Pension reform: Easy first steps

Finance Minister Jim Flaherty says that improving our retirement savings system by overhauling the Canada Pension Plan won’t be easy and won’t happen any time soon.

“This is not something that will happen quickly,” he told The Globe and Mail recently. “We have to first of all agree on where we’re going and make sure everybody’s happy with that.”

It’s already clear that everybody at the political level is not happy. And working Canadians, the ones who foot the bill for any CPP enhancements, haven’t even been consulted yet. The odds are there will be a huge outcry against the changes once people realize what it will mean to their take-home pay.

Mr. Flaherty and some of his provincial counterparts are promoting “modest” changes to the CPP which would result in increased benefits for all future retirees. The catch, of course, is that they’ll have to be paid for by employees and employers, who are already being hit with high annual contributions.

For 2010, the maximum employee contribution is $2,163.15. Self-employed people pay twice that amount. Employers must match their employees’ contribution dollar for dollar. The maximum increases annually with inflation, making the CPP a burdensome payroll tax, especially for marginal businesses.

Moreover, there is no relief for employers in the event of overcontributions, which can happen when a person holds more than one job or changes employers during a year. Employees get a refund for overcontributions when they file their annual tax returns. For employers, that money simply disappears into the CPP maw. No wonder small businesses are skeptical about further adding to the CPP burden.

The government of Alberta has taken the lead in opposing efforts to fix the country’s retirement savings problems by tinkering with the CPP. They’re right. What we need are a number of targeted improvements rather than a universal overhaul that will catch everyone in the net, whether or not they want to be there. Moreover, many of the needed changes are relatively minor and could be implemented in the next federal budget without provincial approval.

A few days before Mr. Flaherty’s interview with The Globe, the Senate Committee on Banking, Trade and Commerce released its report on the study it conducted last spring into retirement savings. In doing so, the committee said it was specifically targeting the segments of Canadian society where it feels retirement savings reform is most needed: “middle-income Canadians, self-employed persons, and the employees of those small and medium-sized employers that may face barriers in sponsoring an occupational pension plan”. I was invited to testify before the committee in April and I was pleased to see that some of my suggestions have been adopted in one form or another.

Here are some of the committee’s recommendations that Mr. Flaherty can and should incorporate into his 2011 budget speech.

1. End discrimination against low-income retirees. One of the most abhorrent failings of the existing system is the penalty it imposes on low-income people for having saved a little money during their working years. Anyone who qualifies for the Guaranteed Income Supplement (GIS) will be shocked to discover that they lose $0.50 in benefits for every dollar that comes out of an RRSP or RRIF. The government treats these withdrawals as income and penalizes GIS recipients accordingly. (GIS payments are calculated based on net income.)

In my testimony to the committee, I pointed out that the logical result of this policy is that no one who might qualify for the GIS should contribute to an RRSP. It is one thing to treat withdrawals as taxable income — those in a low bracket won’t be hit very hard. It’s quite another to impose a 50 per cent penalty on their pension benefits because they had the will and the discipline to save.

The committee agreed. Recommendation number two was that “the federal government make the necessary legislative amendments to ensure that, while remaining taxable, withdrawals from registered retirement savings plans have no impact on eligibility for, or the amount of, federal income-tested benefits and tax credits.”

2. Increase the RRSP contribution age. Why should people be forced to stop contributing to RRSPs and start making withdrawals when they reach age 71? It’s an important question at a time when mandatory retirement has become an outdated policy and an increasing number of people are working into their 70s, either by choice or necessity.

We also need to consider the fact that a significant percentage of baby boomers are approaching retirement age without a pension plan or adequate savings to sustain them for a life span that may extend into their 80s or beyond.

The only obvious reason for an age cut-off for RRSPs is to enable the government to start taxing these savings sooner rather than later. In other words, it’s a tax grab. My view is that people should be allowed to contribute to RRSPs for as long as they wish. The government will get its money sooner or later. Remember that at the death of the last surviving spouse, all money in an RRSP or RRIF is deemed to have been taken into income and is taxed accordingly.

The committee didn’t go so far as to endorse a lifetime RRSP but the proposal to increase the age limit to 75 is a good start. Their plan is to phase in the change over eight years (six months per year).

3. Review the minimum RRIF withdrawal rates. This one is a no-brainer. The current minimums are much too high in relation to the returns a prudent investor can earn in a RRIF. A 71-year-old has to take out 7.38 per cent of the plan’s value and the percentage increases annually. With interest rates at record lows and income trusts a thing of the past, this means most people will have to begin dipping into capital immediately. This is folly, especially at a time when life expectancy is steadily increasing. The last thing we need is for retirees to start running out of money in their 80s because the government forced them to withdraw more cash than they needed when they were younger. My view is there should be no mandatory minimum, period. Let people take out what they need to live on and save the rest.

4. Increase TFSA contribution room. This was another issue I touched on in my presentation to the committee. I think Tax-Free Savings Accounts are a great idea but the low contribution limit of $5,000 a year works in favour of younger people and places older Canadians, with fewer years to contribute, at a disadvantage. The committee strongly agreed. Recommendation four proposes that a lifetime contribution limit of $100,000 be established for TFSAs, which would be in addition to the annual limit.

“Such a change could have several benefits,” the report said. “The lifetime contribution room could be used by individuals who experience a ‘financial windfall,’ including those we identified earlier as being our principal focus… Lifetime contribution room could also benefit those who are close to retirement and have had relatively less time to make TFSA contributions and to accumulate unused TFSA contribution room.”

The committee said that the Department of Finance estimates that such a plan would cost about $600 million initially, gradually rising to about $1.2 billion annually. But that assumes everyone would take advantage of the provision. Clearly, they won’t. The Finance estimate isn’t a worst-case scenario; it’s an impossible scenario. The committee dismisses the cost issue with the comment: “While we recognize the federal budgetary constraint that currently exists, we believe that the benefits of lifetime TFSA contribution room of $100,000 per individual, as adjusted for inflation — such as reduced public pension costs as well as higher levels of saving — would outweigh the cost.”

None of these changes is dramatic in and of itself. But taken together, they would provide meaningful improvements to a retirement savings system which, while not broken, can certainly be made better. Let’s hope that Mr. Flaherty won’t wait for national agreement on the CPP to introduce the necessary amendments.

Photo © Bryan Delodder

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