The budget: good news for retirement savers

About a week before last month’s federal budget was released, a newspaper reporter asked me which option I would pick if it came down to a choice between raising the 18 per cent formula for calculating RRSP contributions or increasing the maximum allowable limits. I unhesitatingly chose an increase in the 18 per cent figure, perhaps back to 20 per cent of earned income, where it used to be.

My rationale was simple. Such an increase would benefit everyone who wants to save for retirement via the RRSP route. Raising the maximum limit would only benefit high wage-earners.

High-income earners may contribute more
As we all know, the Finance Department opted in favour of the high-income folks. Starting immediately, you can contribute an extra $1,000 to your RRSP (up to $14,500 a year), if you had earned income of $80,555 or more in 2002. The maximum will rise by another $1,000 a year in 2004 and 2005, and will jump to $18,000 in 2006, after which it will be indexed. Limits on pension plans and deferred compensation plans will also go up.

All this assumes that Ottawa doesn’t renege in the interim, as it has done so many times before on plann RRSP contribution limits. In fact, when Paul Martin was Minister of Finance he actually reduced the maximum limit one year. That could be an ominous sign for the future.

If you are one of the fortunate few who can benefit from the higher RRSP limit and you normally contribute the maximum allowable, you may want to sock another $1,000 into your plan right now. It’s always better to get money into an RRSP earlier rather than later, to maximize the effect of tax-sheltered compounding. Even if you do nothing more than invest the money in a one-year GIC, it’s worth it.

Major change to defined benefits pension plan rules 
There was another wrinkle to the changes in the retirement savings rules that appeared to escape the attention of the media, but which could be the most significant move the government made in terms of the number of people it will ultimately affect. If you belong to a defined benefits pension plan, this budget provision could be of major importance to you.

Before I give you the details, here’s some background. Few people are aware of the fact that there is a limit on the amount of the pension you can draw at retirement from a defined benefits plan. Way back in 1976 it was set at $1,722 per year of service and, if you can believe this, it has not been changed since. That’s 27 years!

Here’s how it works. Let’s say you’ve been a member of an employer pension plan for 20 years. The maximum pension you can draw when you retire is $34,440 annually ($1,722 x 20), no matter what your income level may have been. For many people, this may fall way short of what they expect, or need.

The budget will finally increase the ceiling, to $1,833 per year of service in 2004 and $2,000 per year in 2005. The net effect is that by 2005, an employee with 20 years in a plan will be able to draw a maximum annual pension of $40,000, an increase of about $5,500 from the present limit. So if you’re considering early retirement, you may want to hold off for a while.

Note that the ceiling only affects the first year payment. After that, indexed pension payments may be increased, within the limits prescribed by the government.

There is also a proposal that will provide more flexibility to people with defined contribution pension plans (also called money purchase plans). Starting next year, you’ll be able to leave your money in the plan instead of buying a life annuity or switching it into a RRSP or RRIF. Withdrawals from the pension plan will be structured in the same way as RRIF withdrawals.

So all in all, it’s good news for retirement savers. But increasing the 18 per cent formula would still have been the better course of action.