Executive summary
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The economic well-being of retiring Canadians is of interest to governments, individuals, and businesses for a host of reasons. Population ageing, along with fluctuations in the stock market and low interest rates, have fuelled concerns about potentially inadequate retirement income flows, shifts in the level and type of pension coverage, the increasing number of retirees as the baby boom ages, and the financial standing of some private-sector plans.
Concerns about whether Canadians are financially prepared for retirement are longstanding. In most western democracies, old-age income support garnered considerable attention during the 1950s to the 1970s. In Canada, this resulted in the implementation of the Canada Pension Plan in 1965.
At the time, policy analysts questioned the adequacy of the retirement system for retired Canadians. Their focus was both on low income rates, which were high by western standards in the 1960s and 1970s, and on income replacement rates, that is, the extent to which income earned during the working years would be replaced in retirement. With the maturation of private pension plans and the introduction of public pensions, low-income rates among Canadian seniors progressively declined, and are now among the lowest in the industrialized world.
Recent work by the same authors has focused on the size of the income replacement rate. LaRochelle-Côté, Myles, and Picot (2008a) asked whether family income during the working years was in fact maintained during the senior years. That work focused on individuals with "strong attachment" to the labour force, which comprise about 50% of the population aged 55. This paper extends that work to include most Canadians in the study (80% to 85% of the population), whether they have a strong labour force attachment or not.
This paper focuses on the extent to which family income during working years is "replaced" during the retirement years. It does so by tracking different cohorts as they age from their mid-50s to their late 70s, using a taxation-based longitudinal data source, the Longitudinal Administrative Database (LAD), which covers 26 years from 1982 to 2007. The focus of this study is a cohort of individuals aged 54 to 56 in 1983. Their sources of family income and their income levels are tracked until they reach 77 to 79 (in 2006). The family income is adult-equivalent-adjusted (AEA) in order to take account of economies of scale available to individuals who live in larger families. This process adjusts the income for family size, in order to allow for point-in-time (cross-sectional) comparisons and to account for longitudinal changes in family size as individuals age.
For the 1983 cohort, average before-tax family income (AEA family income) falls from about $50,000 in their mid-50s to about $42,000 in their late 60s, and remains relatively stable well into their 70s. When individuals are aged 54 to 56, three-quarters of the family income comes from earnings. By age 77 to 79, when most members of the cohort are likely retired, private pensions account for about one-third of all income, public pensions (including the Canada Pension Plan (CPP)/Quebec Pension Plan (QPP) and Old Age Security (OAS)/Guaranteed Income Supplement (GIS)) for about one-third, and investment income for 14%; earnings continue to generate about 10% of family income.
The extent to which income changes in the retirement years, and the contribution of the components to total income, depends on whether the family is at the bottom or top of the income distribution.
Unlike average income for the population as a whole, average before-tax family income increases with age for people in the bottom quintile, rising from about $19,000 in their mid-50s to $23,000-$24,000 during their mid-60s, and remaining stable to their late 70s. This rise takes place when public pensions (CPP/QPP and OAS/GIS) replace earnings as the main source of income. When individuals are in their mid-50s, earnings constitute about two-thirds of the family income; when they are in their late 70s, public pensions account for 63%, private pensions for 14%, and earnings for about 10%.
Among individuals who are in the middle income quintile in their mid-50s, public pensions continue to play an important role, accounting for 45% of family income in their late 70s; an additional one-third of individuals' income comprises private pensions. Among those who are in the top income quintile in their mid-50s, private pensions become the major source of income 23 years later (accounting for 40% of the total), followed by investment income (20%) and public pensions (18%).
Generally speaking, more recent cohorts have improved their income positions at all ages relative to the 1983 cohort, whether before the retirement years (i.e., in their mid-50s) or in the later retirement years (at age 70 and over). This improvement was driven by both higher earnings and higher private-pension income.
In this paper, a replacement rate measures the extent to which the economic resources available to the individual through income flows (mainly earnings) around age 55 are "replaced" by various sources of income (public and private pensions, investments, as well as earnings) as the individual moves from his or her mid-50s to any given retirement age, such as 78. The AEA after-tax family income available to the "median" individual during his or her 70s was about 80% of that observed when the same person was in his or her mid-50s (a replacement rate of 0.8).
Replacement rates in retirement are negatively correlated with family income. Average replacement rates are 1.1 among individuals in the bottom income quintile, 0.75 in the middle quintile, and 0.7 in the top quintile. In retirement, public pensions and other transfers more than "replace" the income of individuals in the bottom quintile. However, some individuals have very low replacement rates. For example, 20% of individuals in the middle income quintile had replacement rates below 0.6.
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