This week, I’ll compare public- and private-sector pensions to show the ultimate value of three arrangements.
One is the federal public service employees’ plan, which I chose to represent the public sector because of its size and easy access to data. Other public-sector plans would have looked similar in the sense that most are defined-benefit pension plans with inflation protection after retirement.
The second is an above-average private-sector plan – a defined-contribution (DC) plan that requires 12 per cent of employee and employer contributions each year.
Finally, I show results for a person with no pension coverage – a situation which applies to about 75 per cent of workers in the private sector; I assume they contribute 18 per cent of gross pay each year into an RRSP. This is the maximum tax-deductible contribution allowable (ignoring unused RRSP contribution room from prior years).
In each case, the individual is 30 years old, hasn’t started to save for retirement, and earns $80,000 a year. The salary level might seem high, but it is actually close to the average pay for a federal public sector worker age 30-34, with less than five years of service. Regular pay increases until retirement are assumed.
The individual who contributes the maximum possible to an RRSP can expect to accumulate savings equal to 5.1 times final pay versus 11.4 times final pay under the public-sector pension plan.
In fact, this understates the potential gap since I haven’t reflected the additional amount that a public-sector employee can contribute to an RRSP. As for the “good” DC plan, the account balance at retirement would be only 3.4 times final pay.
This comparison begs the question of what level of retirement savings the average Canadian should strive for. A definitive answer is beyond the scope of this article, except to say that it need not be much more than five times final pay. Otherwise, most private-sector workers will be in serious trouble in retirement.
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To project the values 30 years out, I assumed inflation at 2 per cent a year and a real investment return of 1.75 per cent, net of fees. Hence, the nominal annual return would be 3.75 per cent.
This may seem low but it is not much less than what some very large pension plans with very sophisticated investment teams are using. A higher return is possible but not without taking substantial risks.
In putting this chart and commentary together, I received helpful guidance from Malcolm Hamilton, widely considered the most prominent pension actuary in Canada before his retirement in 2015.
Frederick Vettese is former chief actuary at Morneau Shepell. This new YouTube video outlines his recommended retirement income strategy.