February 17, 2008
Ensuring your pension won't come up short
By Ellen Roseman
In her book, The New Retirement, economist Sherry Cooper delivers bad news to affluent boomers who expect to live well after they leave work.
Her message: You haven't saved enough. You have to save a lot more.
"Roughly 41 per cent of Canadian households earning $75,000 a year or more might not be able to replace two-thirds of earnings," she says.
"And a whopping 55 per cent of Canadian high-income households have not saved enough to replace 80 per cent of their employment income."
She's talking about the fact that government pensions (Canada Pension Plan and Old Age Security) were never intended to maintain your living standards after retirement.
The richer you are, the more you will need to rely on employment pensions or your own savings.
But not all pension plans are the same. The traditional defined benefit (DB) plan, which covers 33 per cent of Canadian workers, is more valuable.
With a DB plan with inflation protection and long service with your employer, you have no reason to worry.
But if you have a defined contribution plan, watch out. You're unlikely to achieve the same level of financial health in your retirement as a DB plan member.
She gives the example of two people, Dick and Jane, starting their careers at age 25 and planning to retire at 65.
Their starting salaries are $40,000 a year, increasing at a rate of 2.5 per cent a year, and their average annual income over their last five working years is $102,290.
Dick is employed by a bank and covered by a DB plan. He contributes 2 per cent of his salary each year and gets an annual retirement benefit of $51,145.
According to financial planners, it would take 20 times the annual payment – or $1.02 million – to generate an annual income of $51,145 for an indefinite period into the future.
Jane works for an investment bank and has a DC plan. She puts 2 per cent of her income, as Dick does, into a registered retirement account to get a 2 per cent matching contribution made by her employer.
For her workplace savings to reach the same imputed value of $1.02 million, Jane would have to get an average annual return of 10 per cent during her working years.
"This is not likely," says Cooper, who's chief economist at BMO Capital Markets.
Assuming a more realistic 5 per cent return, Jane would have to contribute much more each year to bring her DC plan up to $1.02 million at retirement.
In fact, she has to save an extra 9.8 per cent of her income – on top of the 2 per cent contribution she already makes – to get the matching contributions from her company.
"This, too, is very difficult," says Cooper.
"Saving 11.8 per cent of gross income is quite a hefty chunk. Whichever way you look at it, the DB plan is very valuable, far more so than the DC plan."
The prospect of coming up short is even more acute if you go into retirement without having paid off your mortgage.
Owning your own home makes a big difference, since it's assumed that one-half of the home equity is an asset from which you can generate retirement income.
Cooper's book has hit a nerve. She's on the bestsellers' list and she's speaking across the country.
Her conclusion: If you're a high-income earner without a good pension plan, you have to save more and invest wisely.
Investing wisely means holding 45 to 65 per cent of your portfolio in stocks – both before and during retirement.
This increases the chance of your money lasting as long as you do, which could be 30 years or longer.
Ellen Roseman's column appears Wednesday, Saturday and Sunday. You can reach her by writing Business c/o Toronto Star, 1 Yonge St., Toronto M5E 1E6; by phone at 416-945-8687; by fax at 416-865-3630; or at email@example.com by email
Torstar Syndication Services
Reprinted from Toronto Star, in the "Business" section.