In a former life as a financial planner, I often took calls from clients who needed to make an early RRSP withdrawal. The standard advice was that clients ought never take funds from an RRSP before retirement, due to the hefty tax penalties triggered by the withdrawal. But a tax penalty in the future often doesn’t mean much to a client who, at that moment, might be holding a hefty repair bill for their family car’s transmission, or were about to miss a rent payment because they hadn’t found work since being laid off. It wasn’t a matter of financial responsibility, for these clients, but survival in an increasingly precarious labour market.
Unfortunately, the RRSP — a financial instrument invented in Canada’s post-WWII economy, has not evolved with that reality.
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Last year, 40 percent of Canadians surveyed by Bank of Montréal withdrew funds from their RRSP accounts before retirement. This comes as little surprise when private sector pensions, increasingly unsustainable and unaffordable for employers, are steadily shrinking, job precarity (according to statistics and to the federal Minister of Finance), has become an unavoidable fact of life, and many Canadians (especially Gen Y and younger) twist in the wind with entry-level jobs, or no jobs at all. Dreams of retirement don’t keep the lights on at home.
When the Registered Retirement Savings Plan was introduced to Canadians in 1957, its intent was to supplement registered pension plans. By allowing Canadians to deduct their savings account contributions from their overall income, it was also a boon to entrepreneurs who needed the type of safety cushion that salaried employees were likely to receive.
But salaried employees no longer enjoy the job stability they once did, and many Canadian workers find themselves entrepreneurs out of necessity in our gig economy. Finding the funds to save is difficult enough to begin with; hanging on to those savings is another matter.
To help Canadians with a rainy-day fund that wouldn’t penalize them when cashed in, the federal government introduced the Tax-Free Savings Account in 2009. The TFSA does allow for withdrawals at any time without incurring a tax penalty, and is in many ways more suitable for Canadians facing income instability. The problem is, many people aren’t quite clear how the TFSA works.
In a 2015 survey by Mackenzie Financial, barely more than half of respondents were able to answer three or more basic questions about the program. And while an increasing number of Canadians are making TFSA contributions, most contributors tend be be aged 55 and older.
Every January, the financial sector’s annual marketing machine spools up to push RRSP contributions before their “deadline” 60 days into the calendar year. As long as a contribution was made by March 1st of 2018, for example, the tax deduction can be carried backward for the 2017 tax year. While the additional 60 day contribution window is helpful to reduce taxes and possibly create refunds, those RRSP contributions are often wind up as a primary savings account. TFSAs, which have no “deadline,” end up becoming an afterthought, even when they’re the more suitable option.
Even if Canadians could make ends meet without making the withdrawal, the tax benefits of RRSPs don’t work the way they did even a generation ago. With wages in many sectors remaining stagnant or even falling, RRSP contributors often see their tax deducted on low wages when younger, and then levied on much higher income when the money is withdrawn at retirement.
As of 2017, an Ontario worker earning $30,000 has a 20.05 percent marginal tax rate. A $2,000 RRSP contribution made at age 25 could generate about $400 in tax savings. But a 65 year old retiring worker with an after-tax income of $75,000 has a 31 percent marginal tax rate, meaning a $2,000 RRSP withdrawal could attract $630 in taxes. There is no “amnesty” for RRSP contributions withdrawn at retirement.
So who does benefit from the RRSP?
According to contrarians in the financial industry like writer Helaine Olen ( Pound Foolish) and index fund guru John Bogle, savings plans like the RRSP do have a purpose: to enrich investment managers. A two percent management fee, over the course of 50 years, can eat up nearly two-thirds of the original investment capital. Because of the tax penalties which discourage withdrawals, and the high management fees for mutual funds into which RRSP contributions are often deposited, the RRSP has increasingly become an inverted pyramid — sold to contributors as responsible money management, benefiting banks and fund companies, but offering no retirement guarantees to the people who earned the money and forked it over for safekeeping.
So what we’re left with is a savings scheme that benefits almost everyone except the people it was designed to protect, and often have the most need for access to emergency cash.
Banks could help fix this problem by better educating their clients on the TFSA, and encouraging its use as a primary savings account. The federal government could also help by redirecting at least a part of the tax penalty for early RRSP withdrawal towards that investor’s Canada Pension Plan contributions. Or we could end the charade and convert the Canada Pension Plan into a universal plan that provides a living wage for all Canadian seniors.
Just about anything would be better than the system we’re stuck with — a system designed for a labour market where workers at least had a reasonable expectation of keeping their jobs and not having to moonlight just to keep the bills paid. The RRSP can still be a decent savings program for working Canadians. But if 40 percent of us are risking tax penalties to withdraw from them, they’re obviously not working as intended. Perhaps it’s time we tried something else.
