Ottawa Should Lift Unfair Contribution Limits on RRSPs, Pension Plans - C.D. Howe Institute
TORONTO, Nov. 7, 2017 /CNW/ - Ottawa should raise contribution limits for savers in RRSPs and defined-contribution pension plans, says a new C.D. Howe Institute report. In "Rethinking Limits on Tax-Deferred Retirement Savings in Canada," author William Robson finds current limits are outdated, unfair, and put savers in RRSPs and defined-contribution plans at a major disadvantage.
"People are living longer and—even more importantly—yields on investments suitable for retirement saving are very low. These changes have raised the cost of obtaining a given level of retirement income," says Robson.
The core of the problem is the Factor of Nine, a little-known, outdated "equivalency test" for savings in various retirement saving plans. First adopted in 1990, the Factor of Nine uses a hypothetical defined-benefit pension plan in which saving 9 percent of annual earnings will let a person buy a retirement annuity equal to 1 percent of pre-retirement income. The Income Tax Act lets a member of a defined-benefit pension plan accrue a maximum annuity of 2 percent of final earnings tax-free in the year of accrual - which, over 35 years, would yield a pension equal to 70 percent of pre-retirement earnings. The Factor of Nine limits holders of RRSPs or defined-contribution plans to contributions worth up to 18 percent of their earnings a year (9 x 2 percent).
While intended to let them achieve an equivalent outcome, this limit badly damages their hopes of achieving retirement security like that of members of defined-benefit pension plans common in Canada's public sector.
For one thing, the hypothetical plan underlying the Factor is less comprehensive than most actual defined-benefit plans. Worse, a quarter-century after its adoption, the Factor of Nine is badly outdated. Ongoing improvements in life expectancy and lower yields on retirement-appropriate assets mean that people must save at least twice as much to replace pre-retirement earnings than the Factor of Nine presumes. Moreover, savers in defined-contribution pensions and RRSPs typically incur higher risks and higher costs than defined-benefit plan savers. RRSPs and defined-contribution plan cannot pool longevity risk across cohorts like direct-benefit plan participants can.
Market downturns are also more harmful to defined-contribution plans since savers cannot contribute extra funds to cover past capital losses: indeed, capital losses incurred by a defined-benefit plan must be offset by plan sponsors. All these considerations would justify more generous tax treatment of retirement saving in these plans - not the less generous treatment dictated by the Factor of Nine.
The author recommends three types of reforms which could alleviate problems associated with the Factor of Nine:
- Updating the Factor of Nine's underlying assumptions to reflect current economic and demographic realities; specifically, allowing a higher tax-deferred saving limit, raising the threshold from 18 percent to 30 percent or more.
- Levelling the playing field for savers catching up on contributions later in life, or for savers with differences in pension plan design.
- Replacing the current annual saving limits with flexible tax-deferral regimes: either index unused contribution room for inflation or, more transformatively, establish an inflation-indexed lifetime tax-deferred savings limit.
"Defined-contribution plan participants and RRSP savers should enjoy the same opportunity for pension wealth as their defined-benefit plan and public-sector plan counterparts," says Robson. "All Canadians should have the ability to accumulate sufficient savings for retirement, and unfair tax-treatment should not stand in their way," he concludes.
Click here for the full report: https://www.cdhowe.org/public-policy-research/rethinking-limits-tax-deferred-retirement-savings-canada
The C.D. Howe Institute is an independent not-for-profit research institute whose mission is to raise living standards by fostering economically sound public policies. Widely considered to be Canada's most influential think tank, the Institute is a trusted source of essential policy intelligence, distinguished by research that is nonpartisan, evidence-based and subject to definitive expert review.
SOURCE C.D. Howe Institute
William Robson, President and CEO of the C.D. Howe Institute or Alexandre Laurin, Director of Research, C.D. Howe Institute. Phone: 416-865-9935; email: [email protected]
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