Income trusts have been grabbing all the headlines, but there are plenty of other capital market challenges facing the federal government. Perhaps the biggest one is crafting a retirement savings regime that accommodates a rapidly aging population by getting people working longer and saving more.

It’s the time of year when policy-makers look toward the next federal budget. The House of Commons standing committee on finance recently started pre-budget consultations, which are slated to run through early November. Assorted interest groups and lobbyists are queuing up to provide their policy prescriptions for the coming year.

It is inevitable that a primary topic for discussion will be the retirement savings system.
Not only is it critical to many of the economic issues with which the government must grapple — productivity, competitiveness and demographic change — but it is also an area in which the federal government appears to recognize the need for reform. In the late 1990s, the feds tackled the funding of the Canada Pension Plan, and that now appears to be on firm financial footing. Now, the rest of the system needs attention.

Ottawa has recently shown a fondness for making surprise moves in the retirement savings area of the federal budget. This past February saw the unexpected elimination of foreign-content restrictions. The year before, the federal government first declared its intention to crack down on tax leakage from income trusts, and, after years of pleading from the investment industry, it began hiking pension contribution limits. Other
measures, such as federal subsidies for RESPs, have apparently come out of nowhere.

In another budget surprise a couple of years ago, the federal government mentioned it was looking at establishing tax-prepaid savings plans. This vehicle would work opposite to the way RRSPs work: RRSPs defer taxes by providing an up-front tax break on contributions and then taxing withdrawals; TPSPs are accounts funded by after-tax
dollars, and the funds and compound growth withdrawn upon retirement is not taxed.

The argument in favour of TPSPs is that they would be a better retirement savings option for lower-income Canadians. Many RRSP contributors are motivated to save largely by the up-front tax break and the prospect of withdrawing their money from the plan when they are no longer working and are presumably in a lower tax bracket. The incentive is not nearly as strong for lower-income Canadians, who see less value in an immediate tax break or the tax deferral. (In fact, they may end up paying higher taxes in retirement than they do while working — see page B7.)

To the disappointment of many in the financial services industry, the federal government did not introduce TPSPs in the most recent budget. It noted that TPSPs have not been ruled out, but cited the administrative burden of having two types of retirement savings plans as one of the reasons for declining to introduce them.

That said, industry players are hopeful that TPSPs will make the grade this time around.
The Investment Funds Institute of Canada remains strongly in favour of introducing
TPSPs. Its pre-budget submission recommends that the feds establish TPSPs, calling them “the only practical way in which lower-income Canadians can save for retirement.”

This recommendation is echoed by the Canadian Chamber of Commerce, which suggests that not only would TPSPs be a more practical savings vehicle for lower-income workers, but they would also act as an additional means of savings for those who have already maxed out their RRSPs.

Along with establishing TPSPs, IFIC recommends higher lifetime and annual contribution limits for RESPs, and that Parliament pass a law that would provide creditor protection for RRSPs. The bill proposing some level of creditor protection for RRSPs passed first reading in June. This kind of protection is seen as another way of encouraging Canadian to use RRSPs to fund their retirement.

Indeed, the federal government has demonstrated its support of RRSPs in the past two
budgets by raising the contribution limit last year, and accelerating the increase in limits in this year’s budget.

Between 1996 and 2002, the contribution limit was stuck at $13,500. In 2003, it was bumped up to $14,500. It rose again to $15,500 in 2004, and this year sits at $16,500. The limit will be hiked to $18,000 in 2006, and is slated to increase by $1,000 a year until 2010, when it will reach $22,000. After that, the limit will be indexed to average wage growth.

@page_break@Similar changes were also introduced for registered pension plans. Defined-contribution plan limits are slated to increase to $22,000 by 2009 from $18,000 in 2005. Maximum benefits from defined-benefit plans are also going up. The RPP limits will likewise be indexed to wage inflation once planned limits have been reached.

So far, it appears that these changes are having the desired effect on RRSP contributions, reversing a downward trend in contributions. Statistics Canada reports that total RRSP contributions rose 4.5% in 2004 from 2003 levels, to $28.8 billion. The number of contributors is also up.

But the numbers are not nearly as encouraging as they appear at first glance. Less than one-third of those eligible actually make contributions. And the number of contributors rose only 0.9%. Yet, between 2003 and 2004, the ranks of full-time employed workers grew by 2.3%, according to StatsCan. This indicates that the volume of contributors is not keeping pace with the growth of the workforce.

The increase in total contributions appears to be largely a result of the higher contribution limits, which only helps those who are bumping against those limits. StatsCan data show the median annual contribution was more or less unchanged, at $2,600. Yet, average weekly earnings grew about 2% between 2003 and 2004. That total contributions grew faster than wages and employment and that the median contribution was unchanged suggest that contribution growth is primarily occurring at the upper end of the income scale. So, although the higher limits have helped reverse a trend of declining contributions, it hasn’t done nearly enough to broaden participation in retirement savings plans.

Increased pension contribution limits are certainly a good thing because they boost workers’ ability to provide for their retirement, but Ottawa still has to deal with some of the structural issues that dog the retirement savings regime — specifically, the perverse incentive it can create to discourage older Canadians from working and encourage them to retire early.

The subject is receiving increased attention in the wake of a report published in mid-September by the Organization for Economic Co-operation and Development. The Paris-based OECD warns that Canada’s economic growth prospects could be jeopardized if current demographic trends persist and people continue to insist on retiring relatively early.

The OECD suggests the most important policy response to these facts is removing barriers to employment for older people. One of the primary ways to do this, it recommends, is by introducing more flexibility into retirement and allowing people more freedom to generate employment income, accrue pension benefits and receive them, all at the same time.

These ideas are also being championed in Canada. Jean-Claude Ménard, chief actuary for the Office of the Superintendent of Financial Institutions in Ottawa, reports that a study by his office found the treatment of benefits under current federal law encourages early retirement and provides a financial disincentive to work past age 65.

In his testimony to the standing Senate committee on banking, trade and commerce in late October, Ménard called on policy-makers to look at ways of preserving retirement flexibility while restoring neutrality among different retirement ages. He also suggested policy-makers consider adjusting the CPP rules to allow people to take the CPP pension and continue to accrue additional benefits.

“My personal view is we should put all necessary efforts into creating more flexibility and more of a choice for older workers to work longer if they want to. In that sense, we should try to remove all disincentives to work later that are in the system, whether they are in the Canada Pension Plan,private pension plans or the Income Tax Act,” he says.

Support for these ideas is building. In its pre-budget submission, the Certified General Accountants Association of Canada calls for elimination of mandatory retirement at age 65 and tinkering with public pension incentives in order to reduce the appeal of early
retirement. The association also promotes the introduction of TPSPs.

In another report released earlier this fall, the CD Howe Institute recommended raising the age limit for savings plan contributions to 73 years from 69 years (it was lowered from 71 years in the early ’90s), boosting RRSP contribution limits to $30,000 or 30% of income, and introducing TPSPs.

It is impossible to say whether any of this will happen. There are rumours that the age limit on savings plan contributions will be restored to age 71. Beyond that, there is not a great deal of hope for serious structural reform this year. And there appears to be little
buzz about TPSPs, beyond the industry lobbying for them.

Resolving the income trust issue is clearly Finance’s top priority and, as a result, other issues may not get the attention they deserve. Whatever the feds do with trusts may impact other retirement savings measures. If the federal government decides to resolve the tax arbitrage problem it sees with income trusts by cutting dividend taxes, it may be reluctant to tinker with other aspects of retirement savings rules because anything that supports savings will probably mean forgone tax revenue in the short term.

But if Ottawa cracks down on trusts by layering on additional taxes, it may try to defuse a possible voter backlash with some investor-friendly measures. And there is always room for surprises. IE