The number of Canadians entering retirement while in debt is rising three times faster than for any other age demographic, raising concerns about retirees’ long-term financial security, according to a recent study released by Toronto-Dominion Bank’s economics department in Toronto.
Although mortgage debt has been the driving factor behind the growth in overall household debt, the TD study found average mortgage debt among retirees has doubled within the past decade — more than for any other age group. A big question is what happens when interest rates move up from today’s rock-bottom levels.
TD’s study is not alone in highlighting this growing trend of debt among retirees. Research conducted by Winnipeg-based Investors Group Inc. this year found that more than half of survey respondents are retiring while still having debt — primarily, property mortgage payments, with a median mortgage balance of $82,000.
“I think it’ll come as a shock to those people that they will spend just as much in their retirement as they were when they were working,” says Gaétan Ruest, assistant vice president, strategic investment planning, with Investors Group. “If a mortgage payment has made itself a significant part of expenses in retirement, then [retirees] would need to generate relatively more retirement income in order to cover off that expense.”
The TD study also found that retirees are the only age group for which debt loads expanded at twice the pace of asset growth during the past decade, raising more red flags.
“What surprises me most is the extent of the swing with this age segment,” says Derek Burleton, vice president and deputy chief economist with TD in Toronto. “It’s the sheer growth and the level of indebtedness.”
Burleton sees this trend as likely to continue over the next five to 10 years: “All evidence points [in that direction] because it’s a trend that’s recorded at the group just below the ‘age 65 and over’ segment.”
Those close to retirement — ages 45 to 64 — are amassing debt at a brisk pace. The average debt load in that age group has risen to about $70,000 per household this year, up from $40,000 in 2002.
“Unless there’s an awareness campaign on the importance of paying down your debt while you’re still employed, I don’t see there being a change in this trend of maintaining high levels of mortgages when people retire,” says Ruest. “This will require a big change in mindset for people — what retirement means to them and how much they will be able to spend in retirement when significant savings are not going to be their offset.”
Substantial mortgage debt puts a strain on the retiree’s income-replacement ratio — the percentage of pre-retirement income an individual needs in order to maintain his or her standard of living in retirement.
Estimates of this ratio differ substantially among financial planning experts, but usually fall within the 50%-80% range. However, with seniors carrying heavier debt into retirement, the ratio may need to be rethought, says Burleton: “I do think that Canadians entering retirement and holding debt does support the need for an income-replacement ratio higher than the traditional number.”
Adds Ruest: “It shouldn’t be just about replacing income; it should be about expenses you’ll have in retirement and whether or not the income is enough to cover them.”
A 2010 study by Toronto-based Russell Investments Canada Ltd. looked at pre-retirement incomes of Canadian households and then tracked their spending patterns through retirement. That study found that 63% income replacement per individual and 66% income replacement per household were more realistic projections to cover the range of essential expenses such as food and shelter, as well as discretionary purchases such as travel and entertainment.
However, those calculations were based on 2007 Statistics Canada data. Bob Leeming, Russell Canada’s director of client solutions, says the ratio is now probably higher, considering the increase in households that are carrying higher amounts of debt into retirement — requiring more income to service that debt.
“If increasing debt loads with retirees continue, you will see less of a decline in essential expenses over time,” says Leeming. “Looking at the interest rate environment we’re in now, rates have nowhere to go but up. If that’s the case, as mortgages come up for renewal, it will lead to increased payments and expenses.”
Russell Canada is currently looking into StatsCan’s latest data and plans to release a new study on replacement ratios next year.
“The methodology we use will capture this increasing debt load because we’re focusing on expenses,” Leeming says. “Even as a general rule of thumb, income-replacement figures can make it easier for clients, in that the better prepared they will be, the more comfortable they will be when their advisor talks to them about their retirement decisions.” IE