Is an RRSP always worthwhile?

The conventional wisdom within the advisor community is “save, save, save.” While this rule is almost always true, low-income clients may pose a slight exception. With RRSP season in full swing, there is some debate about whether this group’s money would better serve them elsewhere. With a number of forms of social assistance at their disposal when they retire, blindly saving can potentially leave clients worse off than if they hadn’t saved at all.

Social policy analyst Richard Shillington has spent so much time studying this topic that he’s writing a book on it, Retirement Planning for the Rest of Us, which is slated to be published later this year. The “rest of us,” Shillington explains, refers to the demographic of Canadians who are not part of a private pension plan and have not likely accumulated a great deal of wealth for retirement.

Shillington worries that many advisors aren’t taking into account the projected financial status of low-income clients when they retire and need to be aware that, due to government tax restrictions on social assistance, many will face a double financial penalty if they draw any income from a registered plan.

“RSPs are sold on the wisdom that you contribute when your marginal tax rate is high, and you take it out when your marginal tax rate is low,” Shillington says. “But for low-income people, they would contribute when their marginal tax rate is low and take out when their marginal tax is really quite high.”

Shillington says this is primarily due to the government’s guaranteed income supplement for low-income retirees. The GIS benefit is clawed back by 50 cents for every dollar of income earned by a retiree; if that is factored in with the income tax on an RRSP or RRIF withdrawal, the financial penalty for a low-income retiree can be substantial, and, in some cases, his or her savings could be potentially worthless.

“The GIS program is the core of the problem. Thirty-eight per cent of seniors, or 1.5 million [in Canada], are on GIS. The majority of people who retire without an employer pension plan are on GIS. They face a 50% clawback on income not just from RSPs but from CPP and any other earnings or wages that they earn,” Shillington said.

“If you take a senior citizen who is low-income, and therefore they are on GIS, and, further, put them in social housing, where their rent is determined to be 30% of their income, including RRSP withdrawals as income, their tax rate is 100%. I can’t imagine why anybody would want an RRSP if it meant their tax rate would be 100%.”

For advisors, Shillington says the distinction has to be made whether their clients are going to qualify for GIS. If they’re not, he thinks an RRSP can be an effective saving tool, and that even low-income earners should contribute to one early on in their careers. But by the time they are a few years from retirement and know they will require GIS, he says it is wiser for them to cash out before retirement.

“If [the RSP] is only 40 or 50 thousand, cash it out,” he says, emphasizing that they should invest it in equity like their mortgage, because GIS is not asset-tested but determined by income.

Graeme McPhaden, a CFP with Armstrong & Quaile Associates, says that advisors do have to be concerned with the potential of GIS clawbacks for low-income clients. For some of his clients, GIS was an integral part of their retirement income.

McPhaden believes all clients should start saving early, even if their income is very low, to avoid getting into a situation where their advisor has to look at cashing in their RRSP to maximize their retirement income because they are on GIS.

If the client is able to invest $30 a month for 30 years, even at a moderate rate of growth, McPhaden estimates an RRSP could be worth in excess of $100,000. “They can do small amounts. Give up one coffee a day, you have $30 a month,” he says.

For clients who are only starting to save late in their careers, McPhaden suggests advisors look for alternative methods. “You might want to use a universal life plan at that point. I’m not a big proponent of using life-insurance plans for savings. [But] at least there, you can accumulate money in savings and it grows tax-free, and you’re not forced to cash in at age 69 like you would with a RRIF.”

McPhaden also warns that clients on GIS can pop up when you might not expect it, particularly with the parents of first-generation Canadians, who commonly have no CPP or company pension plan.

“This can be common for people who move here from other countries and bring their parents over who have never contributed to CPP. All they are going to get is GIS, so instead of getting just $400 a month, they’ll usually get just eight or nine hundred dollars with the supplements. That’s something I’ve seen quite often,” he says.

Jason Schella, BMO Mutual Funds’ regional sales manager for Atlantic Canada, agrees with McPhaden that the best strategy for low-income clients is to start saving early and diversify. Even in light of the GIS clawbacks, he thinks somebody nearing retirement should never overlook the value of saving for a retirement nest-egg.

Schella says that clients need to take into account lifestyle needs in retirement, and rarely will social assistance give a retiree the ability to utilize a substantial lump sum of money.

One of the mantras of financial planning is “You can plan, but you can’t predict,” Schella adds. He believes this is particularly true for retirees because having money available to deal with the unpredictable — such as a health crisis — can be absolutely critical.

“I had a couple who were at around age 55, and they had just started investing with me for about four years. One of the partners in the couple took ill. One was working and one was not,” Schella said. “This was a low-income client. When one took ill, even though they had only started saving for a limited number of years, they found it much more beneficial to have even the moderate lump sum of money available to them.

“A client can address an urgent need for [for money] by having their RRSP saved. Yes, they would have turned out to not get the full GIS benefit. But if, at a minimum, they have that lump sum of money available to them, they can handle any other need that may arise,” he said. “In the example I used, having that money set aside for any unexpected need was much better than not having it at all.”