Employers can help debt-laden workers retire sooner

Mercer research shows saving for retirement instead of paying down debt could force younger Canadians to retire later

Employers can help debt-laden workers retire sooner
Jillian Kennedy, partner and leader of defined contribution and financial wellness, Mercer Canada

For younger generations in the workforce, paying off debt can be as valuable as saving for retirement. New research from Mercer shows that if these employees had access to a workplace savings plan with 100 percent matching contributions from their employer, they could retire two years earlier with an additional $250,000 in retirement savings at age 65.  

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

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 Mercer analysis assumes that a 30-year-old worker earns $70,000, has five percent 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. 

The impact of matching contributions 

If that same individual has access to a workplace savings plan with 100 percent 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.  

Kennedy says 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. 

“The results create a call to action to employers within the marketplace. 

“We believe that paying down debt is a meaningful part of a retirement readiness strategy even though, as a marketplace, we don't talk about this and we don't educate on this. We see this as part of personal consumer finance. 

“It's a change in philosophy and it requires a closer look at the population the employers have. And if employers believe that and set objectives around that, they can change the way they design their savings programs to allow more flexibility. It is less paternalistic and is of great value.” 

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. 

Kennedy says businesses want to see the outcomes, and financial wellness can have a positive effect on both employees and an employer’s bottom line.  

“We've seen in our research for a very long time that when people have debt, it wears on their ability to be confident. It causes them stress. It can affect their mental health and the ability to show up at work and focus. 

“In the in the past, employers have had the mindset that an employee’s debt is the employee’s problem. As an employer, they were there to build retirement savings. However, research shows that these problems are actually everybody's problems. Empowering employees will create confidence. 

When high interest rates are advantageous 

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 percent 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. 

The importance of financial literacy 

These findings from the 2024 MRRB illustrate that, ultimately, 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.