Thursday, September 24, 2015

Personal Finance Election Issues

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.


  1. I love a counter argument!

    I always find it interesting we complain about the higher TFSA, but nobody says anything about the RRSP limit. Most Canadians don't max out that account. :)

    RRIF and LIF minimums still don't make sense to me. Sure, middle or higher-income earners benefit from this but then again, most lower-class Canadians don't need the RRSP anyhow. They are better off with the TFSA, hence point #1.

    Someone needs to explain to me how a senior needs "income security" making over $70k per year.

    I enjoy reading differing views Michael. Aren't there any tax or personal policies you would change?


    1. @Mark: Most Canadian don't max out either account (RRSP and TFSA). It's a sad state of affairs.

      If we abolish the RRIF withdrawal minimum, wealthy Canadians will pay significantly less tax. Lower income Canadians would need to make up the difference. That's a problem.

      If you want OAS to not be paid to those making $70k/year, you need to start clawing OAS back somewhere in the $30k to $50k range. Otherwise you get the problem of earning a single dollar and losing all your OAS.

      The main policy I would change is the one where almost all governments at all levels fail to fire bad employees. Continuing to employ useless employees costs taxpayers billions of dollars every year.

    2. I am always surprised that so many folks fail to appreciate the effects of inflation over time. I fear for those that belong to a DB pension plans that have managed over time to weasel out of COLA clauses. Could be some nasty surprises...

      One policy change I would like to see would be to change the eligibility rules for those collecting the GIS. As it stands now, it is perfectly legal for wealthy folks who arrange their income properly to collect. See the article here to see how...

    3. @Garth: I discussed this problem back in 2008:

      I think it is likely that changes will be made to GIS eligibility as TFSA balances become large.

    4. I have heard of seniors who invest most of their wealth into their (multi million) main residence, and the rest in a low yielding checking account to live off of. They then collect the GIS from age 65 up until their deferred CPP and RRIFs kick in. Cash in the residence and go merrily on their way. No TFSAs required...totally legal but morally wrong IMHO. Maybe the means test will have to look at net worth...

    5. @Garth: I've heard such stories as well, but I prefer to react to real statistics. If some actual stats showed that significant numbers of seniors were gaming the GIS system, I'd be concerned. However, I'm not aware of any such evidence. The truth is that it's much better to earn investment income and forgo the GIS than it is to leave money in a chequing account. I'm suspicious about claims that significant numbers of seniors are acting against their own interests just to abuse the GIS.

  2. re: "Most Canadian don't max out either account (RRSP and TFSA). It's a sad state of affairs."

    Do most Canadians earn enough to max out either/both?

    You've got my vote for changing the bad employee policy! I've experienced it first hard for a decade and it is stunning. Perhaps the worst part is that the bad/useless employee will collect a (tax-payer partially funded) pension in exchange for having contributed very little or no value besides simply putting in time.

    1. @SST: RRSP room is scaled to income (18% up to a maximum). SO, by definition everyone earns enough income to max out their RRSPs. Certainly many Canadians don't earn enough to max out their TFSAs.

      Yes, the real pay of many government employees is much higher than their nominal pay because the pension and other benefits are so valuable.

    2. The RRSP favours wealthier people, by giving them more contribution room. The TFSA puts everyone on an equal footing.

      People who eventually sell their home will be able to shelter the proceeds into their accumulated TFSA contribution room, if they had not already filled it. So, the TFSA is a better program for them than the RRSP. The $10,000 limit is just OK and should be indexed to inflation.

    3. @Anonymous: The $10,000 limit, if indexed, would benefit me personally, but I think it is too high for the country. It will allow well-to-do people to avoid taxes on substantial investment income.

    4. Yet, you don't think that it is too high for the country that well-to-do people get an RRSP limit of near $25,000.

    5. @Anonymous: I'm not sure if I've ever commented on whether RRSP contribution limits are too high. So, I'm not sure why you think you know my opinion about RRSP limits. In any case, TFSA contribution room is much more valuable than RRSP contribution room because it involves after tax dollars and TFSA contributions don't have to be withdrawn starting at age 71.

  3. RRIF minimums (somewhat) help to prevent wealthy people from manipulating their incomes in order to maximize OAS (or even GIS!) income.

    Agreed that OAS should start to claw back at lower incomes (~$50K). Retirees with incomes greater than the median worker income should not have their incomes subsidized by tax dollars.

    I think the TFSA limit should be determined based on what is appropriate today. Although the $10K limit is not indexed to inflation, a future government would eventually raise the limit again, or index it to inflation at that time.

    1. @Justin: I agree that the TFSA limit should be set based on what is appropriate today. It should also be indexed. However, I don't think $10,000 per year with indexing is sustainable. Responsible future governments will either cut the limit, or more likely, allow it to erode with inflation for a long time.

    2. What would be an acceptable TFSA limit, then, Michael?

    3. @R: I haven't done any deep analysis, but I think the original $5000 (now $5500 with inflation made sense). There are a couple of reasons why TFSA room is more costly to governments tax-wise than RRSPs. The first is that TFSAs hold after-tax dollars. For someone at a 50% marginal tax rate, a dollar of TFSA room is worth twice as much as a dollar of RRSP room. The second reason is that TFSA holdings can remain sheltered from tax your whole life, but RRSP holdings have to start getting taxed at age 71.

  4. Thanks for this, I was going to point out the need for a smooth taper on Mark's post, but didn't have the time yet. I agree that the thresholds could be shifted down (e.g. to make the last dollar of OAS in the ~$70k range vs the first clawback). Given the talk about the importance of inflation to the TFSA, perhaps just stop adjusting the OAS claw-back threshold for inflation?

    IMHO, GIS could also use a more gradual taper (~30 cents for each dollar vs 50 cents? Hard to say exactly what to make it but that "feels" more right to me), perhaps starting a touch earlier to balance that out.

    1. @Potato: The question of when to clawback OAS is difficult because I think it should be different for individuals and couples. $70k may seem a lot to young people now, but a widowed senior with an income of $70k might actually need OAS money to stay in the long-time family home. But a couple both earning $70k certainly don't need OAS money.

  5. What a relief to read a money advisor who has actually thought through BOTH the individual and broader societal implications, rather than a knee jerk reaction either way. Thank you. A breath of fresh air in a very rank environment.

    1. @Jean: Thanks for the compliment. I'm certainly driven by self-interest, but I try to consider others as well.