Why employees are not taking on enough investment risk

The RRSP deadline is fast approaching but people’s retirement readiness has been called into question.

A new annual report from Mercer Canada concludes that many employees face having to delay retirement because their defined contribution plans are not taking on the appropriate level of risk. The inaugural Mercer Retirement Readiness Barometer has strongly indicated that Canadian employers must do more to influence employees’ decision to ensure they are financially secure and on track for a dignified retirement.

The Barometer’s annual findings used Mercer’s proprietary Retirement Readiness Analytics to measure the projected retirement age of Canadian Millennials, Gen Xers and Boomers. The results are clear: Canadians need to adopt a less conservative investment approach, maximize participation and gain greater access for personal savings through their workplace. Otherwise, they “risk leaving money on the table, and being forced to retire later - or not at all”.

Jillian Kennedy, partner and Canadian leader of defined contribution and financial wellness at Mercer, said: “The Canadian workforce is more diverse than ever – and different generations have different needs. The Mercer Retirement Readiness Barometer will help employers gauge their employees’ retirement readiness, and gain deeper insight into their employees’ financial security.”

While acknowledging that defined contribution plans are a critical source of retirement security, the study reported that without the appropriate level of risk with the proper investment mix, people will struggle to achieve the level of asset growth they need to build their nest eggs and retire comfortably.

The report said: “Our proprietary datasets show that Canadians suffer from the classic retirement trilemma. They want, at once, asset growth, access whenever they want it, and assurance that they will have enough when they retire. But these goals cannot all be satisfied at once, and without the proper information or incentives, many Canadians are not saving enough, or are invested too conservatively, leading, potentially, to delayed retirement.

“If Canada’s workforce is to be financially well and able to retire at the age they desire, more must be done to encourage them not just to save, but to invest.”

Mercer built three personas to measure the retirement readiness of Canadian workers – the mmillennial, gen-Xer and baby boomer. The Barometer worked out when each could comfortably retire based on their participation within an employer-sponsored DC plan and benefits provided by the government (like CPP/QPP/OAS).

It assumed that all three personas contributed the same rate annually to their company plan over their course of their career. Also, it assumed the following investment mix:

• asset mix for periods before 2000 - 100% invested in fixed income;
• asset mix for 2000-2010 - invested in a balanced portfolio, (60% equity/40% fixed income);
• asset mix for periods after 2010 - invested in a target date asset mix based on the MFW target date fund glide path, using actual index returns prior to 2019 and Mercer’s capital market assumptions effective 2020.

The total savings rates of 10% that is used to anchor this analysis is based on insights from Mercer’s proprietary defined contribution plan design database which includes data from more than 400 plans across a wide array of sectors and industries.

Will millennials ever be able to retire?

Mercer’s analytics concluded that millennials, although just starting their careers, are not saving at the rate they will need to in order to retire. It estimated that a Canadian millennial – aged 28, with current annual earnings of $45,000 and with a total combined company and employer contribution of 6% to a workplace retirement program – will be retirement ready at the age of 70.

By tweaking this prototype millennial to one who takes a long-term perspective by investing their workplace program money in a healthy mix of equities and bonds, they will be able shave off three years and retire sooner at age 67.

The report warned, however, that for many, achieving the perfect retirement at 65 is “not a realistic prospect”.

“Savings rates are equally critical [as investment mix]. The Barometer shows that a savings rate any lower than 6% total annual company and employer contribution means that retirement may be altogether impossible for a millennial. 

“Further, in order to achieve the traditional retirement age of 65, our prototypical millennial would need to increase their combined savings rate to 10%, starting today. This is not a realistic prospect for many members of this generation, who have more immediate financial priorities: paying down debt, managing student loans or buying their first home.”

Are boomers really the lucky ones?

The study estimates that a Canadian boomer – aged 60, with current earnings of $100,000 and a combined company and employee contribution of 10%-12% to their workplace plan – will be retirement-ready by 65-69.

However, many are struggling. Unlike millennials and Gen Xers, boomers generally had access to defined benefit pension plans, where investment and contributions were both managed by the company. But as DB plans closed and boomers began to enter DC plans, a real shift of mindset was required – and many boomers were unable to save enough money.

Changes by employers to nudge investors into less conservative investment vehicles, like target date funds, may have come too late for boomers to benefit.

The report concluded that it may actually be time to reconsider the “default” retirement age. “Even where these boomers, like our boomer persona, enjoyed every stroke of luck – where they were encouraged to invest appropriately by their employer, where they were encouraged to save enough money – they still find it difficult to retire at age 65.”

Is it all too late for gen X?

The study forecasted that the average Canadian gen-Xer – aged 45, current earnings of $70,000, making a combined company and employee contribution of 10% - will be retirement-ready by 68.

With 20 years left before a traditional retirement age of 65, it would seem obvious to recommend that this gen-Xer increase their savings rates to meet their goals. However, if the gen-Xer wants to achieve the traditional retirement age of 65, they will find it difficult if they relied on increasing savings rates alone.

“Our estimates show that even if they were to save an additional 3% every year for the rest of their career, this gen-Xer will only see their retirement readiness age move up by 1 year to age 67. In order to retire at 65, they must immediately raise their combined employee and company by 7% to a total of 17% per annum, and remain at that level for the remainder of their career.”

So what does all this mean? Mercer strongly believes that employers must act, and that while higher levels of savings are critical to the success of future workplace retirement programs, many different levers must be used together to improve retirement readiness.

This is possible but will require an “increased focus on re-engaging employees through innovative and less traditional approaches that evolve with the change in generations”.  This involves allowing access to employee savings that promote debt re-payment while the company contributes towards retirement, access to personal savings accounts through the workplace and guidance to prepare employees as they approach retirement.

More effort must also be made to address ‘gaps’ in the pension system.

“At present, certain low-fee investment vehicles are only available to Canadians through pension funds. But should a person lose access to that pension fund – whether through maternity leave, or switching jobs – their fees often abruptly increase, potentially adding unwanted years to a person’s working life.”

Kennedy added: “While everyone’s circumstances are different, our data shows that employees need a combination of both higher asset growth and levels of saving early in their career to achieve financial security.”