The Registered Retirement Savings Plan (RRSP) has been one of the mainstays of saving money for retirement since it was introduced in 1957.
Since then, the popular tax-deferred savings vehicle has undergone changes, perhaps the most significant being in the early 1990s when the government tried to equalize retirement programs and changed the maximum allowable contribution to the lower of 18 per cent of previous year’s earned income, or $11,500.
Since then the maximum allowable contribution has slowly crept up to where it currently is at $26,010 in 2017 but the 18 per cent of earned income has remained the same over the years.
The 18 per cent contribution limit percentage came about from an obscure equivalency test for saving in various retirement savings plans known as the factor or rule of nine.
The factor of nine was devised as a way to try and equalize the savings opportunities in defined benefit (DB), defined contribution (DC) and registered retirement savings plans.
The Income Tax Act allows members of defined benefit pension plans to accrue a maximum annuity of two per cent of final earnings on a tax-deferred basis in the year of accrual. Over a working career of 35 years this would provide a pension equal to 70 per cent of pre-retirement earnings.
The factor of nine limits contributions in DC and RRSP plans to 18 per cent (the factor of nine multiplied by the maximum annuity of two per cent — 9 x 2 = 18. This is based on the assumption that in 1990 it would have cost $9 in order to provide a life annuity of $1.
While the formula may have helped to level the playing field between DB, DC and RRSP plans in those days, a lot has happened in the ensuing almost three decades.
Most notably, people are living longer, and therefore generally will need more money to see them through their retirement, and yields on fixed income are much lower than they were in the past.
“It’s a lot harder for people to save enough for their retirement than it was in those days,” says Dave Ablett, director of tax and estate planning with Investors Group. “The rule of nine is outdated and needs to be adjusted for longevity and yields.”
Ablett says the factor of nine is understated for younger Canadians and overstated for older ones. This means that the formula gives more contribution room for younger people than they often can use and the contribution limits for older people are not high enough – which could partially explain why Canadians had more than one trillion dollars in unused RRSP contribution room at the end of 2015.
Two recommendations made by the C.D. Howe Institute are that contribution limits be changed to a lifetime limit of $2.5 million instead of annual limits based on annual income or the amount of unused contribution room be indexed.
“These are good ideas but the government has some objections because they could reduce tax revenues due to the fact that higher contribution levels tend to benefit higher income individuals,” Ablett says.
The introduction of the Tax Free Savings Account (TFSA) in 2009 provided Canadians with a tax-free retirement savings option, particularly for younger people in lower income tax brackets who can’t maximize and/or take advantage of the tax-deferral benefit of an RRSP.
“The TFSA is a lot more flexible than an RRSP in that you can take money out tax free to fund your RRSP or for other purposes and then replenish it,” Ablett says. “It’s like double tracking.”
Ablett recommends that people who have an employer pension plan contribute to it to take advantage of the company’s matching contributions, and generally to take advantage of any and all other savings opportunities including non-registered savings plans, Registered Education Savings Plan (RESP) and Registered Disabled Savings Plan (RDSP) for the disabled.
“We favour providing more incentives for people to save for their retirement, but from the government’s perspective what may make sense from an actuarial or economic point of view may not make as much sense from a political one,” Ablett says.
Talbot Boggs is a Toronto-based business communications professional who has worked with national news organizations, magazines and corporations in the finance, retail, manufacturing and other industrial sectors.