It's time to rethink Canada's tax grab on old people.
The law, as it now stands, requires savers to start drawing down their registered retirement income funds (RRIFs) after they turn 71. With each increasing year of age, the law ratchets up the percentage of a senior's portfolio that must be withdrawn.
Of course, this means paying taxes on the withdrawals, which is the entire point of the awkward system. It's designed to ensure Ottawa gets its cut of your assets now rather than waiting, perhaps for decades, until you and your spouse go on to that big tax-free zone in the sky.
The system has been a sore point for retirees since it was introduced in 1992, because the minimum withdrawals mandated by law increase the risk of outliving your money. The 2015 federal budget attempted to fix the problem, but as a new report from the C.D. Howe Institute makes clear, the issue is still with us.
A better system would simply do away with the requirement for minimum withdrawals from RRIFs. Retirees would breathe easier once they were no longer the prisoners of an artificial schedule for drawing down their savings.
For its part, government could stop trying to predict the unpredictable. It would still get its money, of course. It would just have to wait a while longer.
That doesn't seem a huge sacrifice to make given the problems with the current system. The challenge is that increasing longevity and dismal returns on safe investments are making it difficult to lay down any rules for minimum withdrawals that don't also create a significant risk of Canada's most elderly citizens running out of savings.
William Robson and Alexandre Laurin, authors of the C.D. Howe Institute report published Thursday, give Ottawa credit for its revisions in the 2015 budget, which substantially reduce the risk of old people going broke. But the researchers point out that updating the rules to keep up with increases in longevity and investment returns is not something that can be left for the occasional update every generation or so. Ottawa could choose to revise the withdrawal schedule every year. Failing that, it should simply abolish the minimum withdrawals.
The new minimums, laid down in the 2015 budget, still expose retirees to a significant risk of running out of money, according to the calculatons of Mr. Robson and Mr. Laurin. They figure, given current yields on safe investments, that a man faces an 8.8 per cent chance of seeing his RRIF portfolio fall by 90 per cent or more in purchasing power. A woman runs a 16.1 per cent chance of the same hazard.
The biggest culprit is today's rock bottom yields on safe investments. The original rules for minimum withdrawals, set down back in 1992, assumed a retiree could achieve a 7 per cent rate of return on his or her investments. Even after the bite of inflation that still worked out to a 5.7 per cent real rate of return.
Given such rosy projections, it made sense in 1992 to assume that a retiree could be required to withdraw a hefty amount each year without running much risk of running out of money. But that was then. Returns on conservative investments, such as government bonds, have plunged since the financial crisis.
Ottawa based its revision of the minimum withdrawal rules on the assumption that retirees can now count on a 3 per cent real rate of return. Even that, though, is looking optimistic now that the real return on a portfolio of Canadian government bonds has fallen below zero, according to the C.D. Howe Institute report.
It expresses worry that retirees will start taking on more risk to improve their returns in a low-yield world. The problem, of course, comes if those dicier investments don't pan out and leave retirees with next to no savings as they head into their late eighties or beyond. That is a problem that hits hardest at women, who typically live longer than men.
An improved system, according to the authors of the new report, would be to revise the minimum withdrawal rules at least every three years, if not annually, so the required minimums would reflect the current state of the market. Even better would be abolishing the rules entirely.
For government, an end to minimum withdrawals would mean a delay in when it can get its hands on your assets, but the impact would be negligible in the long run. "For RRIF holders, by contrast, elimination [of the rules] would remove complexity in financial planning and alleviate a threat to income security in retirement," the report argues. Let's hope Ottawa is listening.