Questions about when to retire, and how much to save, are often informed by data on average life expectancy, typical life cycles and anticipated consumption patterns. But new research has revealed some of the dynamics operating behind the headline numbers, which households, advisors and policy-makers alike should be taking into account.

Looming demographic change has sparked debate over whether to alter the current retirement savings system in Canada — and, if so, how. Meanwhile, at the household level, individuals are making daily savings and consumption decisions that have implications for their long-term retirement prospects. Underpinning both the reform debate and these routine household decisions is some conventional wisdom about retirement — and typical patterns of spending and saving.

However, some recent research has found that reality may not match those expectations.

For example, a recent paper from the Center for Retirement Research at Boston College in Chestnut Hill, Mass., that examines the economic impact of children leaving a household says the conventional view is that household costs will shrink when the kids leave and that empty nesters can then ramp up their retirement savings because they no longer have kids to support. Also, conventional wisdom states this probably occurs at a stage in the empty nesters’ careers at which their incomes are peaking.

“If households do, in fact, behave in this manner,” the CRR report notes, “then low levels of retirement saving among younger households may not be a matter of public policy concern because they will catch up later in life.”

However, the CRR’s research — using data from the University of Michigan’s Health and Retirement Study — found that household spending stays about the same even after the household’s size has shrunk. And the CRR research found that total net wealth didn’t change much, either: “These findings suggest that households do not dramatically change their savings or consumption patterns when their children fly the coop. Those households that are already behind in their retirement preparations will remain at risk of entering retirement with insufficient wealth to maintain their pre-retirement standard of living.”

The paper suggests several possible explanations for the lack of increased savings by empty nesters. For example, it could be that people are used to spending a certain amount, and so they substitute quality for quantity. Or, they may adopt more expensive leisure activities once the kids have left home. However, the data don’t allow the researchers to reach a conclusion on why households behave this way — they just do. And, as the report points out, these results have implications for assessing how well prepared households are for retirement.

“Households that saved little when the children lived at home continue to save little subsequently, despite the increased capacity for saving,” the report states. “These households will arrive at retirement with insufficient wealth to maintain the average level of consumption enjoyed over their working life, let alone the increased standard of living enjoyed after the children leave.”

That finding has implications for financial advisors plotting retirement savings strategies. For one, clients that expect to ramp up their savings later in life may have to be pushed to do so when the time comes. Alternatively, clients may have to be persuaded to save more earlier so that their retirement plan doesn’t depend on a late-stage catch-up. And the level of consumption that households expect in retirement may not shrink as much as expected, which, again, suggests that more aggressive savings may be in order.

Another critical consideration, for clients, advisors and policy-makers is life expectancy. Average life expectancy has been rising steadily in Canada, as it has been in many developed countries. According to data from the World Bank, a baby born today can plan on living to age 81, whereas a baby born in 1960 could expect to live to 71 years of age.

But while overall average life expectancy may be increasing, it is not necessarily increasing equally for everyone. New research from the Center for Economic and Policy Research in Washington, D.C., found that “there has been a sharp rise in inequality in life expectancy by income over the past three decades that mirrors the growth in inequality in income.”@page_break@The CEPR paper reveals that for men born in 1912 in the U.S., there was a modest gap in retirement length based on income. Those in the top half of the income scale could expect to live 15.5 years after retirement, vs 14.8 years for those in the bottom half. However, that gap has widened over the years. For men born in 1941 in the U.S., those in the top half could expect 21 years of retirement, vs 15.7 years for those in the bottom half. (This translates into a 5.5-year increase in retirement duration for workers in the top half, vs an increase of less than a year for those in the bottom half.)

In Canada, income inequality isn’t as pronounced as it is in the U.S. But there is, nevertheless, evidence that income has a similar effect on longevity. Statistics Canada last looked at this subject in 2008 by linking followup mortality data from 2001 to census data from 1991; the StatsCan study found that life expectancy increases with income for both genders.

The StatsCan study divided the population into quintiles by income and found that progressively higher income correlated with longer life. Men in the richest 20% could expect to outlive those in the poorest 20% by seven years, on average. And although only about half of men in the poorest group could expect to reach age 75, almost three-quarters among the richest are expected to reach that age. For women, the gap between rich and poor was much narrower, and the overall rates much higher: 72% of the poorest women could expect to live to 75; 84% among the richest.

Indeed, the differences in life expectancies for men and women becomes particularly stark when you throw in the wealth factor. For instance, the life expectancy for the poorest 20% of women is still more than a year longer than the richest 20% of men. And the gap in life expectancy between poor men and rich women is a staggering 12.3 years, which represents a huge difference when you’re trying to plan for retirement.

Although your clients may want to consider some of the underlying factors affecting their probable lifespan when planning for retirement, the overall increase in life expectancy has policy-makers contemplating changes to the retirement savings system.

According to the Canada Pension Plan’s latest actuarial report, the current contribution rate is sufficient to meet the CPP’s future obligations — although some investment income will be required by 2020 to make up the difference between contributions and expenditures. Moreover, the report says that if recent increases in life expectancies continue, the CPP will face pressure to increase the minimum contribution rate above the current level.

One possible way to address this is by raising the age for CPP eligibility. A recent paper from the Mowat Centre for Policy Innovation at the University of Toronto argues that gradually increasing the normal age of eligibility for the CPP to 67 years of age from 65 (and the earliest ages to collect benefits to age 62 from 60) would allow benefits to remain undiminished and avoid contribution increases.

The MCPI report projects that a two-year increase in the eligibility age would mean that, by 2050, CPP expenditures would be reduced by about $15 billion a year — and contribution revenue would increase by about $5 billion annually. The report also argues that increasing the eligibility ages is a fair way to finance the costs of population aging because it divides these costs across younger and older generations — although the report concedes that this could harm low-income workers disproportionately within each generation.

Workers with lower incomes are already disadvantaged under the current system, the MCPI report notes, because they are eligible for retirement at the same age as richer workers yet have a shorter life expectancy: “When the retirement age is increased by the same number of years for all income groups, low-income employees are even further disadvantaged.” The report adds that this situation is exacerbated by the fact many low-income workers probably don’t have workplace pensions.

Indeed, the CEPR paper says that increasing the retirement age in the U.S. to offset the increase in overall life expectancy is likely to impact poorer workers disproportionately. The paper calculates that if the U.S. were to increase the normal retirement age to 70 years of age from 67 over the next 25 years — and if trends in retirement inequality continue — then workers in the bottom half of the income scale could expect to enjoy just 13.8 years in retirement (less than a worker born in 1912 did), vs 24.5 years for workers in the top half. IE