RRSP contributions: Making excuses could prove costlyBy Olivia Glauberzon | February 20 2014 07:31PM
Registered retirement saving plans contributions are on the decline, and the set of misconceptions driving the decline could be costly to clients’ retirement lifestyle, according to research by Amin Mawani.Government funding, reliance on inheritances and the belief that home values will outpace the stock market are just a few of the reasons clients failed to contribute to their RRSP, says Mawani, taxation professor at the Schulich School of Business, Toronto-based York University. “By operating within these realities, clients could end up costing themselves the retirement lifestyle they want to have.”
The Office of the Superintendent of Financial Institutions Canada confirms the decline in contributions. According to its January report on RRSPs, the number of tax filers contributing to an RRSP fell to 6.0 million in 2011 compared to 6.2 million in 2001. During that same 10-year period, the percentage of workers contributing to an RRSP who are between the ages of 55 and 64 fell to 46 per cent from 59 per cent.
“If advisors can understand the misperceptions clients are operating under and they could turn this trend around,” adds Mawani.
With this year’s March 3rd RRSP contribution deadline around the corner, below are the ways to identify and combat the top six misconceptions your clients could be grappling with:
The battle between spending for current consumption and saving for the future is an ongoing roadblock for clients in their younger years, says Mawani. “With priorities such as paying for a mortgage or child’s education, the desire to save for retirement may come in third or fourth place.”
It’s also difficult for clients to make RRSP contributions a priority without anyone they know in that life stage, says Chris Buttigieg, senior manager, Wealth Planning Strategy with Toronto-based BMO Financial Group. “When you start looking at how your parents at age 65 are handling retirement, that’s when you start asking yourself if you have enough money in your RRSP.”
The key to helping clients overcome this roadblock is to ask them to visualize the retirement lifestyle they would like to have, adds Buttigieg. “Once they are attuned to how their current savings rate falls short with the future they would like to have, they can start adjusting their savings habits accordingly.”
Another way to help clients make more use of their RRSPs is to help them see that RRSP contributions add to achieving their current goals as opposed to competing with them, says Lorne Zeiler, vice-president and associate portfolio manager with Toronto-based Tridelta Financial. “Once clients see that the refunds from RRSP income deductions help as opposed to hurt them on an after-tax basis, they’ll be able to utilize the tool a lot more.”
Clients also need to be reminded that they have a longer life expectancy than they did in the past, says Zeiler. “The older you get, the more your life expectancy increases and unless you’re independently wealthy or entitled to a huge inheritance, the reality is you can’t afford not to start saving early.”
For most clients, the desire to be debt free often trumps saving for the future, says Mawani. “This is especially true when the interest on a loan such as a mortgage or credit card is higher than the interest earned in an RRSP.”
For high income earning clients, they should be reminded that RRSP contributions can actually increase their savings and reduce their debt at the same time. For example, an individual earning $150,000 that contributes $15,000 (10% of gross income) to her RRSP will earn a tax refund of nearly $7,000. “The refund can then be used to reduce overall debts in one large lump sum,” says Zeiler.
Since it’s 2009 inception, the TFSA has grown rapidly, while RRSP contributions continue to decline. OSFI in its January report found that the amount Canadians who opened a TFSA nearly doubled between 2009 and 2011 to 8.2 million from 4.9 million.
Part of the TFSA’s popularity is due to the fact that investment gains within a TFSA, as well as withdrawals, are non-taxable. However, without using an RRSP in combination, they are subject to the contribution restriction of $5500 a year, says Mawani. “There is a much larger amount of contribution room in the RRSP, and that helps them compound more annually.”
Clients also lose out on the income tax deferral advantage an RRSP offers – the ability to defer an RRSP deduction during their prime income earnings years to a later date in retirement when their income drops, adds Buttigieg.
The only time strictly investing in a TFSA over an RRSP may be more advantageous to a client is when they are a lower income earner, says Zeiler. “If they aren’t reaping the tax deduction benefit since they are already in a lower income bracket, they could be better off putting their money in a TFSA.”
Almost 90 per cent of Canadians plan to rely on the Canada Pension Plan/Quebec Pension Plan (CPP/QPP) to cover costs during their golden years, BMO’s RRSP January study found, with almost a third citing an intended heavy reliance on CPP.
This thinking is dangerous since government payments of CPP are no more than $600 a month and most clients need more than that to survive on, says Buttigieg. “Clients need to realize that by planning for retirement they are opening themselves up to a lifestyle they want to have, instead of being constrained by these minimal payments.”
Governments may even be forced to cancel their old age security program, adds Mawani. “Mounting budgetary pressures and political reluctance to raise taxes might mean that CPP and OAS get scaled back.”
The average home price in Canada rose 10.6% year over year in December 2013 to $390,000, according to the Canadian Real Estate Association.
The upwards price trend on real estate in Canada has left many clients convinced that their home will become their main source of retirement income, especially when capital gains on the sale of principal residences are tax exempt, says Mawani. “The risk of this is that a client leaves themselves extremely undiversified and there is no guarantee that home prices will always rise.”
Clients need to be reminded that despite having high aspirations for selling a home, they still need a place to live, says Buttigieg. Much of the value of a home is tied to its location and size. For clients to profit from a home sale and fund their retirement, they need to be able to find a place to live for a lot less. “Clients may not be prepared to forgo the size and location like they originally thought,” says Buttigieg.
About 40% of the one thousand Canadians polled in BMO’s January study thought that an inheritance would help fund their retirement. Along side that, 34% of Canadians thoughts they would win the lottery.
The danger in relying on a future inheritance is that with people living longer, parents or grandparents may need their savings to fund long-term care costs, says Mawani. “Health care costs can suck up a lot of a parents’ assets and may leave a very limited amount for their legacy.”
Aside from issues such as probate and estate taxes that can take away from an inheritance, it can be a big “if” factor, adds Zeiler. “With clients living longer, that might be too much of a risk to take.”