Frances Woolley is an associate dean and professor of economics at Carleton University
For decades, Canadian governments have been sacrificing tax revenue, allowing people to deduct RRSP and other pension contributions from their taxable income. Now it's payback time. Baby boomers will start withdrawing funds from their RRSPs and RRIFs, and paying the taxes they have been deferring for years, precisely when the revenue is needed to pay for their health care and other needs.
Smart economics. Lousy psychology.
People feel the pain of paying tax on their RRSP and RRIF withdrawals far more strongly than they ever enjoyed the gain from their long-ago tax deductions – a phenomenon called "loss aversion." No matter how reluctant we are to save initially, when faced with the prospect of spending down, and paying tax on, our RRSPs and RRIFs, our animal instincts kick in. Like a dog with a bone, we fight to hang onto what we have, and snap at anyone who tries to take it away.
In 2012, there were 8.6 million families in Canada with an RRSP, RRIF, or similar registered savings plan, accounting for close to a trillion dollars in assets. These savings should permit older Canadians to support themselves financially without accessing government supports such as Guaranteed Income Supplement. Better off seniors should be able to shoulder their fair share of the tax burden.
But seniors are reluctant to make tax-triggering RRSP and RRIF withdrawals. A 2006 Statistics Canada study suggested that, "high-income earners may have little need to withdraw from their RRSP accounts prior to mandatory conversion." U.S. research by economists James Poterba, Steven Venti and David Wise has found that, generally speaking, people don't withdraw funds from their personal retirement accounts until they have to do so.
Some analysts believe seniors' reluctance to tap into their retirement savings is well-founded. York University professor Moshe Milevsky has noted that the current RRIF withdrawal rates were designed for a time when life expectancies were lower and interest rates higher than they are now. He argues the minimum RRIF withdrawals should be one-quarter to one-third lower than they are at present. Others, such as the CD Howe Institute, have suggested that the minimum drawdowns from RRIFs and similar vehicles "should start later … or even disappear entirely."
There is a case for lowering the amount that people are required to withdraw from their RRIFs, but allowing later drawdowns could have serious fiscal consequences for Canadian governments. Eligibility for Guaranteed Income Supplement is income-based. A person with a million dollars in their RRIF could potentially be eligible for GIS if they did not draw upon their savings. Minimum RRIF withdrawals should be set high enough to prevent abuse of Canada's income maintenance system.
The existence of TFSAs further weakens the case for reducing the minimum RRIF withdrawal amounts. If a high-wealth senior is required to withdraw more from their RRIF than they need to finance current consumption, they can always put at least some of the difference in a TFSA, and continue to enjoy the benefits of tax-free saving.
Many people did not realize that, when the government gave them a tax deduction for their RRSP contributions, it was effectively buying a share of their retirement portfolio. Now that they are beginning to understand what their side of the bargain entails, they are trying to renege upon the agreement. Even if the minimum RRIF withdrawal amounts are lowered in Tuesday's federal budget, there will soon be demands for the required drawdowns to be reduced again. If the RRIF withdrawal rules were eliminated entirely, people would start campaigning to change the "deemed disposition" rule, to avoid incurring tax liabilities upon a RRIF account holder's death.
From a psychological point of view, reluctance to share what one has with others is entirely understandable. But, with an aging population, if the old do not pay taxes, who will?
Frances Woolley