Do clients need to work longer to protect pensions from inflation?

Why your clients may need to work up to three years longer to recoup lost spending power

Do clients need to work longer to protect pensions from inflation?

Canada’s pension system has maintained its B-level rating in the 2022 Mercer CFA Global Pension Index, but advisors need to talk to clients with defined benefits pension plans before they retire to ensure they’re well-positioned to deal with inflation since it may not be covered by their plans.

“We need to be concerned about inflation, even with defined benefit pension plans because most pension plans, especially in the private sector, do not have indexation features,” F. Hubert Tremblay, principal and senior wealth advisor for Mercer Canada, told Wealth Professional.

Tremblay said advisors should discuss this with their clients since those who retire now will not benefit from pre-retirement indexation in their plans.

“If they retire before they see some inflation impact on their salary and directly on the value of their pension plan, they won’t see their pension increase with the impact of inflation,” he said. “They will get into retirement and not have post-retirement indexation, so lose purchasing power.

“It’s a really good question to ask them if they should not delay their retirement for two or three years, if possible, if they have the energy and health to continue working to recoup, to some extent, the impact of pre-retirement inflation.”

Tremblay noted this would benefit clients in two ways. First, they could recoup the inflation they’re losing in their salaries. Second, they could also leave their money in the market longer.

“Advisors really need to ask clients if working an extra two, three, or four years could provide them with those benefits, so they can erase some of the losses that they’ve incurred in the last year,” he said. “At the end of the day, both from a DB (defined benefit) or DC (defined contribution) perspective, maybe retirement plans should be adjusted to, if possible, extend the working life before getting into retirement and before crystalizing the retirement income.”

While that is an issue that pre-retirees may need to face, Tremblay said there’s a retirement wave going on right now – and those with plans may not realize their vulnerability with how inflation is impacting their retirement income unless their advisors point it out and suggest working longer.

He noted that while Canada has slipped slightly in the Mercer pension index, it’s doing better than in previous years and has one of the best retirement systems in the world because it more recently indexed the Canadian Pension Plan (CPP) and Quebec Pension Plan (QPP). Defined benefit plans, meanwhile, have eroded in the last two decades, leaving more Canadian workers covered by defined contribution plans, so they have to bear all of their own pension risks, unlike previous generations.

Other countries – such as Iceland, which rated higher than Canada on the Mercer pension index – have mandatory employer contributions to their pension plans, which Canada does not. Only 10% of Canadian workers have defined benefits plans. Only 40% of workers get contributions from employers, which is a small percentage of the total work force.

Voluntary savings retirement plans haven’t been as effective in preparing workers for retirement, either, so Tremblay encouraged the wealth management industry to participate in the government’s policy discussions, particularly regarding whether people collecting CPP or QPP should be delayed.

“Advisors are close to their clients. They know their situations. They know that one size fits all does not make sense to improve the Canadian retirement system,” he said. “So, they should participate in the discussions with other stakeholders and provide governments with their ideas to help retirees.”