We need a $2M lifetime RRSP limit

A paper recently published by the C.D. Howe Institute argues that maximum annual income-based retirement savings contributions should be replaced with an inflation-indexed $2 million lifetime retirement savings limit for all Canadians.

Pension reform in the mid-1990s was intended to equalize the playing field for people who saved in defined benefit plans, defined contribution plans and registered retirement savings plans. However pension lawyer and co-author of “Legal for Life” James Pierlot says workers saving for in RRSPs cannot hope to accumulate even half the pension values that routinely accumulate in public or private sector defined benefit pension plans.

"That's because annual contributions to defined contribution plans and registered retirement savings plans are limited to the least of 18 per cent of income and fixed-dollar limits indexed to wage inflation. In contrast, there is no limit on contributions required to fund permitted defined benefit pension benefits," he says.

Pierlot also believes that because years of low income can unfairly penalize immigrants, small business people and people who leave the workforce to raise children, RRSP contribution levels should be de-linked from annual earnings.

For example, consider Anjani who launched a software firm in 1995 and used all of her personal and RRSP savings for living expenses until 2001, when the business became profitable.  With 25 employees she now draws a salary of $200,000. However, her RRSP savings since 2001 only amount to $218,000 – enough for a yearly pension of $9,500.

“If you come to Canada and do well in the last 15 years before you retire, you are simply not going to be able to save enough for a pension that replaces 60 per cent or 70 per cent of your final earnings, whether you retire at 60, 65 or 70,” Pierlot continues.
 
While he acknowledges that many people react with “sticker shock” to the  proposed $2 million retirement savings limit, he says this figure was selected based on a top public servant’s salary at retirement of $150,000. “People who are earning $75,000 will only have to save $1 million over their career to get adequate income replacement.”

Given the $670 billion of unused RRSP room in 2010, will Canadians step up to the plate and save more if they are given the opportunity?

Pierlot thinks they will.

“What the data shows is that middle and upper income workers are not leaving contribution room on the table. Most contribution room is left unused by lower income people for whom Tax Free Savings Plans are probably a better savings vehicle.”

Since Canadians would pay tax on compulsory RRSP withdrawals after age 71, ultimately a higher lifetime retirement savings limit would be a wash from a tax perspective. However, he agrees it could impact government cash flow in the short-term.

Also read: Tax rules prevent Canadians from saving enough: report http://www.moneyville.ca/article/1077824--tax-rules-prevent-canadians-from-saving-enough-report and RRSP vs. Tax-free savings. Which is best?

 

Sheryl Smolkin is a Toronto lawyer, writer and editor. She can be contacted through her website or you can follow her on Twitter @SherylSmolkin.