RRSP Silly Season
I don’t entirely agree with Jim Stanford that RRSPs are a bad way to save for those not fortunate enough to be covered by a good pension plan, but I am struck by the absence of sober, independent analysis as we head into RRSP season. Today’s special Report on RRSPs in the Globe and Mail is, predictably, totally uncritical, and basically argues that just about everybody should max out their contribution to the extent possible to take advantage of the tax savings.
The argument for saving through an RRSP is that the contribution is tax deductible, and that the capital income earned within an RRSP is untaxed. At the other end, RRSP withdrawals (and income from RRSPs converted into RRIFs) are taxed, usually at a lower effective tax rate as income falls after retirement.
Tax deferral is attractive, but the attractiveness of saving through RRSPs has been undercut by increasingly generous tax breaks for capital income (eg only 50% of capital gains income is now included in taxable income), and by a flattening of the tax structure. If the right-wing dream of no tax on capital income nd a flat tax rate came true, there would be no point to RRSPs at all. If one thinks that right-wing tax proposals are likely to be implemented, one should not be very attracted to RRSPs.
For low income earners, RRSPs are not a very attactive way to save, since withdrawals will, at best, be taxed at the same (bottom) rate as previous earnings, not at a lower rate. At the very low end, RRSP withdrawals will, in effect, be much more heavily taxed than were pre retirement wages since the RRSP income will reduce the Guaranteed Income Supplement, an income-tested supplement to Old Age Security. Richard Shillington has showed that many low income seniors face punitively high marginal tax rates from loss of various income-tested benefits, making it foolish to save in any vehicle that delivers taxable income in retirement.
At the other end of the scale, a layer of people with good incomes and generous pension plans should not save through RRSPs since income withdrawn from plans will be taxed at a high marginal rate due to the income test applied to Old Age Security (which is taxed back at incomes of over about $60,000).
I’m a bit surprised that the financial advisers whose RRSP investment strategies are studied in today’s Globe choose to invest in RRSPs given that (1) they will likely lose OAS income as a result, and (2) given that savings in non RRSP vehicles would be more attractive to them in retirement since capital assets outside of RRSPs can be liquidated without giving rise to anywhere near the same amount of taxable income.
Actually the stock market itself is a bad way to save for your retirement if you aren’t capable of successfully doing it yourself. Handing your money over to someone to invest in this ponzi scheme is ludicrous.
There should indeed be more discussion of cases in which RRSPs are not the best way to save. However, I suspect that the great majority of individuals who have money to save would gain by putting it an RRSP.
We on the left have rightly criticized RRSPs as an expensive gift to the well-off. RRSPs cost the government so much precisely because they are quite beneficial for most of the people who use them.
In my view, the excessive promotion of RRSPs is less problematic than the excessive promotion of mutual funds, which tend to under-perform the stock market. I separate these issues because one could hold many different securities in an RRSP, including ones not tied to the stock market (such as GICs). So even someone who takes Robert’s view would probably still gain by using an RRSP.
The argument I would make against RRSPs is not that they fail to benefit those who invest through them, but that they succeed in benefiting this relatively well-off group at the general public’s expense. RRSPs are mainly a boon to the rich, who are able to contribute the most and who gain the most from tax deductions (since they face higher tax rates). Also, there is little evidence that RRSPs increase the amounts that people save and invest.
Well, it seems that they benefit the middle class, not even the upper middle class. The rich don’t need them, and if they have them they save nothing, and are limited to how they can use the proceeds. In this light they are constructive, provided the lower income group is warned off.
I did an analysis of the after tax return and found the compounding of the tax savings in the RRSP was more beneficial then the after-tax investment outside an RRSP. I looked at about 20 yrs of compounding. Where this strategy fails is when people do not invest the tax saved. I always thought that if the RRSP was put in at 30% and taken out at 30% the savings would be nil, however, this is not the case. It only takes about 10 minutes to build a simple excel sheet so try it yourself using your marginal tax rate and see if you would be better off in 20 yrs. What I ended up recommending was to place the interest-bearing portion of the portfolio into the RRSP.