In 1992, a deficit-strapped federal government, urgently needing cash in a hurry, came up with an idea for extracting it from Canada's seniors. It looked at the billions of dollars retirees had stashed away in their registered retirement income funds, or RRIFs, and decided to dip a straw into the pool.
Seniors were ordered to annually withdraw – and face income tax on – a set percentage of their RRIF savings, starting at age 71. What's more, the federal government decreed that the older you got, the more of your retirement savings would have to be withdrawn, and the more of it would be subject to tax.
It was a cash grab, pure and simple; a short-term move by a government frantically trying to close a growing budget shortfall. Nearly a quarter-century later, the rule is still in place.
In the coming days, we'll be looking at steps that need to be taken to turn Canada's solid but imperfect retirement savings system into the world's best. Some of these involve hard choices and difficult trade-offs. Others are politically contentious. Some address distant challenges, and offer no immediate benefits.
Ditching the RRIF withdrawal rule, however, faces none of these obstacles.
The policy undermines the financial health and retirement plans of millions of seniors – while doing nothing for Ottawa's long-term fiscal health. It simply pulls future tax revenues into the present. Canadians are paying a cost, but it comes with no real benefit.
There is an easy fix: Get rid of the rule. Allow individual Canadians to decide when they want to turn their retirement savings into an income stream. Stop forcing seniors to draw down their nest eggs sooner and faster than they want to.
Last weekend in this space, we wrote about TFSAs – tax free savings accounts – which a growing list of critics believe are growing into the Godzilla of Canada's tax system. Two recent studies, from the Parliamentary Budget Officer and Simon Fraser University professor Rhys Kesselman, see the cost of the program skyrocketing over the coming decades. They also say that TFSAs, which were originally intended to help lower-income Canadians, are largely benefiting higher-income savers and seniors.
Four years ago, the Conservative government promised to double TFSA annual contribution limits, which are currently $5,500. Instead, the government and the opposition should be looking for better, more equitable and less costly ways to improve retirement incomes. Ditching the RRIF withdrawal rule should be Item No. 1.
Here's how the rule works, and how it hurts seniors. Once you hit age 71, you must convert your RRSP into a RRIF, and you must start taking money out. At age 71, you must withdraw 7.38 per cent of the value of your RRIF. Got $100,000 in savings? You'll have to take out $7,380, and pay income tax on it. You can take out more if you want – but you can't take out less.
And 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.
According to an analysis by the C.D. Howe Institute, mandatory withdrawal rates that are far higher than expected investment returns, combined with longer life expectancy, mean a large and growing number of Canadians will outlive their retirement savings. It is as guaranteed as a GIC.
For example, according to C.D. Howe, a 71-year-old woman can expect to deplete about 80 per cent of her RRIF savings before she dies. There's a one-in-four chance that her RRIF's principal value will drop by 90 per cent. And disappearing principal means plummeting income.
During the 2008 market crash, many retirees begged the federal government to temporarily loosen the law. Annual minimum withdrawals are based on the value of a RRIF on Dec. 31 of the previous year – and over the course of 2008, major U.S. and Canadian stock indexes lost a third or more of their value. Retirees saw their capital devastated, and many wanted to sit tight. "Sell low" is not one of the cardinal rules of investing – yet here was Ottawa, ordering them to do just that.
In this election year, a party hoping to do something significant for seniors, and for all Canadians who will eventually be seniors, would promise two simple things.
First, it would end the RRIF mandatory withdrawal rule. Let seniors take their money out at a pace determined by their own needs. All of a tax-sheltered RRIF eventually becomes taxable, so Ottawa need be in no hurry to squeeze the cash out as soon as possible.
And second, it would stop forcing people to convert their savings-accumulating RRSPs into income-paying RRIFs at age 71. In a world where many want to retire later, or not at all, the timing of RRSP-to-RRIF conversion should also be up to individual Canadians.
This is the low-hanging fruit in Canada's retirement savings garden. We'll turn to the rest of the retirement system, and more difficult choices, tomorrow.