Financial protection for the future, nest egg, retirement savings

A new report from the Association of Canadian Pension Management (ACPM) is urging the federal government to replace the “Factor of 9” component that underpins the Pension Adjustment (PA) calculation with a “Factor of 12.” The PA rules in the Income Tax Act are intended to align the tax treatment of defined-contribution (DC) plans and RRSPs as well as defined benefit (DB) plans.

If the government were to make the change to the factor, a Canadian’s RRSP contribution limit would increase to 24% from 18% of annual earnings. In addition, the money purchase limit (MPL) would rise to about $36,000 from about $27,000.

“[The change to the factor] would allow individuals to save more in their RRSPs and DC plans so that they could accumulate a larger sum of money that would be enough to, in theory, replicate what you could do in a DB plan,” says Todd Saulnier, a member of the executive committee of the ACPM in Toronto and principal at Mercer Canada in Halifax.

Saulnier is co-author of the ACPM report Increasing Support for Retirement Savings: Proposals to Modernize Tax Rules Applicable to Registered Plans, released last week.

The report argues that the factor needs to be updated to better reflect today’s economic and demographic realities, and to level the playing field between DC plans/RRSPs and DB plans. The “Factor of 9” component was set in the early 1990s.

“[Investment] return expectations today are quite a bit less than they were 30 years ago, bond yields are a lot lower, GDP growth is expected to be a lot lower than it was back then, so equity returns in the future are expected to be lower, and people are generally expected to live longer,” Saulnier says. “So if you want to equate those two arrangements [DC plans/RRSPs and DB plans], then that equivalence factor needs to be bigger.”

The report argues that as encouraging retirement savings has long been a policy goal of Canadian governments, updating tax rules governing registered plans would help in achieving that goal.

In addition to the change to the PA calculation, the report makes several other recommendations, including:

> Eliminate Transfer Limits of Commuted DB Plans. Employees who choose to transfer the commuted value of their DB plans to DC plans (such as locked-in retirement accounts) are subject to transfer limits under Income Tax Regulation 8517. Amounts above the limits often have to be taken in cash, which is immediately taxable. The report argues that this result is punitive to taxpayers.

“We certainly see situations where half or more of somebody’s commuted value is not transferrable to an RRSP arrangement, so it ends up being taxed immediately,” Saulnier says. “You end up with a person with a much smaller retirement savings as a result and being really challenged to try to replicate that previous income [under the DB plan.]”

> Raise mandatory retirement age to 75 from 71. Income tax rules mandate that Canadians begin withdrawing from their registered retirement plans by the end of the year in which they reach 71 years of age. The report argues that the mandatory age should be gradually raised to 75 to reflect Canadians’ increasing longevity.

“To force people to commence an income at age 71 when we know there are people who are continuing to work in their 70s just seems to be counterproductive,” Saulnier says. “If people are working, why should they be forced to take retirement income. And the longer you wait to start that income, the longer it’s going to last.”

The report also recommends that tax rules be changed to permit uninsured variable payment lifetime annuities (VPLAs) as part of capital accumulation plans, such as group RRSPs. VPLAs would allow for longevity and investment risk to be pooled, but not insured.

> Equalize Taxation of Pension Income from Various Retirement Vehicles. While income from DB plans can be split with a spouse immediately upon retirement, income from DC plans can be split only when both the annuitant and the spouse have reached the age of 65. The report argues that the rules should be changed so that income from DC plans is treated in the same way as income from DB plans for pension income-splitting purposes, as there doesn’t appear to be a good tax reason for the difference in tax treatment.

“It’s really a function of legal terms in the Income Tax Act that got defined slightly differently and gave the DB plans a leg up over RRSPs,” Saulnier says.