The RRSP scramble

"I think people are overestimating the amount they need to save"

Malcolm Hamilton February 1 1999

The RRSP scramble

"I think people are overestimating the amount they need to save"

Malcolm Hamilton February 1 1999

The RRSP scramble

"I think people are overestimating the amount they need to save"

Malcolm Hamilton


How important is it for Canadians to take full advantage of their RRSP contribution limits? The subject is the source of endless confusion among investors and debate within the financial services industry. To sort through the issues, Maclean’s called on Sue Dabarno, executive vice-president and director of private client services for Merrill Lynch Canada Inc.;

Dan Richards, president of Marketing Solutions, a consulting firm that advises the mutual fund industry; and Malcolm Hamilton, a pension specialist at William M. Mercer Ltd. Excerpts from the discussion:

Maclean’s: Is it a foregone conclusion that every Canadian should maximize his or her RRSP contributions?

Dabarno: I think that everybody should at least attempt to maximize their RRSPs. Having said that, you have to look at individual circumstances. You can’t just blatantly tell people to maximize their RRSPs if they are so deep in debt that they can’t sleep at night. On the other hand, if you decide not to maximize your RRSP and instead use your money to pay down debt, you’re leaving yourself with very little liquidity. If you lose your job and you don’t have some savings to fall back on, it’s pretty hard to go to the bank and say, ‘Can I up my mortgage because I need some cash?’ Maclean’s: What percentage of Canadians maximize their RRSPs?

Richards: It’s pretty small—something on the order of 15 per cent. In part, of course, that’s because RRSP limits have gone up significantly. It’s not that long ago that the limit was $5,500. Well, today it’s pushing $15,000 and there’s pressure to keep it going up. For the average Canadian, even the above-average Canadian, to find $15,000 on Feb. 15 is going to be pretty tough. But the core of the problem for many people is a failure to establish an ongoing plan. One of

the axioms of financial planning is ‘Pay yourself first,’ and it’s true. Contributing to an RRSP has to become routine, and for too many Canadians it’s not.

Dabarno: It also makes sense that the day you get a pay increase, you increase your contribution level. That way, you gradually move closer to your goal.

Maclean’s: Canadians are often told that they need to save more for retirement, and that if they don’t they’re not going to live well in retirement. Is that true?

Hamilton: By and large, I think people are overestimating the amount they need to save. If you look at the retirement system, you’ll see that a couple is guaranteed an after-tax income of about $25,000 a year per annum after age 65 even if they don’t save a penny. That’s what they can expect to get as a couple, net of income tax, from the Canada Pension Plan, Old Age Security, Guaranteed Income Supplement, GST credits and various provincial programs. Well, the irony in Canada is that a senior couple with $25,000 a year after tax will have a standard of living, by my calculations, comparable to a working family with $50,000 in income. That’s because, unlike the working family, the senior couple usually doesn’t have children to support, they

will usually have paid for their house, they won’t have payroll taxes and they won’t be saving for retirement any more. With half the income, they’ll also have a much lower tax burden.

Maclean’s : A lot of Canadians in their 30s and 40s are worried today because they haven’t started saving for retirement.

Are you saying they should relax?

Hamilton: In my view, it’s way too early for them to worry. If you’ve got children and you can get to the age of 45 with the mortgage largely paid off, you’re probably doing just fine even if you haven’t saved anything for retirement. Then, as the mortgage gets paid down and the children leave home, take that money and direct it towards retirement savings. You can do remarkably well saving vigorously in the 10 years before retirement without really making any reduction in your standard of living. The great tragedy in Canada is that we have many families earning $50,000 or $70,000 a year who are horribly overtaxed and their standard of living is no better than seniors who never saved a penny, and yet everybody tells them they’ve got to take what little money they do have and put it in an RRSR

Dabarno: The comment I just heard was that this applies to people who have reached the age of 45, they’ve paid off their mortgage and the children have pretty well left home. That may fit a certain percentage of the population, but you have to look at all different age-groups, at when people are having children, and at what age people are retiring. I still think you should pay yourself first. Richards: There’s another issue here, and it’s a bit of a moving target. You have to consider not just how long you’re going to live,

but how much it’s going to cost you. There are retirement homes at the high end that will cost $2,000 a week. That’s not for everyone, but there are an awful lot of people who, when the time comes, would like to live at an above-average level of comfort. Also, with advances in medical technology there’s no question that we’re not going to continue to be able to provide universal health care. Health will be like education today: you’ll have a good, solid public system that’s available to everybody, and a better system for those who want and can afford it. In fact, there are already all sorts of stories of people queue-jumping by going to the United States for medical treatment. So we know it’s going to cost more to retire in the future than in the past.

Maclean’s: The financial services industry has a vested interest in telling people to save as much as possible. How do Canadians know what to believe?

Dabarno: Every Canadian has the right to be taken through each and every aspect of their situation to make sure they understand it, and no one has to accept the first financial consultant they see. They can shop around and they can ask to see track records and performance.

Maclean’s: Do you agree with Dan’s point about the rising cost of retirement?

Hamilton: It’s true if you accept that we’re all going to need $2,000-a-week retirement homes, but let’s put that in perspective. That’s $104,000 a year after tax, when the average Canadian couple makes $60,000 a year before tax. I don’t think we should be telling average Canadians to arrange their finances so that they can afford the most expensive retirement home.

Richards: I’m not suggesting that’s the universal case because clearly most people won’t be able to afford it. But guess what? There’s going to be a significant number of people who would like to be able to afford it when they reach that age.

Maclean’s: Isn’t it natural to want to retire rich?

Hamilton: If people are prepared to deprive themselves and live miserably for 40 years so they’ll be wealthy thereafter, God bless them. But we shouldn’t be telling people that they have to deprive themselves for 40 years or else they’ll be hungry or unclothed or miserable when they retire. And I’m not talking about people who get individual advice, because most people don’t.

Dabarno: That’s where I come from, because they should get advice.

Hamilton: But there’s a chicken-and-egg problem. People who get advice tend to have high incomes, so the advice-givers tend to be most comfortable with the financial problems of high-income Canadians. Most of what you read in the media are great financial strategies for people with very good incomes, but they’re not great strategies for people with normal incomes.

Dabarno: I’ve done focus groups over the years with a wide range of clients right across Canada, and I can tell you that regardless of income, the happiest and most comfortable clients are those people who started to save, even just a little bit, from Day 1. They don’t feel they’ve deprived themselves. They feel good about themselves.

Hamilton: I’m saying people should know why they’re saving. One of the problems is that all of these pressures are being put on families with young kids when they’ve al-

ready got high taxes, mortgages, child care and tons of other expenses. Now we’re telling them they should pitch $2,000 a year into a registered education savings plan and, by the way, they should also be saving for retirement. For most Canadians, there’s just not enough money there to do all those things. Nor do they need to. If you’re putting money into an RRSP and you’re paying your mortgage at an accelerated rate, you’re already saving a lot of money. Dabarno: But what happens if you lose your job?

Hamilton: If you’re worried about losing your job, save money for that purpose. My problem is with people who have all those other financial responsibilities, and yet they’re being told that unless they’re socking away 10 or 15 per cent of their income into an RRSP, their lives are going to be miserable when they’re seniors.

Richards: You’re absolutely right when you say you can’t do everything. But do we really have a savings problem or do we have a spending problem? Particularly among the baby boomers, we’ve seen a dramatic ratcheting up of expectations. People are saying, ‘If I’ve got to cut back on something, I’m not going to cut back on the new car, the trip to Florida or the larger house.’ That’s legitimate if you understand the consequences, but if you wait until 10 years before retirement to start saving, for most Canadians that’s going to be too late.

Hamilton: I don’t agree.

Most Canadians, if they apply themselves to saving for 10 years, will have a post-retirement lifestyle indistinguishable from their lifestyle before retirement. And if you measure the savings of Canadians by how much money is going into RRSPs and how much is going into pension plans, I think they’re doing not badly.

Dabarno: Not badly isn’t good enough, because there are too many uncertainties. What I need for retirement today is much different than I would have anticipated 10 years ago. And it might be much different again 10 years from now when the baby boomers begin to retire. Not worrying about retirement is the wrong approach. You need to be concerned.

Hamilton: Statistics Canada put out a study recently of 200,000 retiring Canadians, based on tax data. For Canadian individuals who were earning $70,000 to $100,000 a year, the average ratio of retirement income to pre-retirement income was 45 per cent.

The average for all incomes was 58 per cent. And if you survey them, you’ll find they’re very pleased, very comfortable. Yet people are constantly being told they need to save enough to replace 70 per cent of their incomes.

Richards: Malcolm mentioned the $25,000 guaranteed annual income per retired couple. You’ve got to remember that in the future, relatively high-income couples are not going to get the level of public support that they have today because the economics won’t allow it. And if you assume, as he does, that the $25,000 is going to be there, you’re taking away your margin of safety. Hamilton: Yes, one of the ironies in this is that the government is more likely to deny

In the future, Ottawa may cut support for middleincome seniors

benefits to people who save than to people who don’t. The history of Canada is filled with examples where those who save lose out. If you don’t save in Ontario, for example, you get better drug benefits than those who do save. My guess is that the group most likely to lose government benefits will be those who have saved a lot.

Richards: Because they can afford it. Hamilton: But how do you come up with a compelling argument to save when it means that you’ll be first in line to disqualify yourself from public benefits?

Dabarno: This is all just speculation. I get back to good common sense, which is that Canadians need some form of retirement savings and they need advice.

Maclean’s: 1998 was not a great year for Canadian investors. How will that influence what people do this RRSP season? Richards: If you were to characterize 1998, you could call it the Year of Living Nervously. The level of anxiety is palpable,

and one of the consequences is that people look at the alternatives out there and they don’t really like any of them, so maybe they’ll just take a pass. On top of that, we’ve seen for the past two years a slowing down in the rate of increase in RRSP contributions. Part of it is that a lot of Canadians don’t have the money, but another reason is that a few years ago the government changed the rules to allow people to carry over unused RRSP room. The unintended consequence is that a lot of Canadians have decided there’s no pressure on them to contribute this year. More and more people have $20,000 or $50,000 in unused contribution room, and it’s never going to be used because they won’t have the money.

Dabarno: Among our clients, we’re seeing a lot of cautious optimism towards the market today. After the market drop last September, the world didn’t stop and we didn’t see a lot of redemptions—we just saw a passive Canadian public. Now we’re beginning to see some cautious optimism move back in. We’re also seeing much more interest in asset allocation strategies and much more interest in diversification. People are asking more questions.

Hamilton: It’s terribly hard to give general advice, but people shouldn’t worry so much that if they haven’t started saving by age 45, their lives will be tragic when they’re old. If you look at the statistics on who’s saving, how much they’re saving, and how they’re investing, Canadians, I think, are behaving remarkably sensibly. And people who are retiring today are by and large retiring to a life that they find quite secure and enjoyable. So people should worry less. □