Financial Capability is Multi-Dimensional; so is Financial Advice

A just-released synopsis of the FINRA National Financial Capabilities survey of close to 30,000 Americans from June to October 2015 showed a stunning lack of financial understanding there; at a time when wealth and income inequality is at an extreme not seen since World War II. But Canadians did not do much better.

Despite impressive economic gains since the survey was first conducted in the US in 2009, only 14% of respondents to 5 financial literacy questions answered all correctly; only 37% could answer four.

By contrast in Canada, the Financial Capability Survey, 2014 asked a longer series of 14 questions on topics such as inflation, debt repayment, banking fees and credit reports. On average, Canadian adults 62% of the questions correctly, while 31.4% correctly answered 50% of the questions. Only 2.7% provided a correct answer to all 14 questions.

Here are additional highlights of the key financial issues for Americans today, according to their 2016 survey:

  • Spending vs. Saving. Profiles of people more likely to save for the future include those with higher education and income levels. 40% of respondents spend less than their income, 38% spend amounts equal to their income, and 18% spend more than their income. Just under half of the respondents (46%) have set aside three months’ worth of living expenses for emergencies;
  • Health Matters. Over 25% of Americans have avoided some kind of medical service in the past year due to cost concerns. Further, those with unpaid medical bills are more likely to report spending more than their income than those without medical bills (30% vs. 15%, respectively),
  • Debt and Homebuyers. One third of homebuyers have made a down payment of over 20% of the purchase price of the home in the past 5 years; that’s up from 24% in 2009 and 29% in 2012. About 16% percent of mortgage holders have been late at least once with mortgage payments in the last year.
  • Consumer Debt. More than one half of credit card users report paying balances off monthly.
  • Student Loan Debt. Students with loans are having difficulty – 37% have been late with payments at least once in the past year and 25% have been late more than once.
  • Many Millennials are not Financially Independent. 36% of those in the age group 18-34 receive financial help from family members who don’t reside with them; this is up from 32% in 2012.
  • Retirement Readiness. Only 39% have tried to figure out what they need to save for retirement; over 55% worry about running out of money in retirement, according to The National Institute on Retirement Security. This is not surprising as 62% of workers between the ages of 55 and 64 have reported their retirement savings are less than one times their annual income.
  • Gender Differences. Overall, women are more worried about their finances than men: those aged 35-54 are the most likely to be worried, followed by those 18-34. More than half of those women with incomes of $75,000 or more – the highest income group – are worried about retirement.
  • Multiple Income Sources Matter. Surprisingly those who are receiving retirement income were most likely not to have difficulty making ends meet; but 95% of these folks have another source of income; while only 55% of employees have another source of income.
  • Planning Matters. People who have long-term goals are more satisfied with their personal finance, less likely to spend more than their income and more likely not to have difficulty making ends meet. Most important, 61% of planners have set aside emergency funds compared to 17% without a plan. Further, 73% of planners who have planned for time horizons of more than 10 years have tried to calculate their retirement savings needs have a retirement savings account.

One of the cautious conclusions the survey authors came to linked financial literacy to income inequality: “While speculative, the trends in financial literacy scores suggest a shrinking class of moderately financially literate citizens, just as growing income inequality has led to a shrinking middle class.”

The American report also suggested a more far-sighted approach was required to help: “Both policy and education are needed to broaden access to financial products, protect consumers from predatory practices, and foster greater participation in healthy, life-long financial practices.”

Forward-looking financial advisors will focus their attention to the significant opportunities to add value to families as educators and advocates in helping them understand financial options and apply their knowledge to sound decision-making about their financial futures.

A sweet spot is retirement planning here in Canada. According to our 2014 survey, almost 60% of Canadian adults do not know how much money they need to save to maintain their desired standard of living during retirement. Just under 30% are “not very confident” or “not at all confident” that their household income at the time of retirement will be enough.

The American survey defines “financial capability” as “a multi-dimensional concept that encompasses a combination of knowledge, resources, access, and habits.” Clearly the issues of concern on both sides of the border require multi-dimensional financial advice.

Manitoba Signs On: CPP Final Agreement Coming July 15

Manitoba has agreed to sign on for federal Canada Pension Plan reforms and that gives the required 2/3 approval by the provinces required for the federal plan to move forward. Manitoba wanted emphasis on three key issues, discussed below, but the real issue to follow is this: will this be enough to help middle class Canadians fund their retirements?

Manitoba raised some important issues regarding the mechanics of the CPP of the future – thorns in the side of current benefit recipients under today’s rules:

  1. That the clawback under the GIS (Guaranteed Income Supplement) should be eliminated when widowed survivors received the CPP survivors’ benefit
  2. That the CPP death benefit, which has been set at $2500 since 1997, be indexed to inflation
  3. That the government confirm that anticipated increases to CPP benefits as a result of increased premiums extend proportionately to CPP survivor and disability benefits.

Another issue raised by the Manitoba government concerns the ability for higher earners to maximize their contributions to the CPP over a four-year plan rather than a two-year plan. The current proposals call for higher-income employees to add additional contributions of 4% to a maximum of $192 in 2024 and $408 in 2025 (and indexed subsequently). A four-year phase-in would see an additional contribution of about $100 per year over four years. It will take about 40 years of contribution to take advantage of full enhanced CPP benefits, so working throughout the period at a good paying job is important.

Currently the CPP premiums amount to 9.9% of contributory earnings, when both employer and employee contributions are counted. Individual employees contribute up to a maximum of $2544.30 annually, or $212 a month and their employers contribute an equal amount. These numbers are based on maximum contributory earnings of $51,400 ($54,900 less a basic exemption of $3500). Those who are self-employed must contribute both portions: that’s a maximum of $5088.60 per year or $424.05 per month.

According to Finance Canada, workers earning $55,000 would pay $7 a month more by 2019 or $84 per year. This is a result of a contribution rate increase from 4.95% to 5.10%. By the year 2023 however, this same worker would pay $46 a month more or $550/year. This is $22,000 more over the same 40-year period, or approximately $122,000 in lifetime contributions if their income level remained at $55,000.

Under the new plan, the maximum contribution level will rise 14% to $82,700 by the year 2025. There will be a five-year phase-in of increased contribution rates for those below the Yearly Maximum Pensionable Earnings, followed by a two-year phase-in of the upper earnings limit. The premium for that upper level between $54,900 and $82,700 will be 4% rather than 5.95%. In addition, the Working Income Tax Benefit will be increased to help with the extra cost for very low income earners and the enhanced portion of the CPP contributions will qualify for a tax deduction rather than as a tax credit.

Manitoba makes several good points. Currently CPP benefits reduce the GIS available to survivors. Survivors who receive only OAS and the maximum CPP survivor benefits see their GIS reduced from $856.39 per month to $407.39 per month. Proposed changes could increase the maximum survivor pension to about $10,400 in today’s dollars which would reduce the GIS to about $290 per month. The GIS is eliminated completely when annual income reaches $17,376 in 2016.

Further, CPP survivor benefits do not roll over on the death of a taxpayer to their spouse or children. Rather, while a survivor’s benefit may be possible, depending on contributions the deceased made to the plan, the combined survivor and retirement benefits are capped, so the more retirement benefits the survivor has, the less survivor benefits they will receive. Those who die early and never collect CPP benefits can’t leave anything to their heirs from their long time investment in the CPP, short of the unindexed death benefit of $2500. Manitoba is right to raise the unfairness of these provisions under the current regime.

The new CPP plan will have the objective of replacing one-third of the taxpayer’s employment income to this ceiling, or approximately $27,300. Under the current CPP rules, the plan’s objective was to replace 25% of employment income to a maximum of approximately $51,000.

However, despite the fact that the maximum CPP benefit is $13,110, the average CPP benefits are approximately $7,700—about 60% of the target. There are many reasons for this, including the fact that very few people work to the maximum earnings level throughout their entire career.

This gives financial advisors a great opportunity to be of service in retirement income planning.

The CPP changes are the subject of this month’s Knowledge Bureau poll. Be sure to weigh in with your thoughts on the options available to Canadians as we contemplate retirement planning for today’s forty and fifty year olds:

In your opinion is the enhanced CPP a better retirement savings plan than putting the equivalent amount of premiums into a TFSA?