Retired Canadians trying to balance their need for current income against the risk of outliving their savings face serious erosion in the purchasing power of tax-deferred savings, says a new report.
Rules set down 22 years ago that require mandatory minimum withdrawals from registered retirement income funds (RRIFs) and similar accounts have failed to keep pace with longer Canadian life expectancies, according to the C.D. Howe Institute analysis.
The age-related formula requires that RRIF holders withdraw annual amounts that rise; they stop rising at the 20 per cent mark.
The pension policy was instituted in 1992, when the federal government was deficit-ridden and in dire need of cash. But now that it is closer to running a surplus, the timing of the receipt of those RRIF taxes matters less, said authors William Robson and Alexandre Laurin.
"To the RRIF holder, however, the minimums pose a threat. They oblige the holder to run tax-deferred assets down rapidly. Today, people can expect to live much longer after retirement, and real returns on investments that provide secure incomes are much lower.
"RRIF holders now face serious erosion in the purchasing power of tax-deferred savings in their later years."
The government should make the minimum withdrawals from RRIFs and similar vehicles considerably smaller, or even scrap them outright, says the report.
Another policy response would be to raise the ages at which minimum drawdowns from RRIFs and similar vehicles must begin, it says.
"Governments impatient for revenue should not force these Canadians to run their tax-deferred assets down prematurely. Reforming the withdrawal rules for RRIFs and similar accounts would help retirees enjoy the post-retirement security they are striving to achieve," the authors say.
A RRIF is an account registered with the federal government that provides a steady income in retirement; when retirees turn 71, they must shift their existing registered retirement savings plan into an annuity or RRIF. A RRIF has a mandatory minimum withdrawal of 7.48 per cent from the account annually at 72, which rises to 19.92 per cent by the age of 93.
Statistics Canada's latest life tables, from 2009-2011, put the average life expectancy of a 71-year-old man at 14.4 years, and of a 71-year-old woman at 16.9 years, compared with 11.2 and 14.6 years – respectively – in 1992.
In 1992, the expected compound real (after inflation) return on a 71-year-old man or woman's bond portfolio over 30 years was about 5.7 per cent annually, the authors calculate.
That compares with an expected compound annual real return of 0.25 per cent at the beginning of 2014.
A 71-year-old man or woman in 2014 with $100,000 in a RRIF invested in Canada bonds will see the value of this nest egg drop to below $50,000 by the end of 2023, when the pensioner turns 80.
By the end of 2030, at age 87, the RRIF balance will drop below $25,000. At age 94, in 2037, the balance will fall below $10,000 – a 90 per cent erosion of its real value, according to the study.
The life tables give odds of a 71-year-old man reaching the age of 80 – when the RRIF's value would have dropped by half – at about three in four; for a 71-year-old woman, it is better than four in five.
A man who reaches 80 can expect to live, on average, nine more years, while a woman who makes it to 80 has an average further life expectancy of 11 years.
"Good or bad, when combined with out-dated drawdown rules, modern longevity and investment returns spell trouble for holders of RRIFs and similar accounts," said the authors.
The 71-year-old man in 1992 could expect to deplete 25 per cent of his initial balance's real value upon reaching his life expectancy, the study concludes.
Today, the senior can anticipate seeing his initial balance drop about 70 per cent, and he has a one-in-seven chance that its real value will fall more than 90 per cent.
The numbers for a 71-year-old woman in 1992 and 2014 are 40 per cent and 80 per cent, with a one-in-four chance of seeing its real value drop more than 90 per cent.
Even if retirees today were to invest their tax-deferred savings in more growth-oriented assets, rather than Canada bonds, the outcomes would be uncertain and the time frame too long, the authors contend.
"Even if it is true that such a portfolio can reliably earn a premium over safer investments in the very long run – and both theory and evidence are mixed on that point – the time frame over which an investor can count on such a premium is longer than is relevant even for today's longer-lived seniors," they said.