End forced taxation

Zoomer | November 21st, 2008

That was a very interesting shopping list that emerged from last week’s economic summit between Prime Minister Stephen Harper and the provincial and territorial leaders. Big new infrastructure projects to create jobs. Possible help for the ailing automotive sector. A new look at the rules governing RRIF withdrawals.

Wait a second! RRIF withdrawals? Where did that come from?

Actually, it has been around for quite a while but, except for seniors’ advocacy groups like CARP, few people have given it much thought. I can’t recall it ever being mentioned during the federal election campaign. It took a concerted effort by the premiers to bring it to Harper’s attention. Had it not been for a world economic crisis, it would probably still be on the back burner.

The Prime Minister’s response was none too encouraging. He said after the meeting that he hoped the Office of the Superintendent of Financial Institutions (OFSI) would look at the issue “in the not too distant future”. How vague is that? And even if OFSI does get around to studying the matter, its bureaucrats have never shown much interest in the past in moving quickly to deal with the many problems inherent in our retirement savings system.

In reality, this issue doesn’t need OFSI’s input at all. If the federal government genuinely wants to move on it, the cabinet can make the decision to do so. The Prime Minister only needs to give the order.

So what’s this really all about? It comes down to the forced taxation of retirement savings and whether policies crafted decades ago make any sense in today’s rapidly evolving society.

Under the rules as they now stand, people who save for retirement in an RRSP must terminate the plan by Dec. 31 of the year in which they turn 71. (The mandatory age was restored to that level by the Conservatives two years ago.) The RRSP can be cashed in, used to purchase a life annuity, or converted to a RRIF or one of its locked-in siblings, the LIF or LRIF. Most people choose option three.

Once the RRSP is converted, the plan holder must withdraw a minimum amount of money from the RRIF each year, whether or not it is needed. The minimum withdrawal is a percentage of the plan’s value on Jan. 1 of each year and the rate increases annually. A 71-year-old must take out 7.38 per cent of the RRIF’s value and the money is taxed as regular income. By the time the person reaches 77, the minimum is up to 8.15 per cent. At 85, it hits 10.33 per cent. The effect is to steadily deplete retirement savings, and to do so at an accelerating rate as a person ages.

The premiers apparently asked for two things. One was a temporary moratorium on forced RRIF withdrawals, based on the argument that the minimum required for 2008 is calculated on Jan. 1 valuations that are no longer valid in many cases, given the huge losses in the stock markets. With some RRIF portfolios down 40 per cent or more, people should be given the opportunity to let their investments regain value rather than being required to liquidate them and lock in losses.

Finance Minister Jim Flaherty appeared to shoot down this idea in a letter sent to Members of Parliament earlier this month. In it, he pointed out that no one is forced to sell stocks or mutual funds at a loss under the current rules. They can simply be taken out of the RRIF to satisfy the minimum withdrawal rules and held in a non-registered account. That’s a disingenuous response, in my view. Anyone who does this will not only have to pay tax on the amount of the withdrawal but will then be taxed again at capital gains rates if the security regains value when markets recover.

The second idea floated by the premiers is to extend the age at which people can keep their RRSPs to 73. This would allow two more years of contributions and two fewer years of forced withdrawals.

Both ideas are laudable but are only stopgap measures. Canada’s aging population needs the equivalent of a New Deal in our retirement savings program. The Tax-Free Savings Accounts that launch in January are a great start but will be of much more benefit to younger people than to today’s retirees. What is required is a change in the law that will permanently eliminate any minimum withdrawal requirement. In fact, I’ll go so far as to suggest doing away with the entire concept of RRIFs. Allow people to keep their RRSPs for their lifetime, making withdrawals from them as and when they see fit.

There are two reasons why the existing system needs a complete overhaul: people are working longer and they are living longer.

Mandatory retirement at 65 has gone the way of the dodo. It is not unusual these days for Canadians to be actively employed well into their 70s and even beyond – 87-year-old Mississauga mayor Hazel McCallum is living proof. She certainly doesn’t need to take money from a RRIF to survive but she has been forced to do so for the past 16 years (assuming she put money into an RRSP when she was younger and started withdrawals at 71).

Not only are people staying in the workforce longer but every time Statistics Canada issues a new report on longevity it tells us our life expectancy has been extended further. The most recent numbers show that a Canadian male between 70 and 74 can expect to live 13.7 years while a woman in the same age group will survive 16.7 years. At the current mandatory RRIF withdrawal rate, this means the average person in this age group will see most of their savings depleted before they die. Unless they have other income sources to fall back on, they’ll end up as wards of the state. This is certainly not good social policy.

The only reason for mandatory withdrawals is to enable the government to collect its pound of tax sooner rather than later. In the end, when the last surviving spouse dies, all the money remaining in a RRIF is taxed at marginal rates. So ending forced withdrawals will only delay the timing, not the final result.

The Finance Department will undoubtedly point out that ending minimum withdrawals will have an impact on government revenue at a time when we’re flirting with a deficit. That is correct, and it would have been better to introduce this reform when Ottawa was flush with cash. But now we find ourselves in a situation where what was perceived as a low-grade problem has become a major issue. As such, it needs to be addressed quickly.

Harper’s “not too distant future” isn’t good enough. Many people who don’t need RRIF income delay making their minimum withdrawal until the end of the year, when they take it as a lump sum. That’s slightly more than six weeks away, which should create a sense of urgency. The government needs to act now, at least with some temporary relief. A full-scale overhaul can be a core theme of next year’s budget.

This article originally appeared in the Internet Wealth Builder, a weekly e-mail newsletter that provides timely financial advice from some of Canada’s top money experts. For more information about becoming an Internet Wealth Builder member, go here.