like grey, slushy snow and bat- tery cables, February brings RRSP season and an avalanche of advertising that promises freedom later for investments today. You even see advice in the media that students and other young people should start their RRSPs early -- to develop the savings habit.
But there's every reason to doubt the wisdom of this kind of financial advice foisted on unsuspecting low-income earners at this time of the year. When it comes to tax policies, what a shame that no one represents the interests of those without much cash in the way that Bay Street stands up for the comfortable elite.
Let's take a look at students in the lower tax bracket, earning less than $30,000 a year. They're actually better off saving outside RRSPs until their tax rate is much higher, at which point, they could roll their savings into RRSPs and take advantage of the tax breaks.
I'm not disputing that RRSPs are a great savings plan, subsidized by working stiffs, for high-income Canadians, who contribute while their tax rate is high, get half their contribution back as a tax refund, and then take the money out at a lower tax rate. This works because tax rates for higher-income Canadians decline at retirement.
The trend is the reverse for low-income Canadians. They have a tax rate of 25 per cent while working. At retirement, their effective tax rate increases. That's because the income-based benefits to which they are entitled are reduced by an amount if they receive any earnings from their RRSP nest egg. Their eligibility for a range of income, health and social supports is reduced. For example, the Guaranteed Income Supplement (GIS) is reduced by $50 for every $100 of income (including funds withdrawn from RRSPs).
The combined loss of supports can actually eliminate all the value of the RRSP. The impact of RRSPs on income, health and social supports can increase the effective tax rate of low-income Canadians from the pre-retirement 25 per cent to 50 per cent (remember the GIS), or to 75 per cent if they have other income.
To illustrate how this unfairness works in practice, let's compare three retirement savings strategies. Each starts with $1,000 at age 45.
The three investments are, first, inside an RRSP (the tax refund is also invested); second, outside an RRSP in GICs; and third, outside an RRSP in stocks (which earn some dividends and some capital gains).
The funds each earn 5 per cent per year but are taxed at different rates. At 65, the RRSP has grown to $3,538, significantly more than the funds invested outside an RRSP, which are $2,088 and $2,380 respectively. But the money in the RRSP is trapped. Any funds withdrawn are subject to taxation and affect eligibility for income supports like the GIS, the rent in social housing, prescription drugs, nursing- home fees and the cost of meals on wheels and home care. In extreme cases, withdrawing $1,000 from an RRSP can cost you more than $1,000 in supports (so, in effect, your tax rate exceeds 100 per cent).
(I am using the term "tax rate' to refer to more than income tax -- it also includes the lost income and health supports that occur as a result of additional income.)
We can easily understand why the media and the financial industry do not provide investment advice appropriate to low-income Canadians: it's not in their business interest. But the result is that much present financial advice is incorrect for low-income Canadians.
The role of government is more disturbing. Shouldn't it design programs that reward savings -- or, failing that, tell Canadians that its programs can punish those who save? Naive? Perhaps. But if we don't expect and indeed demand more of the public sector, there will be no incentive to improve things. *
Richard Shillington is a statistician who specializes in the quantitative analysis of health, social and economic policy. Reprinted from straightgoods.com