Executive summary

Discussions of pension adequacy for elderly Canadians have used different metrics to inform the debate on how seniors fare as they move into retirement. One metric is the rate at which income falls as seniors age—the income replacement rate or the ratio of post-retirement income to pre-retirement income (LaRochelle-Côté, Myles, and Picot, 2008; Ostrovsky and Schellenberg 2009). A second metric is the consumption replacement rate (Lise 2003; Lafrance and LaRochelle-Côté 2011).

Both are less than perfect. Using income streams to assess post-retirement welfare requires a standard against which the adequacy of the replacement rates can be judged. Because some expenditures (for example, work-related expenses) are likely to fall after retirement, declining income streams do not necessarily signal financial problems for seniors. More importantly, income as normally measured captures only part of what is available to seniors if households have assets that in retirement are not being used to generate measured income.

Alternatively, basing assessments of post-retirement status on consumption is a viable means of evaluating well-being only if the items included in consumption are all that concern households. But for several reasons, consumption of the goods and services that are normally measured may not fully capture seniors’ well-being. For example, the benefits of housing often go unmeasured. As well, gifts and savings for bequests may not be reflected in the consumption streams as they are typically measured.

A third metric, referred to as “potential income,” addresses the shortcomings of income and consumption as indicators of financial well-being. Potential income is the sum of realized income and the potential income that could be realized from owned assets such as mutual funds and housing. Households might be expected to prepare for retirement by saving and borrowing, and investing the proceeds. The assets that are accumulated over a lifetime may or may not be drawn down in later years. If they are not, income streams and consumption streams both underestimate the “potential” available to households in retirement. This paper uses data from the 1999 Survey of Financial Security to take that potential into account when comparing the pre- and post-retirement financial situation of Canadian households.

It does so by calculating the annuitized value of non-housing and housing assets possessed by households and adding it to the actual income streams of retirement-age households (headed by an individual aged 65 or older). The result is then compared with the income of households headed by younger adults to see if the addition of “potential” income changes the relative financial situations of Canadian households. Corrections are made for household size at different stages in the life cycle. The comparisons are presented on a before- and after-tax basis.

The inclusion of the annuitized values of net wealth significantly increases the level of financial well-being of retirement-age households relative to working-age households, with most of this increase coming from housing wealth. The mean before-tax income per adult in households headed by seniors aged 65 to 74 is 74% of that of households headed by 45- to 64-year-olds. When non-housing wealth is considered, this ratio rises to 82%, and when housing wealth is included, it increases to 88%.

Calculations using after-tax rather than before-tax income yield an even greater improvement in the relative position of retirement-age households. The mean after-tax income per adult of households headed by 65- to 74-year-olds is 79% of that of households headed by 45- to 64-year-olds. When non-housing wealth is considered, this figure increases to 95%, and when housing wealth is included, it increases to 105%.

These wealth adjustments also bring the income distributions of retirement-age households closer to those of working-age households.