Ottawa should raise contribution limits for savers in RRSPs and defined-contribution (DC) pension plans, says a report from the C.D. Howe Institute published on Tuesday.
In Rethinking Limits on Tax-Deferred Retirement Savings in Canada, the Toronto-based think tank argues that current contribution limits are outdated and unfair to workers that have to save for their own retirements through RRSPs, or belong to DC plans, rather than participating in defined benefit (DB) plans that assure their retirement security.
“People are living longer and — even more importantly — yields on investments suitable for retirement saving are very low. These changes have raised the cost of obtaining a given level of retirement income,” says William Robson, the report’s author and president and CEO of the C.D. Howe Institute, in a statement.
According to the report, the core of the problem is the “Factor of Nine”, a little-known “equivalency test” for savings in various retirement saving plans. The test, which was adopted back in 1990, is based on a hypothetical DB plan that involves saving 9% of annual earnings, which translates into an 18% limit on contributions by RRSP holders and DC plans.
The report argues this is a crude measure, and its use if “badly outdated” due to improving life expectancy and lower investment returns. As a result, people must save at least twice as much to replace their pre-retirement earnings than the factor assumes, the report says.
The report also notes that RRSP and DC plan savers incur higher risks and costs than DB plan savers.
“All these considerations would justify more generous tax treatment of retirement saving in these plans – not the less generous treatment dictated by the Factor of Nine,” the C.D. Howe Institute says in a statement.
The report recommends three types of reforms, which it says could alleviate problems associated with the Factor of Nine:
> allowing a higher tax-deferred saving limit, raising the annual threshold to 30% or more from 18%;
> revising contribution rules to accommodate differences in plan design; or
> replacing the current annual saving limits with flexible tax-deferral regimes: either index unused contribution room for inflation or establish an inflation-indexed lifetime tax-deferred savings limit.
“Inaction over another quarter century would be unconscionable,” the report warns. “Canadians continue to live longer. Slower world growth and high saving will likely depress real returns for decades … Canadians who do not participate in public-sector pension plans should have more opportunities to save, and unfair tax treatment should not stand in their way.”
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