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HOW ACCURATELY DOES 70% FINAL EMPLOYMENT EARNINGS REPLACEMENT MEASURE RETIREMENT INCOME (IN)ADEQUACY? INTRODUCING THE LIVING STANDARDS REPLACEMENT RATE (LSRR)

Published online by Cambridge University Press:  19 September 2016

Bonnie-Jeanne MacDonald ,
Lars Osberg  and
Kevin D. Moore
Bonnie-Jeanne MacDonald*
Affiliation:
School of Mathematical and Computational Sciences, University of Prince Edward Island, Halifax, Nova Scotia, Canada
Lars Osberg
Affiliation:
McCulloch Professor, Department of Economics, Dalhousie University, Halifax, Nova Scotia, Canada E-Mail: lars.Osberg@Dal.Ca
Kevin D. Moore
Affiliation:
Principal Researcher, Statistics Canada, Ottawa, Ontario, Canada E-Mail: kevin.Moore@statcan.gc.ca
*
E-Mail: Bonniejeanne_macdonald@hotmail.com
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Abstract

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Will 70% of a worker's final annual employment earnings sustain living standards after retirement? Despite increasing skepticism, the most dominant measure of retirement income adequacy by financial planners, pensions plan advisors, academics and public policy makers is the “final employment earnings replacement rate”, where 70% is considered the right target to ensure living standards remain at approximately the same level after retirement. Using Statistics Canada's LifePaths dynamic population micro-simulation model, this paper asks whether those individuals from the 1951–1958 Canadian birth cohort who attain roughly a 70% final employment earnings replacement rate (as conventionally measured) at retirement do, in fact, achieve approximate continuity in their living standards. We find that the conventional final earnings replacement rate measure has little predictive value for living standards continuity between working-life and retirement. The primary reason is that employment earnings in a single year is not a reliable representation of a worker's standard of living — it relies on an inadequate pre-retirement measurement period, does not incorporate important components of consumption sources (such as home equity), and ignores household size (particularly children). As a result, we find that the correlation between the conventional earnings replacement rate and actual living standards continuity is relatively low (0.11). The paper therefore suggests an alternative metric for assessing how well a worker's living standard is maintained after retirement — i.e., the Living Standards Replacement Rate, or the LSRR. The LSRR provides a more accurate, understandable and consistent measure of retirement income adequacy.

Keywords

Retirement income adequacy70% earnings replacement ratemicro-simulationstandard of livingLiving Standards Replacement RateLSRRretirement planningemployer pension plan designpublic pension plan design
Type
Research Article
Information
ASTIN Bulletin: The Journal of the IAA , Volume 46 , Issue 3 , September 2016 , pp. 627 - 676
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Copyright © Astin Bulletin 2016

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