Outdated RRSPS: The Registered Retirement Savings Plan was first introduced in 1957
The Registered Retirement Savings Plan (RRSP) was first introduced in 1957. It’s a great way for your investments to grow, tax free, while you’re still working. RRSPs also help to reduce the overall income tax that you pay during the years that you contribute.
I n 2016, the average contribution was $5,088, according to a Bank of Montreal Survey of 1,500 Canadians. Despite its continued popularity, the RRSP has been around for more than 50 years, and a new report suggests the rules are in need of a major update.
The report, by the C.D. Howe Institute called Rethinking Limits on Tax-Deferred Retirement Savings in Canada, suggests that Canadians who manage their own retirement savings, or have invested in a Defined Contribution Plan (DCP), are at a disadvantage to those who invested in a Defined Benefit Plan (DBP).
When the RRSP was first introduced, it was (and still is) a way to promote retirement savings for employees, as well as for those who are self-employed. Decades ago, the majority of working Canadians were contributing to a DBP through their employer. DBPs guaranteed a fixed income (that wouldn’t change) in retirement. Fast forward to 2017, and only one third of working Canadians contribute to a DBP plan, leaving many to save for retirement on their own.
Increased RRSP limits
Currently Canadians can contribute an amount that equals 18 per cent of last year’s income. However, there’s a maximum, and in 2017 that number was $26,010. According to the report, this is no longer enough. “People are living longer, and even more importantly, yields on investments suitable for retirement saving are very low. These changes have raised the cost of obtaining a given level of retirement income,” says author, William Robson. He suggests the tax-deferred saving limit be raised from 18 per cent to 30 per cent.
Robson also comments on the Factor of Nine. A hypothetical, defined benefit pension plan was used, which suggests that nine per cent of your annual earnings will let you buy a retirement annuity equal to one per cent of your pre-retirement income. This ‘factor’ was first introduced in 1990, and, at that time, it made financial sense. However, in 2018, increased life expectancy, as well as lower yields on retirement appropriate assets, means that people must save at least twice as much to replace pre-retirement earnings than the Factor of Nine.
DIY saving disadvantages
RRSP contributions, as they exist now, are not in favour of those who are saving for retirement on their own, or through a DCP. A DCP does not guarantee a retirement income, but for those who were lucky enough to have a DBP plan, they are more likely to be financially secure when they leave work. The report suggests that the playing field should be leveled for savers with differences in their pension plan design, and for those who start saving later in life. In addition to increasing limits, Robson suggests that an inflation indexed, lifetime tax-deferred savings limit be established.
The RRSP needs to be updated to reflect today’s reality. In the meantime, visit https://srv111.services.gc.ca/generalinformation/ index to see if you’re on track for a financially healthy retirement.
Rubina Ahmed-Haq is a journalist, personal finance expert and HPG’s finance editor. Rubina appears on CBC TV and radio, CTV Your Morning, Global Toronto, and writes for ratesupermarket.ca. Follow her @alwayssavemoney. AlwaysSaveMoney.ca