The U.S. age of retirement is rising as workers stay in careers longer and the age at which government benefits kick in is rolled back. However, working longer doesn’t correlate to an extended life span. In fact, data released last week suggests that American’s quality of health and average life expectancy is declining. According to the journal ‘Health Affairs’, Americans in their late 50s already have more serious health problems than people in same age group 10-15 years prior. This may very well be credited to the higher rates of stress, obesity, and limited access to healthcare throughout the nation.
It is predicted, that by the year 2027, the average age of retirement will jump from 65 to 67. Although this article is prominently US based, we suspect these same trends can be found here in Canada.
In 1990, the RRSP entitlement Factor of Nine formula was created to give non-defined-benefit pensioners a fair shot at accumulating a sizeable tax deferred retirement income through RRSPs. The Factor of Nine formula defined 18% as the maximum amount of annual earned income that could be contributed to RRSPs to provide a comparable retirement income stream to the defined benefit pensions that were offered.
Both interest rates and equity returns were quite healthy in that era, so the 18% factor was tight, but reasonable. I remember when our office was offering 5 year GIC’s at a rate of 9.25% in 1993. Today you would be hard pressed to find a GIC’s paying more than 3% interest.
The authors of “Rethinking Limits on Tax-Deferred Retirement Savings in Canada” argue that this 18% entitlement factor is very outdated due to low investment returns and increasing life spans and living costs. As a result, they speculate people must save nearly twice as much to afford retirement than the factor assumes. The study recommends increasing the annual savings threshold from 18% to 30+% to accommodate for decreased rates of return, and increasing life spans and living expense.
We recently reviewed a couple different pension plans where the employees were receiving a rate of return capped at 2% for the next ten years. These low rates drastically minimize the future income benefit in retirement. For example, $1,000 compounded annually at 2% for the next 30 years would be worth $1,848. However, if you took the same $1,000 at a rate of 6% compounded annually, it would be worth $6,088 at the end of the 30 year term. It is important to understand your pension plan and how it may or may not meet your expectations in retirement.
Bottom line: Spend less than you earn and save the difference, or hope our future government will be able provide you with a comfortable retirement. Please call us if you’d like to ensure you have adequate savings to provide for your future retirement.
C D Howe institute of Toronto issued a new report “Rethinking Limits on Tax-Deferred Retirement Savings in Canada” https://econpapers.repec.org/article/cdhcommen/495.htm