RRSP’s and the Savings of Low-Income Canadians
Richard Shillington, March 2007
Currently, the design of income-tested benefits, principally the GIS, makes RRSPs an ineffective savings mechanism for lower-income Canadians. The net effect of this is that while several billions of dollars of federal tax subsidies are invested in the retirement savings of Canadians. At retirement those tax subsidies are largely confiscated from those seniors with an income low enough to be eligible for the GIS.
Who should avoid RRSPs
Those who face significant income-tested benefits at retirement are well advised to avoid savings in an RRSP. The main culprits, income-tested benefits which made retirement savings futile are as follows:
- GIS; benefits are reduced by 50% of income.
- Nursing home fees; subsidizes are reduced by 100% of income after income tax.
- Subsidized Housing; rents are set at 30% of income.
- immigrants who have lived fewer than 40 years in Canada
Once one accepts that the status quo is one where many Canadians are unknowingly saving in a fashion which is not wise, there are two remedies.
- Change the rules for the GIS and/or taxation so that saving in an RRSP would be appropriate.
- Alternatively, given the existing rules one could educate Canadians, and educate their advisors about how to save effectively.
Policy Options – Change the Rules
Option 1: RDSP/TPSP
One option for policy change is to create a new savings vehicle which would work much like the RESPs. Contributions would not be deductible from income tax but withdrawals would be tax-free.
Option 2: Investment Income Tax Credit
An alternative to TPSP style savings vehicles would be to protect investment income from taxation without creating a special fund.
Option 3: Exclusion from GIS Income
The Clawback which makes RRSPs an ineffective savings vehicle, also makes CPP a compulsory savings which has many advantages (forced savings, disability insurance, portability) but an unwise investment purely from the perspective of return on investment.
Conclusion - Comparing the Options:
Educating the consumer would appear to be the least attractive of these options. First, it is not easy to identify those who should avoid having an RRSP at retirement. As well, circumstances can change, so that, an individual who would not appear to be heading for GIS can all of a sudden become GIS destined. Education requires that complicated information needs to be understood by consumers. There is little chance that this information will be fully understood by most of those who need this information.
Other Policy Options were evaluated using the following criteria
Ease of implementation
GIS exclusion is the easiest and simplest mechanism to implement for consumers requiring little administrative changes.
What can you do in the meantime?
An on-line financial calculator has been developed to guide consumer choices. Please note that the calculator can only be a guide as the research has demonstrated that the interaction of income tested benefits and the tax system has many variables and continuous changes to determinations which cannot be fully integrated in a financial calculator. The calculator can be found at:
or click the link below
Retirement Planning for the "Rest of Us"