The federal government should raise the contribution limits for RRSPs and defined-contribution pension plans to reflect lower yields on investments and longer life spans, a report from Toronto-based think tank C.D. Howe Institute says.
“People are living longer and — even more importantly — yields on investments suitable for retirement saving are very low. These changes have raised the cost of obtaining a given level of retirement income,” said William Robson, the report’s author, in a release.
The report, called “Rethinking limits on tax-deferred retirement savings in Canada,” says those with defined-contribution pensions and RRSPs face a number of challenges that make saving for retirement much more difficult than for those with defined-benefit plans. It points to the factor of nine, an equivalency test for savings in various retirement saving plans. First adopted in 1990, the test uses a hypothetical defined-benefit pension plan in which saving 9% of annual earnings will let a person buy a retirement annuity equal to 1% of pre-retirement income.
But the factor of nine hasn’t kept up with life expectancy and lower yields on retirement assets, the report says, and people now have to save more than twice as much as it presumes. Those saving in defined-contribution pensions and RRSPs also typically face higher risks and costs than those with defined-benefit plans, and can’t contribute extra funds to cover past capital losses.
The report recommends three reforms to fix the factor of nine:
- allow a higher tax-deferred saving limit, raising the threshold from 18% to 30% or more;
- level the playing field for savers catching up on contributions later in life, or for savers with differences in pension plan design;
- replace the current annual saving limits with flexible tax-deferral regimes: either index unused contribution room for inflation or establish an inflation-indexed lifetime tax-deferred savings limit.
Read the full report here.