“Always be saving for retirement” has been a prime rule of personal finance since – well, forever.
Reality has forced a rethink. There’s a growing recognition today that people would be best off if they first paid down their debts. Then save for retirement. Also, saving for a house will to be jammed in there somewhere.
Evidence of this shift can be found in a recent development in company pensions. The basic pension idea is to invite or require employees to have money deducted from every paycheque for retirement. Now, some employers offer an option to put some of this money into non-pension savings that can be accessed for purposes like debt repayment.
“It’s about being strategic and not just forcing everybody to put money into investments that they can’t afford,” said Jillian Kennedy, partner and leader of defined contribution pensions and financial wellness at Mercer Canada. “Let’s just help you pay down your debt so you can become a future saver.”
Mercer is a human-resources consulting company that, among other things, helps employers run their pension plans. The company estimates that 10 to 15 of its corporate clients have adopted the approach of providing a savings plan employees can access as well as a retirement savings program. Another 20 to 30 clients are looking at adding savings plans, with recent experience suggesting an 80-per-cent adoption rate among employees.
To back up the importance of debt repayment, Mercer offers research showing that people in their 30s could retire sooner and with more money if they focus first on repaying non-mortgage debt and then get serious about retirement saving at 40 and beyond.
Mercer’s case study starts with a 30-year-old with $30,000 of non-mortgage debt, a $70,000 salary and the wherewithal to use 5 per cent of gross income for retirement saving or debt repayment. A key underlying assumption here is that the cost of borrowing is higher than the potential rate of return from investments. Mercer projected a 10-per-cent rate for non-mortgage borrowing and a 6-per-cent net return for investments.
Mercer says this 30-year-old could retire one year sooner with $125,000 more in savings if they focus strictly on debt repayment within 10 years rather than using 3 per cent of earnings for debt repayment and 2 per cent for retirement savings.
This is a snapshot analysis – it’s possible borrowing costs will fall below potential investment returns at some point in the future, which would change the math. But Mercer’s numbers accomplish something important in sending a message that paying down debt isn’t a second-best choice to retirement saving.
“We asked ourselves, is paying down debt not a part of a retirement readiness strategy? And we think it is,” Ms. Kennedy said.
The latest thinking on pensions and saving mirrors what already happened with health and wellness benefits, Ms. Kennedy said. Where employees pay premiums for health benefits, they commonly get to choose from a broad range of services rather than a narrower list determined by the employer.
“It’s a little bit harder now to force your employee to pay money towards benefits and not allow them to have some type of a menu to choose from,” she said. “On the retirement side, we are now seeing the same trend.”
One model for companies that want to help employees manage their debt could be to allow them to make contributions to a group tax-free savings plan or a non-registered savings plan that could be based on a high interest saving account. This is instead of a contribution to the company pension.
Meanwhile, matching employer contributions would go into a pension or other retirement savings program and thus not be available for near-term use.
Ms. Kennedy said employers feel some anxiety about letting people access savings that otherwise would have been earmarked for retirement. But they also recognize that flexible savings programs can help retain employees and lessen stress that causes people to be less productive at work.
Money held in a flexible savings program could be used for any type of debt, including mortgages. Ms. Kennedy said Mercer’s research on paying down debt versus retirement saving didn’t consider mortgages because people accept them as part of the cost of owning a home.
“People are saying I’m able to pay my rent or my mortgage, but I can’t do anything else,” she added. “This definitely matters to the emotional state of the average person.”
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Rob Carrick