No incentive to save

Are you a “futile saver”?

Doesn’t sound very flattering, does it?

Well, guess what. If you live in Canada you have a one-in-three chance of being one.

The expression “futile saver” was coined by Richard Shillington, a statistician and social policy researcher who wrote a groundbreaking paper in 2003 for the CD Howe Institute entitled New Poverty Traps: Means-Testing and Modest-Income Seniors.

Regular readers of 50Plus magazine will no doubt be familiar with Shillington. His views were the subject of two columns by Gordon Pape but, for those who may have missed them, here’s the nutshell version of Shillington’s analysis.

If you are a lower-income Canadian, you are better off not investing in an RRSP – at least in the long term – because much of what you save could be clawed back in the form of taxes after you turn 65. That or transmuted into baser metals by lack of eligibility for social programs, particularly the Guaranteed Income Supplement (GIS), and related programs, such as ones that provide rebates for prescription drugs.

This because in addition to maintaining eligibility for social programs, non-savers enjoy t luxury of actually spending the money they earn on themselves prior to retirement rather than investing it in savings programs that won’t materially enhance their spending power after retirement. In other words, futile savers sacrifice current consumption for a future benefit they may never realize.

Have we been duped?
Neither government nor the investment industry has had much to say about Shillington’s analysis. Wondering why?

Well, for one thing, futile savers who can be duped into thinking their savings will provide them with a more comfortable retirement are a boon to government, partly because much of what they have managed to stash away, often at great personal sacrifice, is either headed back to the taxman or is going to be cited as evidence that the holder of these funds doesn’t qualify for government programs.

On the other side of the equation is the retirement-savings industry, which has financial products to sell.

No offence to the people marketing RRSPs. For many mid- to high-income Canadians, RRSPs are an essential part of a retirement-planning package. But RRSPs aren’t necessarily for everybody, and it isn’t fair to lower-income Canadians ($20,000 to $30,000 a year for a single person and about $40,000 for a household of four) to say they are if the greater part of their RRSP holdings is going to get clawed back.

What’s the answer?
But if RRSPs aren’t the answer for lower-income Canadians, what strategy would work better?

I for one am keenly interested in the answer because after reading Shillington’s paper I came to the grim realization that I could be the poster-boy for the futile-saving generation, the template for the genre.

I am a 50-year-old freelance writer, and last year I grossed about $32,000. I married late in life (46), had a child even later (48) and took on my first mortgage last March. At the time I met my wife, I had about $15,000 in RRSPs, but we cashed in most of that earlier this year, along with the better part of my wife’s savings, in order to buy our home, a home we needed because we had a son, my beautiful two-year-old boy, James, who is the light of our lives but whose day care alone costs us $700 a month. We also started an RESP for him that costs us another $100 a month each.

Put the mortgage and the child together, and you’re looking at a couple who’s contemplating Freedom 95. I’m not complaining. I made my choices, but someone who is 10 or 15 years away from retirement would be a fool if he or she put what little savings-bound capital they had in an investment vehicle they’re never going to be allowed to drive.

Mext page: What are your options?

Now I know there are a lot of people out there who are going to read this with steam coming out their ears because what we’re talking about here is shifting the responsibility for supporting lower-income seniors from themselves to the state. In my defence, I turn to Malcolm Hamilton, a pension consultant with W.H. Mercer in Toronto.

Here are your options
“If you design a system that encourages sponging, then that’s what you’re going to get,” Hamilton says. “It’s silly to design a system where rational people behave like sponges and then think poorly of them for behaving that way. I don’t like the system, but there it is.”

So what’s a fiftyish Canadian to do? The first person I went to for advice was Shillington himself. He brought the problem to public attention so I figured he’d have some answers.

His first bit of advice is this: if you think you’re going to require the Guaranteed Income Supplement, which is worth about $11,000 a year to people who don’t have any retirement income, be sure you cash in your RRSP before you hit 65. If you don’t, the income derived from the RRSP will scotch your eligibility for the GIS.

You’ll have to pay the tax when you do cash out but, according to Shillington, doing so will save you money big time. Here’s an example. Let’s say you have $40,000 in an RRSP. If you wait until you’re 65 to cash it in – taking it out over a four- to five-year period – you’re going to lose about $20,000 in GIS benefits. On top of that, you’ll be paying income tax, leaving you with about $10,000.

Alternatively, you could cash in the RRSP over a four- to five-year period before turning 65, pay about $10,000 in taxes and have $30,000 left, which cannot be counted as income, so it won’t affect your eligibility for the GIS. Net gain: about $20,000.

What if you’ve already turned 65 and you have the same amount of money ($40,000) in your RRSP? What’s your best course of action? Shillington suggests either cashing it in all at once or very, very slowly. “The worst you could do is take out $4,000 a year,” he says. “Cash it in all at once and take the tax hit. You’ll lose your eligibility for GIS for one year, but you’ll get it back the next – and you’ll still have the money.”

If you’re pre-retirement and thinking you’ll be in need of the GIS – and this one really resonates with me – forget about saving for retirement until your mortgage is paid off.

“Say you’re 55 and you don’t have a pension plan but you have $40,000 in an RRSP,” says Shillington. “That’s not enough to fund retirement, so you’re going to be on GIS. In that case, take the money out of your RRSP and put it on your mortgage. You’re far better off because owning your home at least provides you with an asset you can trade, one you can sell without tax implications because you paid for it with after-tax dollars. More importantly, being mortgage-free does not affect your eligibility for GIS.” (By the way, the amount you have in your RRSP could be more than $40,000 or it could be less, the important point is that it’s not enough to last throughout your retirement years.)

What the financial experts say
Doubtless many readers will dismiss Shillington as a left-wing policy wonk bent on teaching lower-income Canadians how to avoid taking responsibility for their retirement. So to balance out the equation, I invited a dozen or so certified financial planners from across Canada – via e-mail – to contribute a little advice for lower-income savers planning for retirement.

I heard back from two of them.

Next page: RRSP alternatives

One was David Christianson, a planner with Wellington West Total Wealth Management in Winnipeg and a columnist with the Winnipeg Free Press. Christianson, who typically charges “high net-worth” clients $250 an hour for his advice, says it’s hard not to give two conflicting messages about saving for retirement in Canada.

“What I generally tell people is that if you want to retire and enjoy the standard of living you have now, get serious about it,” he says. “But the other side of me wants to say, ‘Let’s get this in perspective because the other extreme is, hey, don’t worry, be happy. The government will take care of you.’”

A benchmark is, he says, that if you’re a single person making less than $33,000 before taxes and you’re buying an RRSP to shelter money, it may not be worth doing. You’ll save tax at a rate of 22 to 27 per cent but when you draw it out later, you may be paying that much tax or more. And if it prevents you from getting GIS and all the other benefits you’re eligible for, you may wind up paying more.

Remember, he adds, every dollar out of an RRSP costs you 50 cents of GIS along with your eligibility for the GST tax credit.

Christianson agrees with Shillington that paying off a mortgage should be a priority.
“Calculate what your retirement income is going to be,” he says. “If it’s less than your net income today, make sure your mortgage is paid off. Either increase your payments or be prepared to downsize prior to retirement.”

Another piece of advice for our futile savers is to save for retirement outside a tax-sheltered plan – if you can afford to, that is. You may still be in a bind.
“There’s a catch though,” says Christianson. “Saving money outside an RRSP still leaves you open to taxes on your capital gains, so you’ll pay something there when you realize those capital gains. And don’t forget that those capital gains will be added to your income and will affect your eligibility for GIS.”

Government must provide RRSP alternatives
Is there a better way for people of modest means? Wouldn’t it be nice if there were investment vehicles that didn’t have built-in disincentives for lower-income Canadians?
Dr. Jon Kesselman, an economist in the public policy program at Simon Fraser University in Vancouver, says there could be if only the politicians had the will because the vehicle has already been invented. All it needs is an operating licence from the government.

The vehicle is called a tax pre-paid savings plan (TPSP) and it works like this. Investors buy into investment vehicles with their after-tax dollars, but the accumulated value over time – the capital gains, as it were – would not be taxable. Imagine being able to invest $5,000 or $10,000 and have it mutate into $100,000 on retirement – and go into that golden-hued era not worrying about having all your gains stripped away by Canada Customs and Revenue! As the Bard might say, “’Tis a consummation devoutly to be wished.”

Evidently, says Kesselman, the politicians have neither embraced nor rejected this RRSP alternative. “The 2003 federal budget devoted a paragraph to it, suggesting it might be a proposal worth pursuing,” says Kesselman. “And while the 2004 budget did not follow through with a proposal, it did say it would study the idea.”

And in case you’re thinking TPSPs are just another left-wing plot to deprive the treasury, the federal Tories under Stephen Harper included a policy proposal called a Registered Lifetime Savings Plan in the last election, which Kesselman says was your basic TPSP program by another name.

Re-think how you plan for retirement
Ultimately, left wing or right, Canada needs to re-think the way it allows Canadians to plan for retirement. Lower-income Canadians are starting to realize they’re being sold a bill of goods as far as RRSP investing is concerned, and they – we – are starting to bail out. I and many other lower-income Canadians who work just as hard as anybody else for the money we earn would rather not sponge off the government, but we need an alternative that works for us.

And by the way, if you don’t like this analysis, don’t blame the messengers. Instead, send your missives to your local member of Parliament. Ultimately, he or she is the only one who can do anything about it.