Tax Rules Hit Canadian Retirement Prospects

by Mike Godfrey, Tax-News.com, Washington

01 November 2011

Canadian workers are unable to save enough for their retirement because federal tax rules are preventing many from doing so, the C.D. Howe Institute has said, arguing that major reform is required.

According to a new report, “Legal for Life: Why Canadians Need a Lifetime Retirement Saving Limit,” by James Pierlot with Faisal Siddiqi, workers relying on Registered Retirement Savings Plan (RRSPs) cannot accumulate even half the retirement wealth of career members of defined-benefit (DB) pension plans.

More than twelve million Canadian workers do not participate in a DB pension plan. Many of these workers need to save for retirement, and must do so in RRSPs and defined-contribution (DC) pension plans. The report argues that tax rules prevent these workers from saving enough, even as career members of DB plans accumulate retirement savings worth as much as 60% of their total career incomes. Pierlot has stressed: “Solving this ‘have’ and ‘have-not’ divide in the pension outlook for Canadians is becoming urgent”.

The Institute believes this demonstrates a serious problem of inequity, the prospect of low living standards for future retirees and an increasing burden on income-support programs funded from general tax revenue. Those at particular risk of not having enough DC/RRSP contribution room include new Canadians, self-employed workers, and those who have incurred investment losses, experienced periods of unemployment or made RRSP withdrawals before retirement.

The Institute argues that labour market realities – such as increased job mobility, years spent on post-secondary education, low early-career earnings and lack of pension coverage – mean that private sector workers tend to under-save in the first part of their careers. In addition, low interest rates, an ageing population and increasing longevity mean that workers have less time to save for retirement.

The study also examined contribution and benefit limits in “tax assisted” DB pension plans, DC plans and RRSPs. These plans are intended primarily for workers with middle class incomes, who will not receive enough pension income from programs such as Old Age Security (OAS) and the Canada/Quebec Pension Plan (C/QPP) to maintain their living standards in retirement.

The report found that Canadian workers with career membership in generous DB plans can and do accumulate good pensions with values ranging from CAD550,000 (USD552,000), for a worker with a career-end salary of CAD50,000, to CAD2.1m with a career-end salary of CAD150,000. With RRSP savings included, their accumulations of retirement wealth are even greater. The study also found that workers with similar career earnings who save in DC plans and RRSPs are prevented from accumulating even half of these amounts.

The Institute argues that major reform is needed, so that all workers for whom the “tax-assisted” retirement saving system is intended can save enough for their retirements. To make this a reality, it is proposed that Canada’s annual, income-based tax limits on retirement saving be discarded and replaced with a uniform, inflation-indexed lifetime accumulation limit of CAD2m – the value of pensions now accumulated by high-income workers with career membership in generous DB pension plans, especially in the public sector.

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