The 4 per cent rule is a favourite rule-of-thumb for retirement planners, and with good reason: Research has shown that if you withdraw more than 4 per cent a year from your retirement savings, you run the risk of drawing down your capital too quickly – and running out of money before the end of your life. In fact, given today’s ultra-low interest rates, combined with a likely future of low stock market returns, and the certainty of Canadians enjoying ever longer lifespans, many experts now think the conservative 4 per cent rule is in fact too aggressive. They’d like to see retirees prudently preserving more of their savings, especially in the early years of retirement.
All of which is news to Ottawa. Some Canadians, especially those working in the public sector, have a solid defined benefit pension plan to fall back on. Most of us, however, are relying on our own savings. The main vehicle for private retirement savings is the registered retirement savings plan, or RRSP. Once you hit retirement age, your RRSP is turned from a tax-sheltered savings plan into an income plan: You either have to buy an annuity, or you have to convert your RRSP into a registered retirement income fund, or RRIF. Similar rules apply to anyone whose company offers a defined contribution pension plan. And since 1992, Ottawa has forced retirees with a lifetime of savings in their RRIF to draw down those savings at an extremely high rate. The law also compels an increase in the pace of withdrawals each year.
In the year when you hit age 71, the rules say you must withdraw 7.38 per cent of your RRIF. You can take out more if you need it – but you can’t take out less. The amount that retirees must withdraw increases each year, to nearly 9 per cent by age 80, more than 10 per cent by age 85, and a portfolio-crushing 20 per cent a year at age 94 and beyond.
As a recent study by researchers at the C.D. Howe Institute points out, this is insanity.
Back in 1992, when the rules were brought in by a government desperate for immediate tax revenues from whatever source, the average 71 year old man could expect to live 11.2 more years and the average woman another 14.6 years. But the most recent data from Statistics Canada shows that life expectancy is continuing to rise. The average person is now living nearly three years longer. What’s more, benchmark investment returns were far higher back then. The 10-year government of Canada bond was yielding 8.5 per cent; today, the yield is less than 3 per cent. The math is complex, the bottom line is not: A large and growing number of Canadians are at risk of outliving their savings unless the rules are changed.
Those rules may have been tolerable two decades ago. Not anymore. In 1992, according to C.D. Howe, if a person with a $100,000 RRIF invested it in government of Canada bonds with maturities matching the withdrawal dates, that retiree would receive an income of roughly $7,750 at age 71, declining to about $6,200 by age 94.
Today, that same retiree would start out with nearly the same income at age 71, but because of lower returns due to lower bond yields, the same mandatory minimum withdrawal percentages would rapidly devour the RRIF’s principal – causing the income to decline to just $1,700 by age 94. And beacuse of lengthening Canadian lifespans, one in seven men aged 71 can expect to reach age 94 – along with one in four women.
C.D. Howe recommends RRIF withdrawal rates be dropped sharply, to just 2.68 per cent at age 71. Other strategies would be also be possible, such as raising the age at which mandatory withdrawals would start, or getting rid of mandatory withdrawals entirely.
Ottawa started forcing retirees to draw down their RRIFs two decades ago, at a time when the federal government was hungry for a quick tax grab. Retirees who withdraw from a tax-shelted RRIF pay income tax; the more they take out in a year, the more tax they owe in that year.
But Ottawa is not currently experiencing anything like a revenue crunch. And a RRIF with assets remaining at the time of its holders death attracts a full measure of income tax. In fact, someone dying with a large RRIF may be pushed into a higher tax bracket, potentially attracting more total income tax than the RRIF that is drawn down over many years in small amounts. In the long run, allowing Canadians to keep more of their savings in a retirement fund for longer will not deprive Ottawa or the provinces of their full measure of tax.
The Harper government is opposed to expanding the solid but too-small Canada Pension Plan, and thinks Canadians should do a better job of saving for themselves. But at the same time, it maintains rules that hamstring private savers, guaranteeing that many Canadians in the 80s and 90s will see their retirement dreams crushed. Ottawa can’t do anything to magically raise investment returns. But it can change its RRIF rules, to give retirees the flexibility to decide for themselves how much to take out of their retirement fund, and when. Such a move would be popular, fiscally neutral over the long term and economically sound. For a government looking to reward middle-class voters in the run-up to the next election, this should be a no-brainer.
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