May 29, 2024 15 min read Investing

Solving Canada’s $13 Trillion Retirement Gap

Netflix's series, Money, Explained, covers a lot of interesting topics. The one that really got my attention was the last episode, titled Retirement.

As a Financial Planner, I help clients out across a wide range of areas. From investments, insurance, mortgages, budgeting, debt and goal prioritization, basically anything that involves money. But no matter what we talk about, eventually the conversation always goes to the big one: retirement.

You can imagine that I was taken back when they said on Money, Explained that Canada is expected to have a US$13,000,000,000,000 (thirteen trillion dollar) retirement savings gap in 2050. In 2050 I will be turning 59, as will a majority of the people I know (give or take a few years). If it’s estimated that there will be a $13 trillion gap in 2050, that gap will be largely amongst my generation — the people that I know.

Immediately there were three things I wanted to find out:

Where does $13 trillion come from?
Is $13 trillion realistic?
And if so, how can we solve it?

So naturally I found the research papers, read them, and summarized my thoughts from them.

Key Takeaways:

Canada is expected to have an aging population, increasing life expectancy, less reliance on pensions, all without individual saving habits getting easier.
Although there are a lot of variables, the $13 trillion gap is a measure from 70% of a retiree's pre-retirement income.
With good financial habits spread over a working lifetime, we can each eliminate the $13 trillion retirement gap with less than $9/day.

Where Does $13 Trillion Come From?

*Size of Retirement Savings Gap (US$Trillions)*

The World Economic Forum (WEF) looked at eight countries with some of the largest pension systems in place today. They were Australia, Canada, China, India, Japan, Netherlands, UK, and USA. They found that in 2015, these countries had a $70 trillion retirement savings gap, and they expect that number will grow to $400 trillion by 2050.

They estimate that Canada will sit at a gap of $13 trillion at that time. Essentially what it means is the gap between what Canadians will have for retirement and what they’ll need to maintain 70% of their pre-retirement income will be $13 trillion.

With a gap of $3 trillion in 2015, and at that time with a population of 65 years and older of 5,780,900, that resulted in a gap of $518,950 per expected retiree. In 2050 the number of Canadians 65 years and older could be more than 11,500,000, resulting in a gap of almost $1,130,000 per Canadian 65 years and older.

Aging Population

For the first time ever, there are more people over the age of 65 than there are under the age of five. This is due to longer life expectancy and decreasing fertility rates. In 2020, age 65 and up represented 17.8% of Canada’s population. It’s expected that same group will represent 25.2% of Canada’s population in 2050.

This means that in 2050 there will be more retirees than ever. This shift to an older population will result in less people working relative to retirees. Currently the ratio of workers to retirees is about 8 to 1, but in 2050 it is expected to be cut in half to 4 to 1. The WEF suggests this could cause added stress on our national pension systems, and if not managed properly could result in shortfalls.

An aging population is not just a problem in Canada. It’s estimated that in 2050, China and India will have over 600 million retirees. That’ll be more than 13 times the total population of Canada at that time (estimated to be around 45 million), which is tough to even imagine.

More Time Spent In Retirement

Life expectancy has increased with each new generation. Every year moving forward more and more Canadians should live past the age of 100, even though the average life expectancy in Canada is currently around 82 years. This is going to result in Canadians spending more time in retirement than ever before. It could become common for people to spend more time in retirement than in the workforce.

If someone bases their retirement on the average life expectancy and outlives it, it puts them in a tight financial situation. The WEF found that on average Canadians have enough saved for 9.3 years of their retirement, leaving an additional gap of 9.9 years for males and 12.7 years for females.

*Retirement Savings Deficit, Years Saved vs Life Expectancy*

More than half of Canadians believe they will outlive their retirement savings, and these statistics show it. This makes a lot of sense when you think of how many retirees have to take a reverse mortgage, downsize to a more affordable living arrangement, or limit their activities and lifestyle.

Retirement is supposed to be all about living your life exactly how you want it, and unfortunately, that isn’t the reality for all Canadians.

More People Are Working For Themselves

Before the COVID-19 pandemic, more Canadians were working for themselves than ever before. I’d bet that trend continued during the pandemic, and will continue more so moving forward. This leaves more Canadians without an employer pension plan. It’s estimated that by 2025, 45% of the Canadian workforce will be freelancers.

For a majority of Canadians their employer sponsored pension is their largest (and sometimes only) source of retirement savings. With more and more Canadians in a position where they won’t be given the option of an employer sponsored pension plan, there could be a significant gap in their retirement savings.

Lack Of Prioritization

The inability to save and invest early on is a reality for a lot of Canadians. Saving for something 40 years from now just doesn’t seem like a priority when there are more pressing concerns like paying bills.

*Survey Results from: What is Your Biggest Financial Worry?*

Research shows that saving for retirement is less of a priority for young people than it is for older people. Which I believe would make sense to most people. But, just because it makes sense, doesn’t mean it’s actually right or the way it should be. Being able to change that mindset, not only could help us better prepare, but also make the amount of effort we have to put into it lessen.

The WEF attributed 24% of the savings gap to a shortfall of individual savings, which doesn’t seem very significant comparatively. But in order to make up the entire savings gap, we would have to eliminate that shortfall, plus make up for the remaining 76%. The elimination of the gap is really up to us. Overcoming one shortfall will put us in a better position to eliminate the remainder, just like tackling a to-do list one by one.

Is $13 Trillion Realistic?

The WEF assumes a replacement of 70% of pre-retirement income during retirement. That 70% will vary though. Lower income earners may need a replacement rate closer to 100%, while higher income earners could be sufficient with a lower replacement level.

Whether 70% is sufficient for each person or household will depend on their unique situation. Factors like the following should be considered:

Do they own or rent where they live?
Is their mortgage paid off?
Do they have any major debts?
Do they expect any major purchases in the near future?
Do they have a sufficient emergency fund?
Do they have appropriate insurance in place?

Being in a good financial position to retire is more than just having a large retirement savings. Eliminating expected expenses prior to retirement could mean you need less to maintain your lifestyle, and having an emergency fund and the appropriate insurance could help prepare you for the unexpected.

Let’s Break Down The Numbers

In 2015 the gap was estimated to be $3 trillion, resulting in a gap of $518,950.34 per Canadian age 65 and over. Resulting in a $1,112.04 per month gap for someone age 65 and expected to live to age 100.

$13 trillion is a lot. But if we break it down by the number of expected Canadians 65 years and older (11,508,702) we get $1,129,580.02 per expected retiree (or $636,080 today assuming 2% as inflation). If we plan for a life expectancy of 100 (35 years in retirement), that equals a shortage of $2,689.48 per month (which would be $1,514.48 in today).

That means Canadians are, and will be, short about their rent or mortgage payment every single month. Trying to find an extra $1,500 every month isn’t easy.

From the outside $13 trillion seems like an impossibly big number. But by breaking it down it seems possible. Many retirees have to give up certain enjoyments and become more budget conscious when they enter retirement. Many people have to continue working, whether it’s full-time or part-time instead of retiring when they’d like.

Many people just can’t afford to retire how they’d like. But even though it’s the case, I don’t believe that it has to be.

How Can We Solve It?

It’s easy to get overwhelmed and in the mindset that no matter what you do it won’t make a difference. It’s easy to look at a problem and take the path of least resistance. But that’s not the right mindset here. The thing with financial planning is it’s all about implementing small but powerful habits into our daily lives to make a big difference.

The issues we see with our finances stem from a lack of financial understanding. It’s only if we take the initiative ourselves, or pursue it as a career that we actually learn the full potential of how better managing our finances can benefit us.

By being here and reading this article, you’re taking a lot of steps to pursuing a better financial state, and moving in the right direction. A direction you’ll look back and be thankful you took a step towards.

Here are some of the things that can help us eliminate Canada’s $13 trillion retirement gap, because as impossible as it seems, it wouldn’t take a lot to make that gap disappear.

Start Investing Early

The magic of investing is compound interest. In the example below, we make a one time contribution of $100, and earn 10% every year. The interest we earn is in green and increases every year, even though it’s a constant 10% return.

With compound interest, you earn interest on the money you contribute, and in future years from your contributions plus the money your contributions made. The longer we can invest, the more it can grow and work for us. Even delaying a year or two can have a huge impact on our retirement picture.

*Investing $125 Bi-Weekly Starting at Age 25 vs 35 — Assumes 7% Return Per Year*

By starting 10 years later, our projections are 10 years behind. In the beginning years it might not seem that significant, but the gap between the amounts grow every year. Starting at 25 means you’ll have more than double at age 65 than if you started at 35.

In the chart below, we take a look at two scenarios: investing $500 per month from age 25 to 40 (contributing a total of $90,000 over 15 years), and investing $500 per month from age 35 to 65 (contributing a total of $180,000 over 30 years), both scenarios earning a 7% return per year.

*Investing $500/Month from Age 25 to 40 vs 35 to 65 — Assumes 7% Return Per Year*

By focusing on investing early, you can invest half of what you would from age 35 to 65, and end up with almost 50% more. Really putting your money in a position to work for you, and take advantage of the time on your side.

This could leave you with a lot of financial flexibility from age 40 on. You could continue to invest, or focus on paying off your mortgage or other debt, or give you the freedom to have a more flexible job knowing you’ve secured your retirement. Doing more early, leaves your future self with more options, more flexibility, and less financial stress.

Proper Asset Management

One of the biggest deterrents of accumulating a healthy retirement fund is improper asset allocation. Having the proper mix of stocks and bonds is the most important factor when it comes to long term performance, other than contributing in the first place.

The chart below shows the typical exposure to return-seeking assets for the countries used in the study.

Proper asset allocation can put your money in the best position to work for you (rather than you working for it), and can also protect you from unnecessary volatility. The WEF found that countries with the highest ending allocation to return-seeking assets ended up with the highest projected average outcome during retirement.

Early on, it makes sense to take on more volatility to grow your investments. If you don’t need to depend on your investments for the next 30 years, it doesn’t matter what happens between now and then. Proper asset allocation protects your investments in much the same way. As your goal moves closer, allocating from high volatility investments towards more conservative investments gives you less exposure to a market drop, while still allowing you to grow your investments.

It’s important to understand the difference between risk and volatility. Risk is the chance of complete loss of your money, whereas volatility is the natural ups and downs of the markets. Risk is more similar to gambling than it is with investing. Stock markets are volatile because like businesses they behave in cycles. Understanding the difference, and knowing what you’re comfortable with can give you a lot of confidence and reassurance in your investments and long term goals.

Your Pension Plan

There are two main types of pension plans, Defined Benefit Pension Plan (DBPP) and Defined Contribution Pension Plan (DCPP).

With DBPPs, your pension is based on your earnings and years of service. You don’t have control over how it’s managed. Typically we see DBPPs used by government or government regulated sectors, like with healthcare workers and teachers. With DCPPs on the other hand, your employer matches your contributions to the plan up to a certain point, and it’s typically up to you to make your investment decisions within the account.

There are two mistakes I typically see with DCPPs: 1. people don’t participate fully in the plan, and 2. people don’t set up their investment instructions.

Not participating fully in a DCPP is like turning down a portion of your salary. Maxing out your participation in a DCPP means that you’re not only investing money towards your retirement, but your employer is too. Based on past market performance, it takes about 10 years to double your money. If you’re doubling your money right from the start with employer contributions, you’re putting your portfolio ahead by a decade.

My hope is that it becomes standard that employees are automatically opted in, and if they want, they would have to opt out, rather than the other way around. The chart below shows how big of a difference something as simple as automatic opt in makes.

Once you are fully participating, it’s also up to you to select your investments. Some plans will have a default option if nothing is selected, but not always, so if you don’t make a selection, your contributions could be sitting idle. Remember compounding is the magic of investing, so you have to take initiative and ensure your investments are working for you.

Pension plans are great, but if you don’t have one, it’s not the end of the world. If you have a pension plan, each time you’re paid a portion of your paycheque goes towards your plan. If you don’t have an employer pension plan, you can basically set up the same thing through a personal investing account, like an RRSP or a TFSA.

The most difficult and time consuming part is just setting it up. But once it’s set up, it’s smooth sailing. A good goal is to aim for about 10% of your income to go in an investment account for your future. If you’re able to consistently put away a portion of your income, especially early on, you’ll be able to accumulate a nice self pension plan.

Approaching Retirement

Accumulating a retirement fund is important, but so is minimizing your expenses during retirement. Having your mortgage paid off and having no other debt will allow you to make the money you do have count. Being debt free could let you live off of tens of thousands of dollars a year less than someone who has to pay off debt.

It’s also important to continue to have your emergency fund. A fund that is readily available to you in case of a financial emergency. This can help you avoid having to take out a loan or spend on your credit card (both potentially costly options). Not only can it help you avoid debt, but it can help you avoid withdrawing from your investments. If investments double every 10 years, withdrawing $10,000 now would mean removing $160,000 from your future self in 40 years.

As long as you’re a Canadian resident, you should have access to the Old Age Security (OAS) benefit, and as long as you’ve worked in Canada, you should have access to the Canada Pension Plan (CPP) benefit.

Taking CPP early (at age 60) might sound appealing but the earlier you take it, the less of a benefit it is, so it might be in your best interest to take it at the standard age of 65, or delay it to 70 (the benefit grows the longer you delay it). You can also take OAS as early as 65 or delay to age 70 (it also increases with delaying it).

When applying for CPP, if you were the primary caregiver for a child and had your income reduced because of it, you may be able to apply for an increased benefit under the child-rearing provision. If qualified, the child-rearing provision could increase your CPP benefit significantly, but it doesn’t happen automatically, you have to apply for it.

During Retirement

One misconception about investing is that you invest your money until you retire and that’s it. But in reality, once you retire your money is still invested, just more conservatively. Your money should still in a position where it can work for you.

Earlier in this article we broke down the numbers from the WEF and figured out based on population projections that it works out to be a $1,129,580.02 shortfall per expected Canadian retiree. At first glance, it might seem like each of us needs to save almost an additional $1.13 million before we retire, but in actuality that doesn’t have to be the case.

By properly managing our investments during retirement, we can ensure our money is still in a position to work for us, and create value.

Canada’s $13 Trillion Problem Solved

There are things that we can all do that can put us in a better financial position in the future.

Investing early and often outs our money in a position where it can work for us, for a long period of time, really taking advantage of compound interest. When we combine that with paying down debt and having an emergency fund, we can put ourselves in an inexpensive position during our retirement. Really making what savings we do have count.

Looking into our own investments or pension plans to ensure our money is being invested in our best interest can create wealth comparable to having a second job, only it requires only a few hours of your time throughout a year.

Accurately or even overestimating our expected years in retirement can help us plan properly and ensure we aren’t only running out of money in retirement, but can help create a more comfortable retirement. It can also ensure that there are assets to pass on to our loved ones, helping shape a positive financial situation for them.

Starting to build these good habits early on in our working years allows us more time to reap the rewards of our actions. And as we saw with compound interest, the best thing for our investments is to give them plenty of time to do their thing. If we invest consistently and start early, that $13 trillion retirement savings gap disappears quickly.

A shortfall of $1,129,580.02 over an expected 35 year retirement works out to $2,689.48 per month. If we have a withdraw of $2,689.48 per month, and we are able to earn a conservative return of 3% a year during retirement, then instead of $1,129,580.02 we’d only need a total at retirement of $698,838.16.

38% less than the shortfall amount.

*Accumulation and Decumulation of the Retirement Savings Gap — Assumes 7% and 3% Per Year*

In order to get our $698,838.16 needed to fund the shortfall, all we’d have to do is contribute $125 every two weeks and after 40 years we’d end up with $714,205.62 (assuming an annual return of 7%). Over those 40 years, we would have contributed a total of $130,000, only 18% of what we’d end up with, while increasing our money 5.5 times.

Simply put, as a generation we could eliminate a $13,000,000,000,000 problem with $125 bi-weekly contributions into a properly managed investment account. For someone making $50,000, that’s only 6.5% of their income.

Your planning impacts a lot more than just you. It impacts your partner, your children, siblings, parents, and even future generations. That’s why it’s important to make it a priority, and not just something you hope works out in the end.

With proper planning, we can make a $13 trillion problem disappear.