New DC pension index shows Canadians working longer

As Michelle Loder, Canadian DC business leader at Towers Watson explains, “the negative impact on corporate pension financials of the “double whammy” of falling equity markets and declining interest rates has been a well-documented DB plan story this year. But there has also been a significant impact on DC and RRSP plan members, who similarly must cover a funding deficit — but in their case though reduced personal spending or deferred retirement.”

The new index tracks the performance of a balanced investment portfolio of a plan member who has contributed over a 20 year period from age 40 to 60. The performance of the plan determines the funds available at retirement to purchase a life annuity (a guaranteed annual income) from an insurance provider. Depending on the markets, the plan member might choose to retire early — or be obliged to work longer in order to achieve the funding required to purchase the annuity.

The index begins with a member who started contributing in 1988, and chose to retire at the end of 2007. That member’s annual annuity income, as a percentage of their final employment income, is the benchmark for later generations who start contributing at age 40 in a year after 1988. “Pension freedom” comes when an individual who stops contributing at age 60 can first purchase the benchmark annuity.

Looking back over the performance history, the 2008-2009 recession hit the savings and annuity purchase prices of later generations hard, delaying their pension freedom well beyond age 60. For a plan member who reached age 60 at the end of 2009, poor market returns while they were in their late 50s pushed their pension freedom back to age 62 — if they wanted to have the same level of income replacement in retirement as the 60 year-old who retired just two years earlier in 2007. The trend did not subsequently improve, as future generations were also hit by higher annuity purchase pricing caused by declining interest rates. Reaching age 60 at the end of 2010 would have meant pension freedom arrived closer to age 64.

While this is bad news for plan members, the impact on plan sponsors is proving equally unexpected. As Ian Markham, Canadian retirement innovation leader at Towers Watson, says, “given the continuing economic pressures, many employees who rely heavily on DC savings are delaying retirement, making it more difficult for organizations to determine if, when and how many older workers will retire, and how to manage their staffing needs.”

These concerns are not likely to fade anytime soon. In the shadow of a recession, continuing market turmoil and declining interest rates, September 2011 data from the index reveal that pension freedom age is now drawing close to 67 years.