Private Savings: Registered Retirement Savings Plans
Registered Retirement Savings Plans (RRSPs), along with employer-based pension plans and non-tax-sheltered savings, are part of the private, non-governmental, portion of the retirement income-savings system. An estimated 8 million Canadians use either RRSPs or Registered Pension Plans (RPPs) to augment their public social-security benefits. In fact, according to the Association of Canadian Pension Management, 77 percent of eligible Canadians utilize private savings facilities, i.e., RRSPs and RPPs.
The focus of this section is RRSPs rather than RPPs or non-tax-sheltered savings, due to the public accessibility of the RRSP system. Pension plans, by definition, are provided by employers and managed largely by professionals. RRSPs, however, are much more readily available, used, and thus understood by Canadians, since they are largely managed and directed by individual investors in conjunction with an RRSP provider. The analysis of losses associated with the FPR is nonetheless equally applicable to Registered Pension Plans (RPPs).
RRSPs are an investment vehicle that can be used by Canadians to save and invest, tax-free. Contributions to RRSPs are made on the basis of gross income rather than on an after-tax basis, since RRSP contributions reduce an individual's taxable income.
Canadians can contribute to RRSPs until age 69 as long as they have earned income in the year prior to the contribution. The allowable contributions are limited to 18 percent of the previous year's annual earned income up to a maximum of $13,500. Only individuals with income less than $75,000 are able to contribute 18 percent of their income to RRSPs because of the monetary limitation on contributions of $13,500.
Additional provisions
It is important to note two special provisions of the RRSP system: carry-forward and spousal plans. The carry-forward provision allows Canadians to accumulate unused RRSP contribution balances at the end of each year. For instance, suppose an individual was eligible to contribute $1,000 in each of three years but was only able to make contributions in the amount of $500 each year. If the individual earned $20,000 in the fourth year, he or she would be able to make RRSP contributions in the amount of $5,100: $3,600 (18 percent of eligible earnings in year four) plus $1,500 (unused portion of past RRSP contributions in years one, two, and three).
The second provision, spousal RRSPs, allows one spouse to contribute to the other's RRSP and claim the deduction. The spousal RRSP provision allows couples to split their income during retirement by dividing their retirement savings during their working lives.
Age limit
Individuals are precluded from making contributions to an RRSP account after the age of 69 and are required to collapse their RRSPs into one of a host of other products including annuities and Registered Retirement Income Funds. The reason for the transition from RRSPs at age 69 is to ensure that individuals claim a portion of their RRSPs as income during their lifetime. For instance, many choose to transfer their RRSPs to Registered Retirement Income Funds (RRIFs) that pay a minimum amount of income from the fund on a regular basis (e.g., weekly, monthly, or annually). The amount paid out by the fund is subject to personal income tax. Thus, the individuals receiving the payments are subject to income tax on an incremental basis rather than all at once at retirement.
Investments
The earnings on contributions to RRSPs also grow tax-free until retirement or until money is withdrawn from the fund. The ability to shelter investment returns from taxation represents an enormous boost to investment growth since it allows returns to compound tax-free.
There are a host of investments that qualify under Revenue Canada guidelines for investment in an RRSP, including:
- certain bonds, debentures, and similar obligations of the Government of Canada, a province, a municipality, or Crown corporation or such indebtedness guaranteed by the Government of Canada;
- guaranteed investment certificates issued by a Canadian trust company;
- shares and debt obligations of corporations listed on a prescribed exchange in Canada;
- shares listed on a prescribed stock exchange outside of Canada;
- shares of the capital stock of certain public companies;
- units of a mutual fund trust (Revenue Canada 1992).
In addition, to the aforementioned investment options, Revenue Canada guidelines also allow for the inclusion of Canada Savings Bonds as part of an investor's domestic assets (Revenue Canada 1992).
There are, however, a host of investment options that are either limited or precluded from inclusion in an RRSP. For instance, precious metals, certificates in respect of precious metals, coins, and collections of currency are excluded from RRSPs (Revenue Canada 1992).
The objective of this paper is to examine and explain the main limitation placed on the investment options of RRSPs and RPPs, the Foreign Property Rule, which places a 20 percent limit on the book value of foreign assets in an individual's RRSP or RPP account. Any amount over the limit results in a 1 percent penalty tax assessed on the amount over the limit. (Revenue Canada 1995).
Changes to RRSPs
In 1990, several important tax changes were announced. The limit for RRSP contributions was originally scheduled to reach $15,500 by 1994 but the government slowed the pace at which the contribution limit increased due to budget constraints. In 1996, the Canadian government further delayed increases in the maximum contribution amount. The 1996 budget froze the contribution limit at $13,500 until the year 2003. Under the new schedule, the RRSP limit will increase to $14,500 in 2004 and $15,500 in 2005 (Department of Finance 1996).
It is important to emphasize that RRSPs are defined-contribution plans, whereby the contributions, as opposed to the benefits, are specified. For instance, RRSPs specify that the investor will contribute a certain amount of money each week or month to the plan. The benefits under a defined contribution plan are a function of the performance of the RRSP account (Ernst and Young 1997). Thus, two individuals who contribute the same amount of money may have different benefits in retirement depending on the rate of return each investor garnered from their investments.
Registered Pension Plans (RPPs), unlike RRSPs, can be either defined-benefit plans or defined-contribution plans. There has been a substantial movement away from defined-benefit plans toward defined-contribution plans. Thus, RPPs are increasingly emulating the structure of RRSPs.
Historical analysis of RRSPs
and RPPs
Table 9 shows the number of both tax filers and RRSP contributors and the value of their contributions and income between 1979 and 1996.
Figure 5: Number of Tax Filers and RRSP Contributors (1980-1996)
Source: Revenue Canada, Tax Statistics on Individuals, Series 1979-1998.
Figure 6: Assessed Income of Tax Filers and Value of RRSP Contributions (1980-1996)
Source: Revenue Canada, Tax Statistics on Individuals, Series 1979-1998.
The number of Canadians claiming RRSP deductions increased, on average, 7.7 percent per year between 1979 and 1996 (See table 9 and figure 5). More importantly the value of contributions to RRSPs increased, in nominal terms, on average, 13.7 percent during the same period (table 9 and figure 6). Controlling for inflation, the real growth in the value of RRSP contributions between 1979 and 1996, as measured in 1996 dollars, was 8.6 percent.
The value of RRSP contributions and the number of contributors grew more rapidly than either the number of tax filers or the total value of income assessed (figures 5 and 6). The number of tax-filers grew 2.2 percent between 1979 and 1996, less than one-third of the rate of growth in the number of Canadians claiming RRSP deductions.
Similarly, the value of income assessed grew at a nominal rate of 6.9 percent, and a real, or constant dollar rate of 1.9 percent. Thus, the value of total income growth was less than one-quarter the growth in the value of RRSP contributions.
Registered Pension Plans (RPP)
Another interesting barometer of the extent to which Canadians are using RRSPs is the comparison between RPP contributions and RRSP contributions. Table 10 presents the number and value of RPP contributions between 1979 and 1996.
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Source: Revenue Canada, Tax Statistics on Individuals, 1979-1996 Tax Years. Calculations by the authors. |
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Figure 7: Number of RRSP and RPP Contributors (1980-1996)
Source: Revenue Canada, Tax Statistics on Individuals, Series 1979-1998.
Figure 8: Value of RRSP and RPP Contributions (1980-1996)
Source: Revenue Canada, Tax Statistics on Individuals, Series 1979-1998.
The number of Canadians contributing to RPPs increased only marginally, 0.5 percent on average, between 1979 and 1996 (table 10 and figure 7). The value of RPP contributions grew at a nominal rate of 5.8 percent and at a constant dollar, or real rate, of 0.83 percent (table 10 and figure 8) compared to an average real growth in the value of RRSP contributions of 8.6 percent. The fact that the nominal value of RPP contributions in 1996 was 25.9 percent of the contributions made to RRSPs is evidence that Canadians are shifting their savings to RRSPs.
Profiles of RRSP contributors
There is a view that only affluent Canadians use RRSPs and that any restrictions placed on RRSPs would disproportionately affect only the wealthy. This misunderstanding of the use of RRSPs is illustrated by information released by Statistics Canada, which asserted that only 29 percent of Canadians contributed to RRSPs and that 81 percent of those earned more than $20,000 per annum (ACPM 1995).
Statistics Canada, however, failed to point out that Canadians with low income do not need to contribute to retirement savings plans in order to maintain a standard of living in retirement which is comparable to their pre-retirement levels (ACPM 1995). As the Association of Canadian Pension Management observed:
Statistics Canada would serve Canada's retirement income system better if it pointed out that while only 29 percent of tax filers contributed to RRSPs in 1995, if one excludes those under age 25 and over 65, the participation rate increases to 36 percent. If those with earnings less than $20,000 per annum are excluded the participation rate increases further, to 56 percent. If those individuals who participate in registered pension plans instead of contributing to RRSPs are also factored in, the overall percentage of Canadians participating in private pension arrangements is 77 percent (ACPM 1995).
The following two tables present 1995 data for contributions made at different income levels and at different ages and show that RRSPs are broadly used by Canadians.
It is clear from table 11 and figure 9 that Canadians in every income bracket use RRSP accounts. It is interesting to note that 82.1 percent of all RRSP contributors earn less than $60,000 annually and that the value of contributions made by individuals earning less than $60,000 represents 63.0 percent of the total value of all RRSP contributions.
Figure 9: Distribution of RRSP Contributors (1995)
Source: Emes 1998.
Table 12 reinforces the findings from table 11 that RRSPs are broadly used by Canadians. It is interesting to note that the largest increases in the proportion of those filing taxes who used RRSPs are in the younger age groups. For instance, the number of those filing taxes aged 20 to 29 who claimed RRSP contributions increased from 6.0 percent in 1982 to 21.8 percent in 1995, an increase of 263.3 percent. The percentage increase for the next three age groups (30-39, 40-49, and 50-59) decreased incrementally as the age increased; 147.9, 91.4, and 52.2 percent increase, respectively between 1982 and 1995.
Contrary to the general impression of many Canadians and, indeed, contrary to the statements made by Statistics Canada, RRSPs are increasingly being used by Canadians in all income groups in an attempt to ensure that they can retire with a reasonable level of income.
The RRSP system offers a flexible alternative to both pension and non-tax sheltered savings and is an attractive vehicle for savings to augment state-funded social-security benefits. The system maintains a few restrictions, namely the age up to which individuals can contribute, the amount of income permitted in contributions, and the investment options permitted.
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