Feds urged to reconsider RRIF withdrawal rules

(July 2008) The current federal tax policy that requires seniors to make minimum withdrawals from Registered Retirement Income Funds (RRIFs) no longer makes sense in an environment of increased longevity risk and low-interest rates, a study released by the C.D. Howe Institute argues.

Currently, after Canadians reaches age 71, they must transfer their RRSP assets into a RRIF or annuity. The Income Tax Act requires RRIF holders to withdraw a minimum of 4% of the beginning-of-year balance at age 65, then an escalating minimum until, from 94 onward, they must withdraw 20% of their balance each year. Of course, all of these are taxed at the retiree’s marginal rate.

According to the C.D. Howe Institute, the minimum withdrawal regulations made sense when they were put in place in 1992, given the nature of financial markets then. The current life expectancy of those approaching retirement is substantially higher now than it was 16 years ago, and the rate of return on fixed income is drastically lower. The traditional conservative investment portfolio of today’s retiree is at risk of being depleted at a faster rate.

C.D. Howe notes that in 1992, the average life expectancy of a Canadian man at age 65 was another 14.9 years, and another 19.1 years for women, according to Statistics Canada. The average interest rate on long-term Government of Canada bonds was 8.7%, and on a three-month money-market instrument it was 6.7%.

Contrast that to today, when the average life expectancy for a 65-year-old man is another 17.0 years, and another 20.5 years for women. In early July 2008, long-term Government of Canada bonds were yielding 4.1%, and three-month corporate money-market paper was 3.3%.

The difference means a 65-year-old man, who retired in 1992 with a moderate $100,000 portfolio comprised of 75% bonds and 25% in the money market, using vehicles costing 100 basis points annually, would have had $80,400 left in it by 2006, his average life expectancy. A 65-year-old with the exact same asset allocation, but at today’s rate of return, would have only $34,200 left by 2025, his average life expectancy, according to C.D. Howe.

C.D. Howe emphasizes that roughly half of today’s 65-year-old men will actually live past 2025, making it even more likely they will outlive their savings if the minimum withdrawal requirement is left in place.

“There are complications people face when they are saving in RRSPs or capital accumulation plans. They get to retirement and find out they can’t get access to their funds, and there has been more attention paid to that,” says William Robson, president and CEO of the C.D. Howe Institute and author of the study. “[The other complication] is they have been forced to access their funds faster than they wanted them.”

C.D. Howe believes that in today’s low interest rate environment, re-examining or abolishing the minimum RRIF withdrawal requirement is something policy-makers should be looking at. Particularly since the majority of Canadian retirees are depending on capital accumulation plans, such as RRSPs, to fund the bulk of their retirement.

The study suggests the government consider abolishing RRIF minimum withdrawals outright or adapt the 1992 rules to today’s reality by raising the formula’s ages to match changes in life expectancy.

Robson still points out that, with today’s lower real investment returns, the latter solution would likely have little impact on slowing the erosion of RRIFs.

“My quick judgment here is the most important thing is the real returns on investment. That’s really critical. The longevity issue matters also but it’s less important,” he says. “My general intent here is to remind policy-makers who tend to be very much focused on defined benefit plans — the kind public servants have — that most Canadians don’t have those plans. They are more likely to be relying on defined contribution plans or RRSPs. They are the ones who we ought to be paying the most attention to. They are the ones having trouble saving for retirement and they are the ones that are likely to have difficulty with some of the rules out there.”

One option that will be available to slow the rate of portfolio erosion is the tax-free savings account (TFSA), which is expected to be available in 2009. Retirees will be able to shelter withdrawals for their RRIF to grow tax-free.

Right now, Robson says the TFSA is not enough.

“The fact the TFSA is there as a safety valve should help over time but they don’t exist yet,” Robson says. “We’ve been promised they will exist. Regulations have to be written. Financial institutions have to put them into place and the amount we are allowed to put into them over time needs to get up to a reasonable level.”

Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com

(07/11/08)

Mark Noble