RRIF minimums and low rates spell disaster

Let’s do a quick historical review of the prime interest rate, the rate at which banks are willing to lend money to their best customers.Question: In the last 60 years, how many times has this preferential borrowing rate dipped to four per cent or lower?

Answer: According to the Bank of Canada, not once until now! In fact, when the prime rate hit 3.75 per cent early last year, it marked the lowest level since 1935, the earliest date for which this kind of information is widely published by our central bank. Even during the Second World War, the prime rate held at 4.5 per cent.

This economic fact is especially relevant to people living on fixed incomes because it means, of course, that a whole generation of Canadians is facing the lowest interest rates they’ve ever experienced. 

Bear in mind also, the interest rate paid by financial institutions on their customers’ savings can be significantly lower than this preferred borrowing rate. Now that’s worrisome enough for older, conservative investors who could once put their money into 10 per cent guaranteed investment certificates with few wores. But those whose money has been converted from RRSPs to RRIFs — the people who are supposed to be enjoying a comfortable retirement on registered plans protected by Ottawa — are in real trouble and, as yet, our federal friends have refused to lift a finger to help them.

New, higher minimum annual withdrawals
Here’s the basis of problem: the government’s 1992 budget changed the rules to allow RRIFs to extend through the life of the plan holder instead of being wound up at age 90 — a change for which CARP fought long and hard. According to the policy-makers, this modification (which is positive for most Canadians) created the need for new, higher minimum annual withdrawal rates for RRIFs (a change that’s not at all positive). The result is that the amount you must withdraw annually from age 71 forward is much higher for RRIFs established after Jan. 1, 1993, than for older RRIFs.

Next page: Indexing may be solution

For example, if you’re 71 and set up your RRIF in 1993 or later, you must withdraw a minimum 7.38 per cent of your RRIF assets annually, compared to a 5.26 per cent minimum for older RRIFs. For the government, the benefits of these new mandatory withdrawals are obvious: the sooner you take the money out, the sooner it becomes income and Ottawa gets its tax revenues.

For the average Canadian, the implications of these new withdrawal rules are just as serious but certainly not as beneficial as they are for the government. In an environment of low interest rates, mandatory withdrawals can easily outstrip the growth of your RRIF investments. The result could be an income shortfall in later years. At the very least, it leaves many Canadians struggling to maintain the capital in their RRIFs, even in periods of modest inflation.

Indexing may be the solution
When then Finance Minister Paul Martin visited CARP’s national offices back in February 2000, we raised the issue of RRIF withdrawal rates and offered a number of solutions. For example, instead of basing withdrawal rates on short-term interest rates, they could be indexed to inflation. That would ensure retirees were drawing enough income and would generate a fair amount of tax for government coffers. Alternatively, withdrawals could be based on historical averages for the 25 years immediately prior to the introduction of this policy.

Not surprisingly, Finance Canada was in no hurry to review CARP’s suggestions — a response was six months in coming and, in the end, did nothing to address our concerns. The government argued that indexing would be too complex (not a good reason for failing to correct a bad policy); that lower withdrawal rates would serve only a minority of relatively wealthy seniors by allowing them to accumulate wealth (untrue, since the larger the RRIF on the death of the RRIF holder or the surviving spouse in the case of a widow or widower, the better the government’s chance of getting the top marginal tax; and that RRIF holders are required to take fewer retirement funds into income for tax purposes than people receiving annuities (true, but only because after-tax income is lower, partly because RRIF capital is being eroded).

Ottawa’s arguments held little water then and are even more porous now with interest rates at historic lows. CARP and 50Plus magazine will continue the fight for more equitable rules — but you can help by telling your MP and/or Finance Minister John Manley that it is time to correct this most unfair situation.

50Plus publisher and editor David Tafler passed away on Dec. 18, 2002. This column, written a few days before he died, reflects his passion about the need to reform RRIF withdrawal rules.Financial editor June Yee will assume the responsibility of writing this column on personal finance in future issues.