C.D. Howe's modest proposal on pensions: change RIFF drawdown rules

OTTAWA – The C.D. Howe Institute says it no longer makes sense to have strict rules that force retirees to draw down their registered income funds as they age and says changes are needed so seniors don’t run out of money.

With the federal government under pressure to reform Canada’s pension system so that retiring baby boomers and future generations don’t fall into poverty, the paper by the think-tank’s chief economist William Robson and Alexandre Laurin offers one way to ease the challenge facing seniors at little cost to Ottawa.

Under the Income Tax Act, seniors must withdraw annual minimum amounts from RRIFs and similar accounts in increasing increments that rise to 20 per cent at age 94. The idea is to have retirees receive a dependable annual source of income, and also for governments to “get back” tax revenue on tax-deferred savings vehicles such as RRSPs.

But while mandatory minimum drawdowns might have made sense when they were instituted in 1992, circumstances have changed, the report says.

Canadians now expect to live much longer and rates of returns on investments are not what they used to be.

“Longer lives are a good thing. Lower yields … may not be good but they are a reality,” the authors say.

“Good or bad, when combined with out-dated drawdown rules, modern longevity and investment returns spell trouble for holders of RRIFs (registered retired income funds) and similar accounts.”

The paper points out that when the rules were first drawn up, a 71-year-old man was expected to live another 11.2 years and a woman of the same age another 14.6 years. Today, an average 71-year-old man is expected to survive and need a steady income for another 14.4 years, and woman another 16.9 years.

Yields are also critical to the calculation. In 1992, the average yield on long-term Canada bonds was 8.5 per cent, whereas at the beginning of 2014 the yield was 3.1 per cent.

The result is that retirees who transfer their tax-deferred savings into an income fund at 71 today will see their nest-egg cut in half by age 80 and will be down to 10 per cent by age 94, when life expectancy tables say they will live an additional four years on average.

The report notes that there are roughly 203,300 Canadians in their 90s and that number is expected to triple in about 25 years. They could be running out of savings just when they need them most to pay for health care and long-term care facilities.

The solution, the authors argue, is for Ottawa to raise the age at which withdrawals become mandatory, or make mandatory minimums smaller so that savings last longer.

Or the government could dispense altogether with mandatory minimum withdrawals, said Laurin, the think-tank’s associate director of research, and let individuals make their own choices of how much and when to withdraw.

He says the policy made more sense when Ottawa faced massive deficits, but now with the government approaching a balanced budget, it could afford to defer the tax grab to later years. In fact, Ottawa could realize more tax revenue by waiting since the accounts will have longer to grow.

“For tax revenue reasons, receiving the tax revenue sooner makes much less sense than it used to,” he said. “There’s no clear-cut case that it’s to the advantage of the government (to have mandatory withdrawals), it seems to be pretty neutral.”

For individuals however, timing matters a lot. “The key difference is that retirees are mortal, but governments are not,” the report notes. “For an individual…it is better to pay taxes later than earlier.”