Guest blog: Dr Bonnie-Jeanne MacDonald, Dalhousie University – Replacing the replacement rate: How much is ‘enough’ retirement income?

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The final earnings replacement rate – where 70% is often advocated as the ‘right’ target – has been a longstanding and widespread measure of retirement income adequacy. Financial planners use this benchmark, as do actuaries and other pension plan advisers, academics, and public policy analysts. It underlies pension systems, drives research that determines whether populations are prepared or not prepared for retirement, and the backbone of retirement planning software.

But does it do the job that it is supposed to do? Will 70% of a worker’s final annual employment earnings sustain living standards after retirement?

The problem
After an extensive literature review, we determined that there is no clear demonstration that for a sufficient sample of workers who hit the prescribed target of 70%, living standards are, in fact, approximately maintained after retirement. We therefore decided to test it ourselves.

In MacDonald, Osberg and Moore (2016)1, we tested the conventional earnings replacement rate using one of the world’s largest dynamic micro-simulation models of society – Statistics Canada’s LifePaths dynamic population micro-simulation model. We asked whether those individuals from the 1951–58 Canadian birth cohort who attain roughly a 70% final employment earnings replacement rate at retirement actually achieve approximate continuity in their living standards.

We found that the conventional replacement rate is a poor metric of retirement income adequacy. Workers who hit this target were found to experience a wide range of living standards continuity after retirement, and we were unable to locate a ‘type’ of worker for whom the 70% target accurately predicts standard of living continuity.

Regardless of whether we looked at workers who hit a 50% earnings replacement rate at retirement, or a 100% earnings replacement rate, the distribution of living standards continuity into retirement looked nearly identical (see figure). In fact, we found that the correlation between a worker’s earnings replacement rate and living standards continuity after retirement is only 11%, making it an unreliable benchmark for retirement income adequacy.


The issue is not whether 70% is too high or too low. The earnings replacement rate fails because a single year’s employment earnings are not a reliable representation of a worker’s living standard – it relies on an inadequate measurement period (only one year), does not incorporate important components of consumption sources (such as home equity), and ignores household size (particularly children). These omissions are crucial in calculating living standards. Moreover, these omissions interact, and the effect of improving one may not emerge without the others. Indeed, it is primarily owing to these significant and interacting omissions in the earnings replacement rate formula that there has been such a wide range of (often conflicting) reports on the retirement preparedness of populations and pension system reform impacts.

The solution
After concluding that the conventional earnings replacement rate is not fit for purpose, I developed the Livings Standards Replacement Rate (LSRR).

Drawing from best academic practices, the LSRR determines how well a worker’s living standards will be maintained after retirement by comparing how much money a worker has available to support their personal consumption of goods and services before and after retirement.

Analysts invest time and effort in the study of retirement income adequacy, but an unreliable benchmark for ‘adequacy’ can lead to misleading conclusions. The LSRR offers a real alternative to the conventional replacement rate, and is bridging the gap between good science and industry need.

The LSRR calculation considers the entire family, includes consumption components comprehensively and covers a representative number of years.  Having this framework available for analysts to reference will enable a more consistent measure of retirement income adequacy, so as to facilitate the interpretation, comparison and integration of findings across different analysis (between authors, over time and across nations). This would help the study of retirement income adequacy to move forward.

The LSRR provides an accurate, understandable, and consistent measure of retirement income adequacy, and this concept has proved extremely useful to practitioners in serving their clients². It has also been applauded for its academic merit (having won the 30th International Congress of Actuaries’ Pension, Benefits and Social Security Scientific Committee Award Prize for Best Paper in 2014). It has also been published in a significant peer-reviewed academic journal, which can be downloaded without fee:

Population ageing has led to widespread concern regarding retirement income adequacy, and now is time to adopt a better measure. The LSRR has penetrated the Canadian financial industry, and has gained considerable traction internationally. If the LSRR can create the necessary paradigm-shift within the pension industry and study of retirement income adequacy, the benefit to the public is incalculable.

Dr Bonnie-Jeanne MacDonald
Dalhousie University


On 17th November 2016 Dr MacDonald will be delivering a webinar to accompany this blog.

Bonnie-Jeanne MacDonald, Lars Osberg and Kevin Moore. (2016). How Accurately does 70% Final Earnings Replacement Measure Retirement Income (In)Adequacy? Introducing the Living Standards Replacement Rate (LSRR). ASTIN Bulletin – The Journal of the International Actuarial Association, 46(3), pp 627-676,DOI: 10.1017/asb.2016.20


One thought on “Guest blog: Dr Bonnie-Jeanne MacDonald, Dalhousie University – Replacing the replacement rate: How much is ‘enough’ retirement income?

  1. Bob T said:

    The 70% rule was created in the late 50′s/early 60′s, not as a financial planning tool but has been misused as a guideline for financial planning for years.

    Back in those days, various employers maybe more so those in the public sector had an interest in designing their DB plans. Based on the studies, they were well aware than 70% would not fit all circumstances but the issue was what amount would best serve a diverse population because one could not vary the defined benefit for each individual.

    The desired outcome was a design which when applied to most would achieve the goal of the same level of take home pay as the individual had while working and remember at the time, the situation was more one of a working male with a non working spouse. There was no consideration of family wealth/other savings or debts.

    It was know that the true replacement amount would vary between 60 and 80% again without consideration of other wealth/debt.

    For the individual in the lower income bracket, a higher number would be need and OAS would likely feed that need.

    For the individual in the higher income bracket, the higher income tax rate on the highest income would likely reduce the maount needed below the 70% level.

    The focus on 70% became worse when the government in the 80″ proposed the changes to align/coordinate the amounts available for tax assisted retirement savings. the view was take the public sector plans designed to accrue a 2% per year benefit at age 62 payable for life with a survivor benefit and indexing and allow the total tax assisted retirement savings to accomplish this target. The result using the factor of 9 was savin $9 each year for 35 years would produce the $1 of pension payable at retirement.

    The target as per the public sector plans was 2% a year or 70% over 35 years, thus the maximum to be saved each year was 9 times 2% or 18% of pay.

    So again the model was built needing a formula that would be applied to all, it was never considered as the ultimate rule although it became that. If one went back to the old mercer handbooks, they all referred to a number between 60 and 80 percent. Again only as a reference to replace the take home pay, not as the needed retirement income amount.

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