plan coverage in Canada:
Source: Statistics Canada
In a 2009 study by Bob Baldwin entitled “Research Study on the Canadian Retirement Income System”, he concluded that “In the provincial public and near-public sectors, pension plans have been moving away from the classic DB (defined benefit) structure for nearly 20 years, led bythe Ontario Teachers’ Pension Plan.”
This trend may be an acknowledgement of the fact that defined benefit plans are far too expensive and create an unacceptable level of cost uncertainty for the plan sponsors.
Trends in Government Benefits
The Canada Pension Plan (CPP) is designed to replace 25% of pre-retirement earnings up to the yearly maximum pensionable earnings (approximately $51,100 in 2012).
Old Age Security (OAS), on the other hand, pays a flat rate rather than a rate based on contributions. As a result, it replaces a higher percentage of pre-retirement income for low income earners and replaces a lower percentage of pre-retirement income for high income earners. Baldwin’s study found that OAS, on average, replaced approximately 14% of average pre-retirement income.
When you combine CPP benefits and OAS benefits, they are designed to replace approximately 35% of pre-retirement income, but that only applies if you continue working until full benefits are payable. Early retirement has a significant negative impact on these figures.
Over the past few years our Federal Government has been slowly introducing changes to CPP. As mentioned earlier, those who choose to start drawing their CPP before age 65 face a bigger discount in the benefits they receive. On the other side of the coin, delaying your CPP benefits until later in retirement can significantly increase those benefits.
The maximum CPP benefit in 2012 for those who began withdrawing benefits at age 65 was approximately $1012 per month. CPP benefits are indexed (adjusted upward) to compensate for the effects of inflation.
OAS was also scheduled to undergo changes but for now, those changes have been repealed. It was introduced in 1952 to provide income benefits to individuals over the age of 70. The eligibility age was subsequently reduced to 65.
Full benefits are provided to individuals with 40 years of residency in Canada, while those with a shorter period of residency will have that benefit reduced. OAS benefits are also indexed to compensate for the effects of inflation.
The maximum OAS benefit in 2012 was approximately $545 per month.
For high income earners’ OAS benefits, there is a provision where payments begin to be clawed back when your net income reaches approximately $70,000 per year and will be completely clawed back when that income reaches approximately $113,000 per year.
The trend is toward encouraging people to retire later and to rely more and more on their own finances for retirement income.
• Develop your own personal vision for retirement.
• Estimate the income required to satisfy your vision.
• Determine all sources of income available to you in retirement.
• CPP benefits can be reduced by as much as 36% if early retirement is chosen.
• You have to apply to receive your CPP benefits; payments do not begin automatically. OAS benefits usually begin automatically in the month after you turn 65. If you want to defer them to a later age, apply several months ahead of time.
• Inflation has averaged about 2% per year for the past twenty years.
• The rate of return on equities (stock market) has been about 5% per year over inflation for the past fifty years.
• The rate of return on bonds has been about 3% per year over inflation for the past fifty years. You can check the history of inflation in Canada on MoneyPages.
• Investor behaviour has been the biggest single factor contributing to sub-par portfolio performance.
• Use a life expectancy of approximately 90 years of age when planning for retirement.
• Set target values for your portfolio based on what you need to accumulate for retirement and the level of income you will be drawing in retirement.
• Measure your progress on a regular (annual) basis.
• There are two types of employer pension plans; they are defined benefit pension plans and defined contribution pension plans.
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