Saving for retirement instead of paying down debt could force younger Canadians to retire later 

New Mercer analysis illustrates the potential impact of high interest rates and how it’s not always advisable to save for retirement, depending on where you are in your career. 

Toronto, April 9, 2024 – Millennials and younger generations who split their disposable income between paying down debt and saving for retirement could potentially delay their retirement by one to two years compared to if they focused solely on paying down debt in the short term, according to the 2024 Mercer Retirement Readiness Barometer (MRRB).

While people have been encouraged to save a portion of their pay cheque for retirement steadily over their working career, this analysis shows that in today’s economic climate with elevated interest rates, a sample 30-year-old with $30,000 of personal (non-mortgage) debt, could retire one year earlier with $125,000 more in savings if they focus entirely on paying off debt within 10 years, before shifting their focus to saving for retirement.

Alternatively, if that individual chooses to split their disposable income between saving for retirement and paying down debt for the entire period until retirement at age 65, it can take more than three times as long to pay down the debt. This leaves them with a shorter period to make larger contributions, which requires them to need to save longer to accumulate enough funds to be able to retire.

“Many people think that if they have not started saving for retirement by the time they are 40 they have failed,” says Jillian Kennedy, Partner and Leader of Defined Contribution and Financial Wellness at Mercer Canada. “This latest analysis shows us though, that if you are diligent about paying down debt as a priority, then later focus on saving for retirement, you may still have time to accumulate savings and you may actually end up in a better position at retirement. Paying off debt can be effectively saving for retirement.”

The above analysis assumes that a 30-year-old worker earns $70,000, has 5% of their income to apply either to paying down debt or saving for retirement, and the interest rate on their debt is higher than the expected rate of returns of their investments.

If that same individual has access to a workplace savings plan with 100% matching contributions from their employer, they could retire two years earlier with an additional $250,000 in retirement savings at age 65, if they pay off debt early rather than focusing on retirement savings from age 30. 

Most traditional workplace retirement programs only provide employees access to pension plans that require savings to be locked-in and not accessible until retirement age, which can make paying down debt more difficult and retirement feel unattainable. As a result, we are seeing increased levels of financial stress reported by employees across all earnings levels up to $200,000 according to Mercer’s 2023 Inside Employee Minds Survey.

Some workplace retirement programs have started to evolve and recognize the importance of supporting financial wellbeing and retirement readiness with a more personalized approach. For example, allowing employees to direct their own savings to a Tax-Free Savings Account (TFSA) or non-registered account where funds can be withdrawn for debt re-payment, while still directing matching contributions from the employer to a traditional pension arrangement. Employers adopting plans with this type of flexible design are noticing higher employee engagement and financial literacy which is helping Canadians in their day to day lives.

While millennials and younger generations are facing difficult decisions about paying down debt versus saving for retirement, boomers nearing retirement age have their own decisions to make, such as what to do with retirement savings as they transition into a period where they are no longer working.

One scenario where high interest rates can be advantageous is in purchasing an annuity to provide a fixed income payment in retirement. Based on January 2024 pricing, a 65-year-old with $500,000 savings who uses those funds to purchase a single-life annuity could have a lifetime income of $26,000 per year in today’s dollars, which is $3,500 per year higher than if they chose to invest the $500,000 in a retirement income product that is subject to market fluctuation with a conservative investor profile.

Purchasing annuities may not be advantageous for long if interest rates fall as they are expected to do later in 2024. This analysis shows that an interest rate drop of 1.5% would result in a reduced annual lifetime income of $21,800 in today’s dollars for the single-life annuity, which would be $1,700 per year less than investing the money with a conservative investor profile. This suggests that while there are Canadians struggling with building savings for retirement, there are also windows of opportunities that may benefit retirees; however, recognizing these opportunities requires a high level of financial literacy.

These findings from the 2024 Mercer Retirement Readiness Barometer illustrate that regardless of whether you are a young Canadian choosing between paying down debt and saving for retirement, or a boomer deciding what to do with your savings as you near the end of your career, having financial literacy is key to achieving success.

Workplace retirement programs continue to make a difference in the lives of Canadians, especially when they provide flexibility for employees to make financial decisions that are right for them. In addition to providing employees with financial assistance through retirement plans, employers can help position employees for success by providing training to increase financial literacy, which can potentially improve employee engagement and reduce financial stress. 

The Mercer Retirement Readiness Barometer measures the age in which different personas can comfortably retire based on their participation within an employer-sponsored DC plan and benefits provided by the government (like CPP/QPP/OAS).

The above analysis is based on Mercer retirement readiness analytics using data from proprietary Mercer databases and tools. Retirement readiness is defined at a 75% probability of not running out of money before death if an appropriate level of income is maintained throughout retirement (including government benefits), which for the 30-year-old is 66% of pre-retirement income. In determining the impact on retirement savings at age 65, it is assumed that for each year until age 65 the interest rate on the debt would be 10% per year and the expected rate of return on retirement savings would be 6%.

For the 65-year-old retiring today, it is assumed that the investment in a retirement income product would be 40% equities and 60% fixed income at retirement and then grade down to 20% equities and 80% fixed income by age 80.