Time to erase an old mistake

More than a decade ago, the finance minister of the day, a fellow named Paul Martin, created a storm of controversy among seniors by lowering the mandatory age for RRSP conversion from 71 to 69.

It was seen as a tax grab, a way for the government to get its hands on people’s retirement savings two years earlier. To this day, no other plausible rationale for the move has ever been put forward.

As anticipated, one of the results has been to force people to start drawing against their retirement savings at an earlier age whether they need the money or not and, of course, to pay tax on the withdrawals. But a Statistics Canada study released in April suggests the move is having other consequences as well, some of them perhaps unexpected.

The study, published in StatsCan’s Perspectives on Labour and Income and covering 2001 and 2002, suggests some low-income seniors are actually being hurt by the forced earlier conversion. The survey found that among lower income people, “a small percentage lost some of their Guaranteed Income Supplement (GIS) entitlement as a result of RRIF income coming on stream.”

That hapens because of the way in which the GIS is structured. The maximum monthly GIS payment for a single person in the second quarter of this year was $593.97, or $7,127.64 a year. However, the annual amount is reduced by about $0.50 for every $1 you receive in income (payments from Old Age Security and the Allowance excepted).

By forcing people to start drawing down their retirement savings two years earlier, the government also reduces the amount it pays to GIS recipients. For example, suppose you have yearly income of $3,000 from other sources. You are entitled to a monthly GIS payment of $468.97, or $5,627.64 a year. Now, let’s say you have a small RRSP that you are required to convert to a RRIF at age 69. In the first year, it adds $500 to your annual income. Sounds okay until you realize your monthly GIS payment will drop to $448.97, or $5,387.64 annually. You’ve lost $240 because of the conversion. Granted, this apparently happens to only a small percentage of all seniors. But they happen to be the most vulnerable group from an income perspective.

What about the others? The study found that conversion from an RRSP to a RRIF or annuity boosted income for 70-year-olds by about $1,600 a year on average in 2002, equivalent to about 6.6 per cent of their 2001 income. But the taxable income of these same people went up by only $800 on average, or 3.2 per cent. The average taxes paid increased by only $200 a person from 2001 to 2002, representing a total of $40 million. When you consider that the federal government collects almost $60 billion a year in personal income taxes, the amount generated by the forced early conversion is a drop in the bucket.

StatsCan found the conversion payments are being taxed at a higher rate than other income. “Although the gain in taxes paid nudged the average tax rate only from 16.1 per cent to 16.3 per cent in 2002, it represented an effective tax rate of 25 per cent on the $800 increase in taxable income,” a summary of the findings stated. That happened because the extra income was taxed at the recipient’s marginal rate, not the average rate.

Overall, the study concluded that the forced early conversion produced great-er financial benefits to higher-income seniors than lower-income people. “The study divided the entire cohort of 69-year-old tax filers into five equal groups based on income,” the summary said. “It showed that about three per cent of the group with the lowest income experienced more than a five per cent increase in income at the age of 70. In contrast, 43 per cent of the group with the highest incomes experienced more than a five per cent gain.”

So let’s add it all up. Forced early conversion has helped higher-income people more than lower-income ones; it has resulted in the loss of GIS payments for some seniors; it has hit withdrawals with higher tax rates; and it has produced relatively little extra tax revenue for the government.

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Opinions expressed are those of the writer and should not be understood as offering advice. Information is of a general nature and may not be appropriate for any single individual.