The Observer


Saving for Retirement Just Got Tougher

by Frederick Vettese

In spite of low coverage rates in workplace pension plans, most Canadians who have retired in recent years have fared better than you would expect. Poverty rates among seniors are low while satisfaction with retired life is high. Unfortunately, this halcyon period might be coming to an end.

The problem is demographics. Like most developed countries, Canada’s population is aging rapidly; this translates into low interest rates since older people tend to have money while younger people tend to need money. For convenience, I will define the group aged 55 to 80 as Savers and those 25-54 as Borrowers.

In the 1990s and earlier, money was scarce because the Savers were greatly outnumbered. In 1993 for instance, there were only 39 Savers for every 100 Borrowers. Risk-free real-return bonds in that era yielded 4% or more while nominal yields on 10-year government bonds topped 8%.

Then the baby boomers started to turn gray. By 2003, the ratio of Savers to Borrowers had climbed to 44% and ten years later, it had jumped to 57%. That ratio will continue rising until 2023 by which time it will hit 73%. It will then remain stubbornly high for several decades. With proportionately more Savers, we should have been seeing interest rates falling after 2000, which is precisely what has been happening. Today, the yield on real return bonds is less than half a percent; on 10-year government bonds it is just 1.5%. 

It is difficult if not impossible to prove that demographics alone caused the decline in interest rates. But if we could find another country that has already undergone a similar demographic transformation and experienced a similar change in interest rates, we could be a lot more confident that demographics really are the driving force. 

Such a country exists: Japan. Its population started to age nearly two decades earlier than Canada’s. As Table 1 shows, Japan’s ratio of Savers to Borrowers in 1975 was remarkably similar to Canada’s ratio 18 years later and that relationship has held fast ever since.

Table 1 – Ratio of Savers (55-80) to Borrowers (25-54)

Canada 18 years later
1975 33% 39%
1985 43% 44%
1995 56% 57%
2005 74% 73%*
* Ratio in 2023 based on a medium growth scenario

Table 2 shows how 10-year government bond yields in each country have changed over the same period. As we can see, Canada is tracking Japan’s interest rate experience with great precision.

Table 2 – 10-year Government bond yield

Canada (18 years later)
1975 8.2% 8%
1985 6.6% 4.5%
1995 2.9% 2.3%
2005 1.4% 1.5%*
* Yield in September 2019, 14 years later

The above trend in Japan continued after 2005. Its 10-year bond yield currently stands at negative 0.2%. If we accept that demographics are the culprit, we should see nominal yields on Canada 10-year bonds dropping to 0% or less by 2037. This result could happen even sooner since aging populations and falling interest rates are happening in almost all developed countries now, even China.

For a variety of reasons, equity returns in an aging country also tend to fall, though not quite as far as bond yields. From June 2000 to June 2019, the real annual return on the Nikkei-225 index including dividends was just 2.5%. As expected, it was higher in Canada as the total real return on the S&P/TSX was 3.3%. This difference may not seem like much more, but remember that the Canadian population was already aging quickly during this period. In the period from 1960 to 1999, when the population was much younger, the compounded real return on Canadian equities was 5.9%.

Given that the Saver to Borrower ratio will remain high for at least the next 30 years, we may therefore be on the brink of a very long period of near zero inflation with returns on balanced portfolios under 3%. Whereas baby-boomers needed to save 10% or less to retire well (see sidebar), millennials may need to save 20% or even 30% of pay. Public sector pension plans that are already contributing upwards of 30% will have to increase that contribution rate further or else cut benefits. None of this will go over well.

Why a 10% savings rate used to be enough: How much would a middle-income couple need to save to maintain their standard of living after retirement? To answer this question, I used historical returns and inflation rates and assumed the couple saves regularly for 30 years, adopts a 60-40 investment mix and retires at 63. The required savings rate varied over time, ranging from a low of 4.2% of pay for the period 1971-2000 to a high of 12.1% for 1946-1975. If we take an average of all the 30-year periods between 1938 and 2016, the average required savings rate was 8%. This is why saving 10% used to be a good rule of thumb. To be clear, the target income was just 35% of final average pay, partly indexed to inflation; this may not seem like a lot but for the typical couple with two children, a paid-off mortgage and substantial OAS and C/QPP pensions, it would have given them the same disposable income in retirement as when they were working.

The easiest and possibly the only viable remedy is to increase the normal retirement age. If we are going to be realistic in assessing the capabilities of older workers, full-time employment should end around age 60 followed by part-time work between 60 and 70. This trend is already underway but it may need to be accelerated by formally changing existing pension, employment and tax laws. In particular, incentives to retire before 70 may need to be removed from existing pension plans. No matter how the situation evolves, we will miss the good old days of high interest rates and investment returns.

Frederick Vettese was previously the Chief Actuary at Morneau Shepell. He is also the author of the book, “Retirement Income for Life: Getting More without Saving More.” This article builds on an idea first expressed by Michael Walker in a 2015 paper released by the Fraser Institute.