4 Trends in income levels after retirement

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We begin by examining the evolution of income levels among a single cohort of workers over two decades. For this purpose, we use our first cohort of workers aged from 54 to 56 in 1983, and we examine the evolution of their average family adult-equivalent-adjusted (AEA) income after taxes over 20 years. We also calculate separate results for individuals that were in the bottom, middle and top quintiles of the 'permanent' income distribution in 1983. The objective is to provide a sense of whether the level of living standards enjoyed prior to retirement are maintained later in life.

The results for this cohort are shown in Figure 1. Average family income reached a peak of $45,600⁶ at age 60 and then fell sharply to $38,600 by age 64. Average income rises slightly at age from 65 to 67, declines over the next three years, and then stabilizes after age from 67 to 69.

In contrast, income did not decline among individuals in the bottom quintile after age 65 (Figure 2), but income levels in the bottom quintile were relatively low to begin with. Individuals in the bottom quintile had incomes of approximately $22,000 per year in almost every year of the panel.

Incomes in the middle quintile income remained stable until age from 59 to 61 ($39,100), fell to $33,800 at age from 63 to 65, rose again the following year, and then fell to approximately $30,000 in subsequent years. As a result, differences in average income levels between individuals in the bottom and the middle quintiles shrank from $18,200 at age from 54 to 56, to $8,300 at age from 74 to 76.

Family income declined even faster among individuals in the top quintile (Figure 4). Average adjusted (AEA) income in the top quintile peaked at $83,400 (equivalent to an after-tax family income of $166,800 for a family of four) around age 60, declined to $66,700, rose significantly the next year (around age 65), then fell to $59,100, but began rising at age 70 to reach a maximum of $67,800 at age from 74 to 76. At age 54 to 56, individuals in the top quintile had 3.8 times the income of individuals in the bottom quintile (an income differential of $56,900), but by age from 74 to 76 the top quintile individuals had only 2.9 times the income of their counterparts in the bottom quintile (an income differential of $42,300). These results point to a significant reduction in income inequality over the retirement years.

Understanding variations in income levels requires a close examination of income sources after retirement. For this purpose, we shift our attention from AEA income after tax to AEA income before tax⁷, and we examine the share of income that came from earnings, private pensions— including registered retirement saving plans (RRSPs)—Old Age Security (OAS) and Guaranteed Income Supplement (GIS), Canada and Quebec Pension Plan (C/QPP) benefits, investment and interest income, capital gains, and other income sources⁸ in every year. Results are shown in Table 2 for everyone (aged from 54 to 56 in 1983) and in Tables 3, 4 and 5 for individuals in the bottom, middle and top quintiles, respectively.

Unsurprisingly, income largely came from earnings at age from 54 to 56 (Table 2). But as the same people grew 10 years older, earnings were gradually replaced by other sources of income— including private pensions (including RRSPs), public pensions (including OAS/GIS) and C/QPP benefits—that eventually became the main sources of income during retirement. To take the full measure of changes in income sources and the short period of time over which these changes are taking place, the reader should note that earnings typically accounted for 82.1% of all income before taxes in 1983, when individuals were from 54 to 56 years old. Some 13 years later, in 1996 (when the same individuals were aged from 67 to 69), earnings accounted for only 19.2% of total income before taxes, while private pensions accounted for 29.6%, C/QPP benefits for 17.6%, OAS and GIS for 14.6%, investment gains for 13.9% and capital gains for 3.9%.

Of note, capital gains were unusually high at 64-to-66, 65-to-67 and 66-to-68 years (corresponding to 1993, 1994 and 1995, respectively). This is because there was a change in the legislation whereby individuals could no longer claim a deduction for gains realized after February 1994. As a result, individuals could report all or part of their capital gains accrued before February 23, 1994 so that they could benefit from any unused part of their $100,000 capital-gains exemption. Since capital gains can be used to offset the losses in other years, the levels of capital gains reported in 1993 were also affected, which is the year corresponding to the sudden increase in income levels observed in Figure 1.

Among individuals in the bottom quintile in 1983 (Table 3),⁹ earnings also accounted for a very high percentage of income levels at age from 54 to 56 (84.3%). However, the OAS, GIS and C/QPP benefits accounted for a much larger portion of income during retirement. Taking 1996 (when individuals were aged from 67 to 69) as an example, C/QPP benefits and the OAS and GIS accounted for 53% of income before taxes, whereas income from private pensions and RRSPs accounted for only 17% of income among bottom-quintile individuals.

While the composition of income sources for individuals in the middle quintile closely resembled that of the cohort as a whole (Table 4), the decomposition of income sources among those that were in the top quintile in 1983 was different in many ways (Table 5). First, top-quintile individuals derived a much larger portion of their income from investment, interest and capital gains in every year of the panel. Second, income from private pensions accounted for a much larger portion of income during retirement, while income from public sources only accounted for a small portion of their post-retirement income. Again, taking 1996 as an example, income from OAS, GIS and C/QPP benefits jointly accounted for 18.1% of total income before taxes, while income from private pensions, investments and capital gains jointly accounted for 57.8% of their total income. Finally, earnings accounted for a larger portion of income after age 65, possibly reflecting higher rates of labour market participation among highly educated individuals.

While it is useful to look at the financial evolution of those aged 55 years in 1983, it is also important to examine the evolution of income trends by cohort. According to Myles (2000), the share of income received from private pensions rose considerably among recent cohorts of retirees, with the continued maturation of registered pensions plans (RPPs) and personal retirement accounts (RRSPs). Other studies also indicate that the labour market participation of seniors is on the rise (Horner 2007, Turcotte and Schellenberg 2007), which suggests that younger cohorts might be more likely to receive income from employment sources. These changes are fundamental and clearly underscore the need to look at various cohorts of retirees to understand the dynamics of income security after retirement.

We begin with the evolution of earnings (shown in Figure 5). Earnings include all income from paid jobs, and also income from self-employment jobs and all other possible sources of employment income (at the family level, adult-equivalent adjusted). As Figure 5 indicates, earnings fell rapidly after age from 54 to 56 but some interesting changes could be noted across cohorts. For instance, average earnings levels at the beginning of the period were slightly higher among individuals from younger cohorts and remained higher after age from 54 to 56 among the 1995 and 1998 cohorts, possibly reflecting higher rates of labour market participation among recent cohorts. Also, it should be noted that earnings fell faster in the early years of retirement among individuals in the 1989 cohort, who were undoubtedly affected by the 1990-to-1992 recession.

Figure 6 reports the levels of income received from private pensions, including income received from RPPs and private RRSPs. The key finding is that the three most recent cohorts (1992, 1995 and 1998) received larger amounts of money from private pensions than earlier cohorts.

Private pension income rises from age 70, which coincides with the age limit for continued RRSP contributions (69 years old). After the age of 69, individuals must transfer the property of an RRSP to a registered retirement income fund (RRIF), or must buy an eligible annuity. The benefits from these plans are fully taxable. However, the increase from age 70 is mainly observed among high-income individuals who receive a much larger share of their income through these channels (see Table 5).

There is no difference among cohorts with respect to OAS and the GIS (Figure 7). The OAS/GIS provides a basic flat-rate benefit (the OAS portion) to all persons with net income below a specified amount. A supplementary benefit (the GIS portion) is allocated to those with little or no other income and an allowance provided to the spouse of OAS pensioners and widows aged from 60 to 64 with limited income. The objective of the OAS/GIS is to guarantee a minimum income to all persons 65 or older.¹⁰ No contributions are required to benefit from these programs. The OAS and GIS programs were not affected by major policy changes in recent years, and benefits are adjusted every year by using the consumer price index. As a result, OAS and GIS benefits remained stable across cohorts and provided more than $6,000 in benefits to beneficiaries.

The C/QPP (Figure 8) were designed to replace a portion of earnings that cease after retirement or disability, and the objective is to provide employees with a basic retirement benefit.¹¹ As with OAS/GIS, the C/QPP has changed little over the years. As a result, the amount received from these pension plans did not change substantially across cohorts, typically yielding more than $7,000 to its beneficiaries after age 68.

Investments gains are important sources of income to many retired individuals and are shown in Figure 9.¹² Average investment gains were unusually high around age 62 for individuals in the 1983 cohort, around age 59 for individuals in the 1986 cohort and around age 56 for individuals in the 1989 cohort, with all three situations corresponding to the year 1990. Investment gains generally follow the evolution of interest rates which were high during this period, reaching their peak in 1990.

Net capital gains are shown in Figure 10. For all cohorts, average income received from capital gains was generally low. The only exception was during the years from 1993 to 1995 when there was a change in the legislation that restricted deductions for gains realized after February 1994. As a result, all cohorts showed a boost in capital gains during the period corresponding to these three years.

Figure 11 shows the evolution of family income after taxes across cohorts (adult equivalent adjusted). Unfortunately, the temporary increase in capital gains induced by the change in the legislation makes it difficult to identify clear differences across cohorts in income trends. One way to deal with this is to examine total income after taxes without capital gains. This is appropriate because Figure 10 has shown that income received from capital gains is relatively low and does not vary considerably across cohorts. Results are shown in Figure 12.

More recent cohorts are entering retirement with higher income levels. These results reflect the rise in private pensions and employment income noted earlier. Around age 60, AEA family income (without capital gains) was $42,200 among the 1983 cohort, rising to $48,600 among the 1998 cohort.

We also examined the evolution of family income after taxes separately for men and women. The results are shown in Figure 13 for all individuals in the first cohort, and results for the bottom, middle and top quintiles are shown in Figures 14, 15 and 16, respectively. With the possible exception of individuals in the top quintile—where men enjoyed slightly higher income levels than women—trends in income levels did not differ much by gender. Differences in the sources of income between men and women were also quite small (results not shown). Since our focus is on family-income levels and not on individual-income levels, this is not a surprise. However, this does not necessarily mean that all aspects of income security are gender neutral. For instance, women are more likely than men to suffer the adverse consequences of a separation or widowhood—events that cannot be properly assessed with the methodology we use in this paper and will be taken up separately in future work.

⁶ It is important to note that this is adult-equivalent adjusted (AEA). To convert this to a number more easily recognizable, an AEA family income of $45,600 is equivalent to a family income of $91,200 for a family of four.

^7. In this case, it is necessary to use income before taxes because not all components of income are taxable.

^8. Other income sources include employment insurance benefits and refundable tax credits.

^9. Recall that individuals earning less than $10,000 at age from 54 to 56 were excluded from the sample (see Section 3). Hence, individuals with very low earnings have been excluded.

¹⁰ The Old Age Security in its current form was implemented in 1952 and replaced the Old Age Security Act, which provided a flat-rate benefit to all persons aged 70 or over meeting the residency requirements. In 1967, the Guaranteed Income Supplement Program was implemented to improve the quality of life of low-income seniors (Maser 2003).

¹¹ These plans are directed at the employed, cover all workers in Canada and are compulsory for those aged 18 or more. Contributions are made to a specified maximum level by both employees and employers with a maximum possible benefit of 25% of the average wage (up to a maximum benefit of about $800 per month).

¹² Investments include any income received from bank deposits, corporate bonds, trusts, mortgage, notes and Canada Saving Bonds. Investments also include income from dividends and net rental income.