Like bricks in a wall, the challenges confronting Canadians in retirement are slowly accumulating
and making it harder for clients to plan for their sunset years
. And given such new obstacles, it may be high time for the government to enhance one valuable retirement-planning instrument.
According to a new CD Howe Institute report titled Rethinking Limits on Tax-Deferred Retirement Savings in Canada,
the current contribution limits for RRSPs and defined-contribution pension plans should be updated to reflect new realities that retirees and soon-to-be-retirees face.
“People are living longer and—even more importantly—yields on investments suitable for retirement saving are very low,” said William Robson, president and CEO of the CD Howe Institute and author of the report.
Robson said the limits to RRSP contributions are derived from the Factor of Nine, a model established in 1990. Based on a specific type of defined-benefit pension plan operating under a specific set of demographic and economic circumstances, the Factor of Nine assumes that someone who saves 9% of their annual earnings will be able to buy a retirement annuity equal to 1% of their pre-retirement income.
“The hypothetical DB plan underlying the Factor of Nine resembles few actual plans in Canada,” Robson said. “[I]t understates the amount of saving required to fund more comprehensive DB plans and overstates the saving needed for more basic ones.”
The report noted that most savers in defined-contribution pensions and RRSPs incur higher risks and costs than defined-benefit plan savers, so the former have less opportunity to pool longevity risk across cohorts. The limits on defined-contribution plans also make them more vulnerable to market downturns since capital losses they incur can’t be offset with extra funds from savers.
Robson proposed several reforms to the Factor of Nine:
Are Canadians saving enough for retirement?
Road to retirement getting longer for Canadians
- Updating the model’s underlying assumptions for current realities so that the cap on tax-deferred savings goes from 18% to at least 30%;
- Giving concessions for late savers catching up on contributions, or for those under pension plans that have a different design;
- Implementing flexible tax-deferral regimes, such as indexing unused contribution room to inflation or formulating an inflation-indexed lifetime tax-deferred savings limit
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