Executive summary
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Population aging and the recent global financial crisis underscore the importance of the discussions of the adequacy of retirement preparation in Canada and the soundness of the Canadian retirement income system. The focus of this study is to examine whether the accumulated private savings of Canadian households is adequate for their retirement, given their expected entitlement to public and private pension when they retire.
The life-cycle optimal savings implied by a life-cycle consumption model provide a normative benchmark level of financial resources required to maintain similar living standards before and after retirement. In this study, the assessment of saving adequacy for Canadian households is achieved by comparing their actual wealth holdings with the optimal savings derived from a realistically calibrated life-cycle model that incorporates household demographics, mortality risk, uncertainty about future earnings and private-pension coverage, the time-varying Canadian tax and transfer system (both federal and provincial), and the public-pension system in Canada.
The life-cycle model adopted in this study is calibrated using the Longitudinal Administrative Databank which provides essential information on life-cycle earnings realization, private pension coverage, and tax and transfer systems. The 2005 Survey of Financial Security is used to document wealth accumulation by Canadian households.
The study finds that a median household aged 60 to 64 in 2005 had a saving surplus of about $73,000 (a positive difference between the observed median wealth and the simulated optimal median wealth implied by the model) and 62% of households aged 60 to 64 in 2005 had accumulated more wealth than the simulated median. This suggests that, in the context of the model, households aged 60 to 64 in 2005 saved adequately overall.
The saving surpluses for households with private pension coverage and couples are the largest, about $158,000 and $172,000, respectively. The saving surplus for the households without private pension coverage is the smallest, about $22,000.
Single households comprise the only group that incurs a saving deficit (a negative difference between the observed median wealth and the simulated median wealth). However, the deficit is not large, at about $30,000.
The same story is told by the shares of households whose wealth exceeds the simulated median wealth. The percentage of households whose wealth is higher than the simulated median wealth is highest for the households with private pension coverage (70%) and couples (72%). It is also slightly above 50% for households without private pension coverage and slightly below for singles.
This study also assesses a potential risk of undersaving for different categories of Canadian households. The adequacy threshold is defined as a point in the wealth distribution above which the actual saving exceeds the simulated target and below which saving falls short of the simulated target.
For all households aged 60 to 64 in 2005 below the bottom 10% of the wealth distribution, the actual wealth is consistently lower than the optimal simulated wealth. However, above (and including) the 25th percentile, actual wealth is consistently higher than the optimal wealth predicted by the model. This threshold appears to be the 23rd percentile in the wealth distribution, which suggests the overall risk of undersaving was low for all households aged 60 to 64 in 2005.
The adequacy thresholds for singles and households without private pension coverage are considerably higher than for all households, at the 60th percentile and 40th percentile, respectively. This suggests a higher risk of undersaving for these two types of households. Couples and households with private pension coverage fare much better, exceeding the simulated targets between the bottom 5th to 10th percentiles.
A series of robustness checks are performed to assess the sensitivity of the main findings to alternative model specifications and sample choice. The overall saving adequacy is largely robust to alternative parameter values and sample choice, although altering a number of assumptions can alter the results. The fraction of households whose wealth exceeds the simulated median wealth is always above 50% across different scenarios, ranging from 51% when only half of home equity is included into the measure of saving to 66% when a lower risk-aversion coefficient is used in the model. Meanwhile, the finding that couples and households with private pension coverage fare much better relative to singles and households without private pension coverage is also robust.
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