Canada’s foremost pension actuary, Mercer’s Malcolm Hamilton, says those whose RRSPs were devastated by the 2008 market crash should be given comparable contribution room in the new Tax Free Savings Accounts (TFSA), retroactive to age 18.
In the first of four video interviews at Wealthy Boomer, Toronto-based Hamilton said people with traditional Defined Benefit (DB) employer-sponsored pensions get better tax treatment than those with Defined Contribution (DC) plans or RRSPs directly exposed to the market.
One unfair aspect of the Canadian pension system is that when DB plans lose money, employers can make it up with large additional tax-deductible contributions. But RRSPs and DC plans that lost money last year do not get the same privilege. Not only do members of those plans lose the absolute amount of money but they also permanently lose the ability to tax shelter any replacement contributions.
Not everyone suffered equally in 2008-2009: the biggest losers are affluent people between 50 and 70 who were not in DB pensions but were relying heavily on savings to finance their retirements. Many are baby boomers once in hailing distance of retirement but are now reconciled to remaining in the workforce longer than originally planned.
One thing that may help them is the new TFSA. “The TFSA is a wonderful thing,” Hamilton says, “The only problem for people like me and you is it came along a little late.” Under the current rules set by the Department of Finance, Canadians age 18 or more can contribute $5,000 a year to a TFSA, starting in 2009. So someone who is 18 today will eventually get $160,000 TFSA room by the time they are 50, an amount that should grow tax free to much higher levels. But, unless the rules are changed, someone who is already 50 today doesn’t get to go back retroactively.
Many have lost that much in irreplaceable RRSP contribution room, even though they may have comparable amounts sitting in nonregistered (taxable) accounts. In theory, it would take only a minor policy change and tax-law tweak to transform such taxable accounts into non-taxable TFSAs. Such a move would require no big up-front investment by government, Hamilton said. “It would just forego taxes on the investment income these unfortunate people would otherwise have earned.”
Many large DB pension funds lost a quarter of their value last year but employers, and in some instance, employees can make up the losses with tax-deductible contributions. “The bottom line is DB plans have better tax treatment than DC plans because with the DC plan when you lose the money you lose the room.”
Hamilton is worried about how aging baby boomers are reacting to the market meltdown and their decimated RRSPs. With interest rates so slow, he perceives a growing “swing for the fences mentality” where near-retirees believe they need to earn a certain high rate of return, taking whatever risk is necessary to get it.
Some behave like the gambler who doubles his bets after each loss in a desperate attempt to get back to break even. “That’s a bad way to manage your finances,” Hamilton says, “It’s a strategy with a high probability of ruin. The fact you’ve lost money doesn’t mean you’re better able to bear risk going forward.”