Recently, Mark Seed at My Own Advisor called on Canadians to turn three personal finance issues into election issues. It certainly makes sense to take personal finance policies into account when you vote. Unfortunately, I mostly disagree with Mark on all three of his points.
Here are Mark’s preferences in bold followed by my thoughts.
1. Keep the Tax Free Savings Account (TFSA) contribution limit at $10,000.
On the surface, the choice is between a $5500 TFSA limit and a $10,000 limit. But that misses a crucial point. When the government increased the limit, they eliminated inflation indexing. So, the real choice is between $5500 with automatic cost-of-living increases or a fixed $10,000 limit whose value declines each year with inflation.
It can be difficult to imagine that $10,000 will become a much less valuable amount of money at some point in the future, but it will happen. Just 5 or 6 decades ago, $10,000 could buy a nice house. Now it’s not much of a used car. Far enough into the future, it will be a month’s rent in a typical apartment. Cost of living adjustments matter.
Another thing to consider is that generally only the wealthiest Canadians can afford to put $10,000 annually into their TFSAs today. Don’t be fooled by the many claims that large numbers of low-income Canadians max out their TFSAs. The numbers are very skewed by parents filling up their children’s TFSAs and retired Canadians transferring existing savings into their TFSAs.
So, in the short term, the $10,000 limit benefits wealthier Canadians, and in the long term, the lack of indexing will make the TFSA limit dwindle in real terms. While the $10,000 limit will benefit me, it’s worse for my sons. I prefer to choose a reasonable limit and have it rise automatically with inflation. The old rules of a $5500 limit with indexing make sense to me.
2. Abolish the Registered Retirement Income Fund (RRIF) minimum withdrawal requirements.
This was a big issue before the government made changes to the minimum RRIF withdrawals. It used to be that your RRIF portfolio had to earn a return of 6% over inflation to keep your RRIF payments matching the cost of living. It is unrealistic to expect to earn an average return this high over the years, particularly after accounting for investment costs.
With the latest RRIF changes, you only need to earn a return of about 3% above inflation to keep up with the cost of living. This is much more realistic. Now there is much less need to change RRIF withdrawal rules.
You may ask why we need RRIF withdrawal rules at all. Why not just leave people alone to manage their RRIFs their own way? Let’s look at who benefits if there are no minimum RRIF withdrawals. Lower to middle class Canadians need income from their RRIFs in retirement, so they won’t benefit from scrapping minimum withdrawals.
Middle to upper income Canadians are often better off tax-wise if they start drawing down their RRSPs and RRIFs after retiring rather than waiting until they turn 71. This only leaves people so wealthy that they don’t want to draw down their RRIFs at all. They’d rather defer taxes all their lives. They’d like to pass their RRIFs tax-free to a spouse or even to the next generation if they could.
RRSPs were designed to allow Canadians to defer taxes until they retire. Why should we allow wealthier Canadians to continue deferring taxes throughout their retirements as well? Scrapping the new lower minimum withdrawals will benefit the wealthiest Canadians, and the rest of us will have to make up for the reduced taxes collected by the government.
3. Stop OAS payments entirely to wealthy seniors over the existing “clawback” threshold.
Currently, OAS payments get clawed back by 15% of your income over $72,809. Once your income gets to about $117,000, the entire OAS is clawed back. The suggestion here is to just take all the OAS payments back (or never send them) for those whose incomes are over the $72,809 threshold.
The problem with this proposal is that it creates a huge difference for just an extra dollar of income. Someone making $72,808 gets to keep all of their OAS payments for the year, and someone making a dollar more gets nothing from OAS.
This would lead to tax-planning strategies in retirement where people with high average incomes keep their income to $72,808 or less in most years. If they have to go over the threshold, then they make sure to go over it by a lot, such as by draining a RRIF.
It is much better to have the current smooth tax policies. Once you hit the threshold, the clawback takes 15 cents out of every additional dollar. This is much better than falling off a cliff and having to give back all of the OAS. We can debate whether the threshold should be higher or lower, or whether 15% is the right clawback percentage, but a smooth transition is highly desirable.
Unfortunately, I have to disagree with Mark on all three of his points. The old TFSA limit was better with its automatic inflation increases, and the RRIF minimum withdrawals and OAS clawback rules are just fine as they are.