Buck Bond Group

You don’t need 70% to pass: Set a personal retirement income goal

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There is a long-standing urban legend in retirement planning that says the magic number for one’s income replacement target (i.e. earnings at retirement vs. active income just before retirement) should be 70%. Despite little scientific support for it, this number keeps coming up as the ideal standard everyone should target to ensure they can maintain their lifestyle as they transition to their golden years.

Some of the most generous defined benefit pension plans out there were designed with a 70% replacement target in mind: a retirement benefit equal to 2% of your final average earnings, times 35 years of service (what used to be a full career, usually with just the one employer you worked for all your life).

"With top marginal tax rates now exceeding 50% in several provinces, parking half of the retirement savings that compose an RCA isn’t such a bad deal, compared with the alternative of giving more than half to the Tax Man right away." Marc=-Andre Vinson, Canadian IPP / Ottawa Market Leader

“The best advice you as an employer can give your employees is to establish a personal goal to have a better sense of what they should be aiming for.” Marc-Andre Vinson, Principal, Ottawa Market Leader, Wealth Practice

It’s all rainbows and moonbeams up to there, except that this hardly applies to anyone anymore.

Consider this:

  • With fewer than 1 in 4 Canadians in the private sector now participating in a defined benefit plan, more and more reliance for retirement income will come from defined contribution plans and individual savings.
  • Only 30% of workers hold any one job for more than 4 years. Even those who have generous employer-sponsored defined benefit plans today may not have them for their whole career.
  • People generally have a very poor sense of how their savings translate into retirement income.
  • Government-sponsored plans, like Old Age Security and the Canada Pension Plan (even once its recent improvements kick in) will only replace a relatively small part of pre-retirement income – and an even smaller part for those who earn more than the average Canadian.
  • Different lifestyles carry different price tags. Blindly setting a 70% income replacement target completely ignores individual goals and preferences. Some want to travel the world, some to play golf every day, retire to live in Panama, or read by the lake at the family cottage.
  • Lifestyles tend to change as we grow older. Recent retirees tend to spend much more on travel and entertainment than older retirees. The amount of money needed to support these activities tends to decrease substantially with time.

The bottom line? The best advice you as an employer can give your employees is to establish a personal goal to have a better sense of what they should be aiming for. It’s worth the exercise to figure out their own target based on how they expect to spend money once they retire. Even the worst attempt at figuring this out will most likely be better than the lemming-like 70%. Except for low-income earners, people are likely to come up with a lower personal target, especially if they’ve already managed to start squirreling away some money towards retirement. With RRSP assets now in excess of $1B and net home equity over $3B, many Canadians have already begun.

Employers that offer a staff pension plan may feel that they already do their part to assist in their employees’ retirement planning.  They may also be loath to provide any direct advice for fear of potentially attracting liability for the welfare of their future retirees. However, there is a lot of goodwill to be gained by pointing employees in the right direction.

There’s lots of help for them out there: banks, insurance companies and the government all offer free on-line resources. Better still, they can visit a financial planner that has nothing to sell other than professional advice in elaborating a personalized plan that suits each individual’s goals. If it buys peace of mind for a person in retirement, it will be well worth their time and the few hundred dollars in expense. A valuable by-product for the employer is to clearly outline where their responsibility ends and where the employee’s begins.