C. D. Howe on RRSP Limits

Yesterday, the C. D. Howe Institute released a brief estimating how much Canadians at various income levels would need to save, through pension plans or individually, to provide various levels of retirement income.

Since the Canada Pension Plan tops out around the average industrial wage and Old Age Security is clawed back from higher incomes, those who make more money need to save proportionally more to generate a retirement income equal to a given percentage of pre-retirement earnings.

While the brief does not make explicit policy prescriptions, it seems to imply that Registered Retirement Savings Plan (RRSP) contribution limits are too low. One of the three “executive summary” bullets misleadingly states, “Income Tax Act limits on tax-recognized savings would prevent many earners from accumulating sufficient RRSP savings over 33 years (by age 63) to securely replace 70 percent or more of their working incomes.”

True, to reach that level of retirement income by age 63, the top 40% of income earners would need to save a little more than the RRSP limit. However, looking at the “normal” retirement age of 65, the brief’s own numbers indicate that only the richest 10% have to save more than their RRSP contributions.

Indeed, the vast majority of Canadians need to save appreciably less than 18% of earnings (the RRSP contribution limit). A reasonable conclusion would be that RRSPs provide more than enough tax-assisted contribution room. The issue is that most working Canadians do not have sufficient savings to take advantage of it.

For anyone able and willing to save more, there is no barrier to saving outside an RRSP. Indeed, the government also offers a Tax Free Savings Account (TFSA). The Howe brief fails to even mention this vehicle, let alone acknowledge it as a form of “tax-recognized savings.”

In any case, investment income generated on savings outside of an RRSP or TFSA is very lightly taxed. Only half of capital gains are taxable and Canadian dividends are partly sheltered by the dividend tax credit.

The Income Tax Act provides ample assistance to personal savings. There is a shortage of saving, but not of tax incentives to save.

6 comments

  • Sure, Canadians should save more, but the market fails to provide the correct incentives, so we don’t.

    I can’t imagine any market incentives that would do the job, so the solution is to double or triple CPP.

  • “but the market fails to provide the correct incentives, so we don’t.”

    Actually the market gives good incentives for bosses to give crappy wages.

  • A critical assumption in the report, as shown in Box 1 on page 3 of the report, is that people will apply their entire savings balance to buy an individual annuity, with no guarantee period, and indexed to inflation.

    There are at least two flaws in this assumption.

    The first is that most people would be uncomfortable giving up control of all their money in this way – the nagging fears of “what if I die tomorrow” and “what if I need money for an emergency” are too strong. It would be interesting to see what resulted from assuming use of a RRIF rather than an annuity.

    The second flaw is that under current legislation, there is no tax-effective way to buy an annuity indexed to inflation with non-registered funds. The Income Tax Act should be amended to fix this.

    Another critical assumption is that people will start saving at 30. This would be wise, but 30 is mortgage prime time for a lot of people, and it would be more realistic to assume serious retirement saving starting at 40 or so.

  • Interest rates need to be higher too, artificially low interest rate at 1% doesn’t allow canadians to save at a return. Saving is not just putting away a certain % of your paycheck, its about allowing the interest to accumulate.

    When my grandmother was 19 she had 1000$(alot of money then) saved with 18.8 rate for 10,13 years before she saw a steady decline in rates in her lifetime from 20% rates to 1%. She is 84 and has the savings but if she was 19 again given todays rates she would have to invest in higher yielding stock to have the intrest she erned for retirement, there is a reason einstein said the greatest thing is compounding interest.

    The relatively low rates can easily explain the dismal savings rate compared to our parents and their parents. Also compounding interest is why low rates are inneffective for the long term borrower. We should have higher rates to make it worth saving for ritirement. Our parents, & their parents who saved every penny did that under higher interest rates.

  • She grew up in bad times, there were no government solutions & you know what people saved responsibility. She’s lived a FULL life. The underlying fact remains No one will Save with economic certainties and artificially low rates. When people thought that housing wouldn’t stop appreciating were was the saving then. But if the government wants me to retire better start raising rates

  • By analyzing the saving rate by generations, we could conclude that while the level of the saving rate in the elderly group has exceeded that in other groups at all times mainly I hypothesize because they grew up in economic uncertainties, the saving rate of the elder itself has decreased over recent periods, its very hard to save even if you remember the bad times if you don’t have the interest rates to encourage saving. We are setting ourselves up.

    Also these low rates are pushing retirement funds into global markets for higher yield, which is a I think a mistake but a understandable mistake, since these funds need to grow for retirement, they cant just sit there, collecting dust, otherwise how would you retire?

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