With debt levels rising and house prices mounting, the temptation to raid retirement savings may be greater than ever. But are people arriving at retirement with inadequate savings as a result of withdrawals before retirement?
We spoke to three retirement planners and one retirement saver to gauge the state of the problem.
Half of RRSP withdrawals made before retirement
Unlike registered pension plans, which largely prevent people from making withdrawals before age 65, RRSPs are available to be "raided" before retirement.
The federal government provides two ways in which tax-free withdrawals can be made from an RRSP – the Home Buyer's Plan and the Lifelong Learning Plan. Both of these allow funds to be borrowed from registered savings in order to cover expenses today – the HBP to purchase an eligible home, and the LLP to fund qualifying education and training costs.
The borrowed funds must be repaid over time, or the withdrawn amounts added to taxable income. Of the two, the HBP is by far the most-used program, with about 1.8 million Canadians withdrawing $1.42-billion in 2011. Statistics show, however, that only about half of the required repayments are made, meaning that Canadians paid tax on the remaining half of the withdrawn funds.
Beyond withdrawals from RRSPs using the HPB and LLP, Canada Revenue Agency reports that people under the age of 60 withdrew $8.2-million from RRSPs in 2013 (the latest year for which statistics are available, and not including HPB and LLB withdrawals). In fact, 55 per cent of total RRSP withdrawals that year were by Canadians under 60.
Although they aren't required to provide a reason for the withdrawal, research by Statistics Canada has shown that several reasons may contribute to RRSP cash-outs before retirement, including the death of a spouse (which increased the likelihood of withdrawals,) the birth of a child or involuntary job loss (both of which increased the overall size of withdrawals).
RRSPs as 'slush funds'
What do financial planners who work with these issues every day think? "It's a huge problem," says Jason Pereira, partner and senior financial consultant at the financial planning firm Woodgate Financial Inc. in Toronto. "With the increasing price of housing in many urban centres, people feel immense pressure to get into those markets now – because they're concerned that if they wait, prices will rapidly become out of reach for first-time buyers." As a result, many turn to their RRSPs as a source of funds for a house purchase.
Beyond the Home Buyers' Plan, however, Mr. Pereira says he's seen others treat their RRSPs "like a slush fund." The beginning of a new year, he says, can prompt people to "start the year fresh" by withdrawing from an RRSP to pay off high-interest credit card debt, for example. But this just "compounds the problem – like throwing water on a grease fire," especially if they have to pay tax at a high rate on the withdrawn funds.
Problem most acute for the self-employed
"There's an overall decline in the culture of savings that we saw as recently as a half-century ago," says Trevor Parry, financial adviser and president at TRP Strategic Consulting.
"The basic math is simple and compelling," Mr. Parry says. "Assuming a 30-year retirement, $100,000 in a retirement nest egg might generate $4,000 per year in retirement income, or about $330 per month – while $50,000 provides just half that. When people arrive at retirement with meagre savings, there's very little opportunity to rectify their situation. We can't count on investment returns to make up the difference. It's much better for people to start with bigger amounts to withdraw from.
"This is a particular problem for the self-employed, who often have 'lumpy' income coupled with inflexible tax remittance requirements. For them, RRSPs or corporate funds in a holding company can function a bit like an overdraft account at the bank. That's why, in my view, solutions that are matched to human behaviour and psychology are key – such as, for example, using individual pension plans for self-employed business owners, which safeguard savings until retirement."
A saver who goes against the grain
Some savers, however, are able to resist the temptation to withdraw from retirement savings to fund current spending. Toronto personal finance blogger Barry Choi and his wife calculated that the decision wasn't either to retain RRSP savings or buy a house, but that they could have both as a result of their practice of building savings.
"The main reason we didn't want to touch our RRSPs was because we felt like we'd just be borrowing from ourselves and affecting our long-term growth," Mr. Choi says. He adds: "I remember reading somewhere that many people struggle to pay back the amount borrowed over the 15 years. Assuming they borrowed $25,000, that's only $1,666 a year. I couldn't believe that people struggled to pay that back. Plus, I don't think some people realize that it's considered income if not paid back.
"Once my wife and I got married, saving became a huge priority. We knew we wanted to be homeowners eventually so we made sure our budget reflected our goals. After paying for fixed expenses, we set aside as much as we could toward savings. Basically, we believe in saving first followed by spending. Many people seem to do the opposite these days."
A focus on long-term savings
Sandi Martin, an advice-only financial planner at Spring Personal Finance in Gravenhurst, Ont., says, however, that a focus on HBP withdrawals to fund first homes is not the real problem: "Whether a person saves up $25,000 in a non-registered account, a TFSA or an RRSP and withdrew using the HBP is irrelevant – what matters is that they saved up a down payment and withdrew it from any source. That means those dollars were diverted from their long-term savings, and the question should always be whether that's the appropriate choice."
Leakage across the globe
Around the world, withdrawals from retirement savings before retirement is called "leakage." Pension and retirement specialists and regulators have identified the need to ensure future retirees don't hamper their income security by depleting retirement savings before they leave the work force.
In the United States, according to a study by the Federal Reserve Board, 40 cents of every dollar contributed to the defined contribution accounts of savers under age 55 eventually "leaks" out of the retirement system before retirement. To make matters worse, most of those lost dollars come from the people least prepared financially for retirement – of those who cashed out their retirement accounts when they changed jobs, 41 per cent had less than $25,000 in household retirement savings.
In Australia although there is a mandatory retirement savings requirement for workers, those funds can be accessed at 55. As a result, many people withdraw funds, go on an "overseas experience trip" – and then qualify for higher means-tested retirement income from the government later on, meaning they deplete private savings at a public cost.