Amid alarming savings statistics, new research proposes that low-to-middle income Canadians could benefit from new TFPP model
In a research paper by Ryerson University’s NIA titled Filling the Cracks in Pension Coverage: Introducing Workplace Tax Free Pension Plans, Dr Bonnie-Jeanne MacDonald called for the creation of workplace Tax Free Pension Plans (TFPPs) to better support financial security in retirement for those who need it most.
Just like a TFSA, which is used for personal savings, the NIA’s director of financial security research believes the same option could be provided to a workplace pension plan with the added benefits of employer contributions, substantial fee reductions because of economies of scale, potentially higher risk-adjusted returns and possible pooling of longevity and other risks.
The research highlights that Canadians without workplace pension plans have only $3,000 on average in retirement savings, with more than three quarters of workers in the private sector not covered by workplace plans at all.
The research also expressed deep concern that, under the current workplace Registered Pension Plan (RPP) model, lower-to-middle income Canadians are essentially discouraged from saving for retirement due to potential financial penalties from income tax dynamics as well as income testing for social benefits later in life.
Workplace RPPs are built similarly to Registered Retirement Savings Plans (RRSPs) in terms of income tax treatment and senior social benefits calculations. Like RRSPs, RPP contributions are tax-deductible at the point of contribution but payouts in retirement are taxable as income, which negatively affects lower income earners who collect Guaranteed Income Supplement and other government programs that have an income-tested clawback.
These create financial disincentives for low-to-middle income earners to save and the NIA believes a workplace TFPP can help solve the problem. TFPPs would operate in a “tax-free” environment like TFSAs and contributions would use after-tax dollars and not receive a tax deduction. It would grow free of tax, and withdrawals would not be taxed or added to taxable income.
This means pension income from TFPPs would not be considered when determining eligibility for federal or provincial income-tested benefits, credits and subsidies. Dr MacDonald told WP that the case for a new pension plan to help low to middle income earners is compelling.
She said: “The strongest argument is to know that only a quarter of private sector workers will have a pension plan when they retire. That’s low. When it comes to saving for retirement, it’s much better to do it within a group because you have better economies of scale, better protection, and there is a fiduciary responsibility to help members. Also, there are concerns that in the retail financial market, there are conflicts of interest.”
The spark for the TFPP theory came after conversations on the possibility of TFSA money being used to buy annuities. It posed the question, why don’t we have tax-free pensions?
Another issue centred around vulnerable seniors and how they could be affected by ill health in later years.
She said: “Senior care and healthcare, that’s going to be a big problem. As a researcher, how can we create a better system in terms of delivering senior care? On the flipside, you have to remind individuals that the government doesn’t pay for these things a lot of the time, unless you end up in a nursing home. If you have money and you become sick, you have options.”
The flexibility of a TFSA is also an attractive element that the TFPP could emulate. For modest-income Canadians, Dr MacDonald questioned whether they wanted all their money locked up in a pension plan. “It’s great for retirement security but not great when the roof is broken.”
To that end, she liked the idea of a rainy-day fund within a pension plan, which has a short-term and long-term savings component.
She said: “People can access it when they hit a certain threshold, that money then goes into a locked-up savings. So, people do have a little pot of an accessible fund, which is good money for emergency and mental health because you know you have some sort of contingency fund but at the same time the money does go to a locked-up fund.”