Although reports suggest the aging of the baby boomer generation will create a pension crisis that will impose financial burdens on the working population, the reality couldn’t be further from the truth.

There are various reasons for this. The first is that Canada does not have a very generous public pension scheme. The first part of the proof comes from the Organization for Economic Co-operation and Development, which keeps track of pension obligations. The critical number in this data is the percentage of pre-retirement net income — that is, income after taxes and pension contributions, replaced at retirement. The normal rule of thumb among financial planners is “70@65” — people should aim for 70% income replacement at age 65.

The OECD tracks these numbers for three income groups: average earners, low earners (half the average) and high earners (twice the average). As we’d expect, most public pensions are geared to low-income earners. In Canada, the replacement rate is 89.4% for low-income earners, decreasing to 57.1% for average earners and 30.6% for high earners.

Compared with Britain and U.S., these replacement rates are not excessive. For these three income groups, the U.S. replacement rates are 61.4%, 51% and 39%. and for Britain, 78.4%, 47.6% and 29.8%, respectively. Except for the figures relating to high-income earners, who do quite well, Britain is slightly stingy, as is the U.S., compared with Canada.

However, in an absolute sense, all three countries have weak public pensions because they are designed on the principle that the state pension is targeted to low-income earners who would otherwise be a burden on the state. But this means average and upper-income earners are essentially on their own for everything except a very basic pension. In contrast, the OECD average for the three income groups is 84.1%, 68.7% and 59.4%, which is more in line with the European philosophy of a comprehensive pension system.

But replacement rates is only part of the story. We talk about “funded” pensions but, at an aggregate level, all pensions are “pay as you go” — meaning the pension contributions we make today pay the pensions of people who are currently retired. In this sense, all retirement programs are essentially intergenerational transfers. So the question is: will the baby boomers impose too heavy a burden on their children and grandchildren?

The Canadian Institute of Actuaries defines the old-age dependency ratio as the percentage of people over 65 divided by the working population between 18 and 65. This dependency ratio consistently increased until the early 1950s, after which it stagnated for 30 years before starting to increase again. Using slightly different figures, the OECD estimates Canada’s dependency ratio at slightly less than 20% and projects it to increase to 44% by 2050.

We should not look at Canada in isolation because the current OECD average is slightly higher, at 20.6%, and projected to increase to 47.4% by 2050. To put things in perspective, if we have a problem, then Italy, Greece, Spain and Japan have significant problems because their old-age dependency ratios are projected to increase to more than 60%.

A more important issue is the total dependency ratio, which includes children under age 18, as well as people over 65. The overall dependency ratio has a different pattern.

Although the effects of the baby boomers are still present — as there is a huge bulge born in the 1960s when the dependency ratio peaked at close to 90% — the overall dependency ratio is now at a record low because there are fewer children. This means that, overall, the current working generation is supporting fewer dependents than ever before, which in turn means there is no excessive burden placed on them. And this overall dependency ratio is not expected to increase.

However, this still raises a number of social questions. Although it is easy to see that education and the other expenses of raising young people should be decreasing because there are fewer of them, that is not what the powerful teacher’s union would have you believe. Closing schools and rationalizing public education in the face of declining demand is a challenge no government has yet taken seriously. The working generation may be more willing to see its tax dollars going into schools for its children, even if the schools are half empty, than into retirement pensions for its parents.

@page_break@The critical point is that this is not an economic but a social question. The burden on the working population in terms of dependents is not going up — it is going down. However, it is also changing from supporting the young to supporting the old. This raises the question about whether the baby boomers have instilled the right values in their children and grandchildren. Those who haven’t have only themselves to blame. IE



Laurence Booth is a professor of finance at the University of Toronto’s Rotman School of Management.