It’s a decades-old debate: Should an advisor treat the first 60 days of the year as RRSP season?
From a technical perspective, investors are effectively timing the market by contributing strictly in the first 60 days. This could work for or against them, but it’s a risky proposition to skew the deposit timeframe to such a limited window.
From a tax perspective, many people are motivated by creating a tax refund. Of course, this is really an interest-free loan to the government, though of relatively short duration if one contributes as late as possible and files the tax return as soon as possible.
Finally, from a marketing and administrative perspective, many advisors extol the virtues of monthly PAC programs over the one-time hit. Combine that with reducing tax at source with CRA Form T1213, and there is a case to be made (with numbers behind it) that one can accumulate more by ignoring the first 60 days allure.
Still, the reality is that industry advertising ramps up – and therefore clients’ ears perk up – as March 1 approaches. In addition, many annual bonuses are paid after year-end, often near the end of February, so advisors who ignore such events may be doing so at their peril.
Thus whether we like it or not, there will always be those who, by choice or circumstance, focus their registered investment efforts on those first 60 days.
The TFSA era
While not specifically directed toward retirement, the tax-free savings account can be coordinated with the traditional RRSP to optimize savings.
No doubt clients have asked you whether they should be contributing towards RRSP or TFSA. For those who are awash in cash, it’s hard to imagine that one would not be maxing out both types of plans. Assuming limited resources, however, should a person contribute to RRSP, TFSA or both?
Recall the basic structure of the two plan types:
RRSP TFSA
Tax-free funding Y N
Tax-free growth Y Y
Tax-free withdrawals N Y
Viewed in this manner, it is clear that the name “tax-free savings account” is a bit of a misnomer. What the plan really does – relative to an RRSP – is change the point at which tax is applied, though both plan types are entitled to internal tax-free growth.
Assuming the same investment choices in each plan, where a person’s marginal tax rate (MTR) is the same on deposit as on withdrawal, the net money on withdrawal will be the same under either plan. Where deposit MTR is higher than the withdrawal MTR, the RRSP will result in more net money – The reverse is also true.
Relative marginal tax rate Favours
Contribution MTR higher RRSP
MTRs the same Neither
Withdrawal MTR higher TFSA
Of course the common expectation is that a working person moves to a lower MTR in retirement, but that may not be the case for those early in a career, taking a sabbatical or on variable commission income. As well, if the savings are targeted for sooner use, such as a house or auto purchase, then it is the MTR at that time that is relevant.
Consider also:
- Unused contribution room carries forward for both plan types
- For an RRSP contribution, the related deduction can be deferred to a later year, presumably when the person is at a higher MTR
- Alternatively, a current contribution to a TFSA could be withdrawn at a later year to service carried forward RRSP room, and that withdrawal recovers TFSA room
Ultimately the appropriate option will depend on an investor’s current conditions and future intentions. Though not so simple, it can be reasoned out with good information.
Changes to the CPP
The Canada Pension Plan comes up for formal review on a triennial basis. A number of significant changes were recommended in the most recent review in the early part of 2009, and these have made their way into law with Royal Assent granted to Bill C-15 on December 15, 2009.
These changes, particularly the early and late take-up adjustments, present financial planners with an opportunity to provide insight and guidance to clients in determining how best to manage their CPP pensions.
Work cessation test – Until now, a person under age 65 had to cease working in order to commence a CPP pension, though there was no requirement that the person remain as such thereafter. Accordingly, a person might ‘retire’ to commence the pension, and return to work after two months. The work cessation test has now been eliminated, so that a pension may be commenced without this unnecessary work interruption. This change will not affect existing CPP beneficiaries or those who take their CPP retirement pension before 2012.
Working beneficiaries participating in the CPP – In the past, once a pension had begun, there would be no further CPP premiums paid. It is now mandatory for those under age 65 to pay the premiums, and voluntary from age 65 to 70. This includes the requirement that the employer pays its matching portion. These contributions will result in increased retirement benefits, earned at a rate of 1/40th of the maximum pension amount ($11,210 in 2010) per year of additional contributions. The exact amount of the additional benefit would depend on the earnings level of the contributor. The resulting pension could be above the maximum.
General low earnings drop-out – The pension entitlement calculation currently allows a pensioner to drop off 15% of the years where earnings are low or nil. This amounts to about 7 years. The drop-out rate will be increased to 16% in 2012 and 17% in 2014, being an increase to about 7.5 and 8 years respectively. This change will not affect existing CPP beneficiaries or those who take their benefit before the change comes into effect.
Adjustments for early and late CPP take-up – The current adjustments reduce a pension by 0.5% per month the pension begins before the normal age of 65, or increase it by 0.5% for each month after the 65th birthday month. The early pension reduction will be gradually increased to 0.6%, spreading the implementation over a period of five years starting in 2012. The late pension augmentation will be gradually increased to 0.7%, spreading the implementation over a period of three years, starting in 2011. Once again, these changes will not affect existing CPP beneficiaries or those who take their benefit before the changes come into effect.
Retirement savings and pension reform
The economic turmoil in 2008 played havoc with a wide swath of investments, but may have had especially dire consequences for those in retirement. While the preceding issues have a practical bent that an advisor may be able to act upon immediately, there could be some broad-reaching structural changes ahead.
At the May 2009 meeting of Federal-Provincial-Territorial Ministers of Finance, a Research Working Group was struck to looking into Retirement Income Adequacy, with six research tracks established for examination:
- Justifications for government involvement in retirement income provision
- Current and future retiree savings levels among Canadian households
- Investment risk and longevity risk in the context of retirement income
- Impact of investment performance and costs of pension and other retirement savings.
- Efficiency and effectiveness of tax-sheltered savings instruments design in Canada
- An international perspective of Canada’s retirement income system.
A 30-page summary document was delivered to the December 2009 meeting of those same Ministers in Whitehorse. That document is available at www.fin.gc.ca/activty/pubs/pension/riar-narr-eng.asp, including links to the six underlying papers. The Ministers have committed to conduct public consultations in their respective provinces/territories before reconvening in May with the intention to move toward more concrete decisions. The options being considered include (and these should not be considered as mutually exclusive):
- Establishing a voluntary supplementary CPP program
- Extension of the CPP itself, in terms of both premiums and benefits
- Greater leeway to financial issuers to set up group savings plans
- A stronger delivery of public education on the savings vehicles available
As a total aside
Kudos to the province of Quebec for allowing donations to the victims of the January Haiti Earthquake to be reportable for the 2009 tax year. In addition to providing tax relief to thoughtful donors a year earlier than otherwise available, the move is designed to encourage early action, with the qualification period ending February 28, 2010. As of publishing deadline, there was no similar relief in other provinces or at the federal level, but hopefully those governments will follow the lead.