Open letter argues policy focus on decumulation phase of retirement is key to retirees’ and pre-retirees’ security
With the right tax policies and regulations, as well as policy attention to the decumulation phase of retirement savings, Canadians’ retirement prospects can improve.
That’s what Alexandre Laurin, Director of Research at the C.D. Howe Institute, wrote in an open letter to Finance Minister Chrystia Freeland.
In the letter published ahead of the federal finance budget, he said retirees and workers approaching retirement would be anticipating tax-rule adjustments to improve their retirement security.
He noted that many new retirees do not have a guaranteed pension for the rest of their lives, and with the demise of private-sector defined-benefit (DB) pension plans, an increasing number of seniors are relying on their accumulated assets in registered retirement plans to fund their retirement.
No one, however, can predict how long they will live. Those whose primary source of retirement income is not guaranteed for life must take precautions to avoid outliving their savings, which may result in excessive precautionary savings and a poorer retirement lifestyle than would otherwise be the case.
Since the 1960s, life expectancy in Canada has increased by more than two years each decade, yet existing retirement age limits do not reflect this, Laurin pointed out.
At the age of 71, Canadians (and their employers) must stop contributing to tax-deferred retirement savings plans, as well as convert their retirement assets into a Registered Retirement Income Fund (RRIF) or an annuity and begin drawing down their fortune. Increasing the retirement age from 71 to 75 years old may encourage older Canadians to work longer, he said.
Despite adjustments made in 2015, retirees with investments in RRIFs run a significant danger of outliving their tax-deferred investments due to the obligatory minimum withdrawal schedule.
More liberal tax laws, such as allowing for more regular modifications to minimum withdrawals to keep them linked with returns and longevity, or abolishing minimum withdrawals entirely, would be important projects to ensure retirees' long-term security.
Laurin also referred to decumulation solutions for capital accumulation schemes that were launched in recent years. Variable benefits (subject to yearly minimums and maximums) are now available to members of defined-contribution (DC) plans. Variable Payment Life Annuities (VPLAs) and Advanced Life Deferred Annuities (ALDAs) were created as a result of changes to federal tax rules.
Large DC plans will provide VPLAs, which will allow members to pool their longevity risk and convert their balances into life annuities with payouts that will vary depending on the plan's experience. ALDAs are likely to be offered by life insurers and will enable for the purchase of a life annuity that will start paying out at a later age.
However, because of certain tax restrictions, the new options only make economic sense to apply among a subset of capital accumulation plan participants, namely those who are involved in the largest DC plans. Effectively, he said, seniors are unduly constrained from buying longevity insurance at a time when governments are concerned about the rising costs of providing long-term care to an aging population.
Furthermore, Laurin said liquidity restrictions prevent the purchase of life annuities within a TFSA. As an alternative to group RRSPs, many firms are offering group TFSAs to their employees. Those TFSA investors who wish to buy an annuity would have to withdraw funds from the TFSA and buy an annuity contract, where the interest portion of the payouts is taxable.
“This additional tax makes the alternative of leaving the funds within the TFSA to self-insure against the risks of longevity – negating the benefits of longevity pooling – more tax effective,” he said. “It is unfair to those who opt to save for retirement in a group TFSA as opposed to a group RRSP.”
Finally, Laurin discussed the pension income tax credit and pension income splitting, tax breaks that are available for pension benefits, lifelong annuity income from a registered savings plan, variable benefits from a DC plan, and RRIF withdrawals. These are generally open to taxpayers aged 65 and over, but for pensioners under DB plans, those tax breaks can be claimed from age 55.
“This age exception is unfair, and perpetuates the growing divide between public-sector workers, almost all of whom receive DB pensions, and those who do not,” Laurin said, arguing that the source of eligible retirement income structured as lifetime periodic payments should not matter in applying tax breaks. “Fairness requires that all should have the same eligibility age.”