RRSPs: A plan for all seasons, Pt. I

In 1957, the government created a system that made retirement possible for millions. Today, we seem intent on burying that dream under a mountain of debt.

Louis St. Laurent’s Liberal government was on its last legs in March 1957. After almost a decade in power, St. Laurent was increasingly seen as arrogant and elitist, and the populist Conservative John Diefenbaker was poised to topple him. But in those last days, “Uncle Louis” had one last revolutionary policy to offer.

At the time, only those with company pensions could hope for a secure retirement — everybody else had only social security to look forward to. St. Laurent’s government created the registered retirement savings plan, allowing people to sock away up to 10% of their income, and accumulate investment gains tax free. Suddenly, retirement was conceivable for almost all Canadians with the means and foresight to plan ahead.

But 53 years after St. Laurent made the RRSP a reality, its legacy is very much in doubt. This rare gift from Ottawa, worth an estimated $17 billion annually in foregone taxes, is wasting away from disuse. The result is that millions of Canadians who mean to retire won’t ever have the means to do so. And rather than facing up to this fact and taking some relatively simple steps to safeguard their later years, they prefer to close their eyes and hope for the best.

Last year, just 24% of eligible tax filers made a contribution to an RRSP. It’s a shockingly low number, but those who have been watching the trends weren’t shocked at all. After 40 years of prodigious growth in RRSPs, the program flat-lined in the late 1990s, and participation has been declining ever since. Last month, RBC’s assistant chief economist Paul Ferley issued a report warning that this trend looks set to continue.

In 1997, Canadians on average contributed roughly 5% of their personal disposable income to their RRSPs. That number has slipped to just above 3% in recent years, and Ferley projects that by 2020, that number will be below 2%. While Ferley says this doesn’t necessarily mean that Canadians will be unable to retire in a few decades, he does say that the trend has a “clearly negative impact for the overall economy.”

Here’s what most big-bank economists believe but hesitate to say: Canada is on the front edge of a retirement crisis. And while it’s true that some people just don’t want to retire, a far greater number appear simply to be giving up on the dream while they are still mid-career. Others are just deluding themselves that it’ll all work out, somehow. If that doesn’t sound like such a big deal to you, it should. Retirement isn’t just about old folks hitting the road in an RV or relaxing in Florida for the winter months. The financial stability of the retirement cohort is a fundamental pillar of any developed economy, and if that pillar is crumbling, it means future generations of elderly Canadians will be even more dependent on government support, even more hobbled by debt, and even more vulnerable to the kinds of economic swoons that we saw last year.

How did we get here?

There are several factors that can help explain the gradual slowdown of the RRSP. The first is demographics. We know that retirement saving accelerates in the years between age 35 and 44, and peaks in the years between 45 and 54. The front edge of the baby boomers have moved through those peak saving years and are now starting to draw down on their savings. As with so many of our social institutions, this means a decline in the number of people paying into the system, and an increase in the number drawing money out of it.

That demographic problem is exacerbated by the fact that the system hasn’t done enough to encourage participation among the young and the poor. For households earning less than $30,000, the tax benefits of contributing to RRSPs are paltry. As a Canadian Chamber of Commerce report from several years ago noted, Ottawa essentially tells low-income Canadians “do not save — public programs will provide you with a minimum income in retirement that you will not be able to significantly augment through your own savings efforts.”

This is more-or-less the same message that very young Canadians get when they are new to the workforce. Their income is so low, and the tax benefit so small at those income levels, they quite understandably prefer to keep that money rather than sock it away for some distant dream of retirement. For millions of young people, retirement saving just isn’t a habit they ever had a compelling reason to get into.

It’s even harder to dislodge that kind of thinking when you consider the psychological turmoil that the markets have produced over the past decade. Since the RRSP peak of 1997, we have seen two full-on market crashes and perhaps the most harrowing economic crisis since the Great Depression. People who started their retirement saving a decade ago have seen precious little growth in their investments, and the volatility has taken a toll.

It’s difficult to quantify the psychological impact of all this, but it has clearly shaken our once-steadfast belief in the wisdom of long-term planning and the inevitability of rising markets. Consider the average person turning 30 this year. More or less their entire adult life has been spent on the back of a financial roller coaster, and that has fuelled a spreading sense of cynicism and hopelessness on the subject of retirement. They’ve seen the ads that say you need to save $1 million to assure yourself a time-share condo in walking distance to a Florida beach. They’ve also seen a hollowing out of non-professional middle-class job opportunities. They see the value of the homes they grew up in climbing ever-skyward, and the cost of a university education saddling them with a decade’s worth of debt. No wonder they ask themselves, “How can I possibly attain what my parents had, let alone more?”

Any financial adviser will tell you that RRSPs can be, and should be, the antidote to that kind of hopelessness. But who under the age of 30 is even speaking to a financial adviser? And those ads urging young people to put away $50 a month to start with? They ring as hollow as the “your seat cushion is a flotation device” charade that starts every trans-oceanic flight.

Debt vs. savings

If there is one thing the experts agree on, it’s this: RRSPs have never been more important. Canada Pension Plan and Old Age Security are relatively stable, but they are designed to alleviate poverty and supplement savings, not to provide a lifestyle that anyone would aspire to.

Furthermore, private pensions have been in retreat in Canada for two decades. Entering the 1990s, 18 million employer-sponsored pension plans covered close to half of Canadians. In 2008, the number of workplace plans had dropped to 10 million, covering just over 40% of the population and falling. If you remove well-covered public-sector workers from those totals, the picture looks even worse. Those who are lucky enough to have a pension are increasingly likely to have a defined-contribution plan (rather than defined benefit), meaning the level of their benefits at retirement is not guaranteed. Many employers have shifted from providing pensions to administering group RRSPs, in which the employer will frequently match a portion of their employees’ contributions. Such plans are less expensive and far less risky for companies to run. But according to a 2007 study by Sun Life Financial, fewer than half of eligible employees typically participate in such programs.

When you consider the steady decline in savings alongside the prodigious growth in household debt levels, you come to understand the financial prison Canadians are building for themselves. In 2008, household debt in Canada hit a record high of $1.3 trillion — more than double the level in 2000. Credit card balances are up fourfold over the same period. By 2012, the Bank of Canada estimates that almost one-in-10 households will be spending 40% of their income servicing debt. What’s more, in a recent survey 32% of households reported that they have no savings. Look at your credit card statement, zero in on the interest line: that’s your retirement savings circling the bowl.

Now, some might say these rising debt levels are a rational response to a decade of low interest rates. After all, that’s why governments cut rates: to spur consumption. But in order to believe that, you must have faith that Canadians will resume saving as soon as rates begin to climb again. And when you look at the surveys, there is precious little to justify that kind of optimism.

In fact, ask Canadians about retirement and you come face-to-face with mass delusion in place of planning. A recent survey from TD Financial found that one-in-five Canadians is counting on an inheritance or a lottery win to provide for their retirement. Meanwhile, an RBC study conducted at the same time found that 46% of those polled believe Canadians are better prepared for retirement today than we were 20 years ago. That’s despite the fact that two-thirds admitted they don’t plan to contribute to an RRSP this year. The top reason why? Not enough money. When it comes to lifestyle, we are in the midst of a generation-wide trade: keep your golden years, and give me the high life now.

So what to do?

There are those who believe that this downturn in retirement savings is just temporary. Benjamin Tal, an economist with CIBC, is optimistic that we’re on the cusp of a rebound in RRSP participation. He notes that Canadian disposable income rose strongly last year, and that the savings rate has bounced up to 5% (a nine-year high). He figures that “the recent financial crisis has, in fact, cemented the foundation of a stronger RRSP market in years to come.” The bottom line, he says, is that Canadians have the money to invest in their futures, and they have every reason to do so.

Others are less sanguine. Various think-tanks and consultants are now busily designing new retirement programs aimed at forcing Canadians and their employers to set aside a portion of their income that would only be accessible after retirement age, to augment social security. Whether or not you like that idea, it’s probably a political non-starter for the time being. As far as Ottawa is concerned, last year’s introduction of Tax-Free Savings Accounts was the last big-ticket tax break we’re likely to see for a while. And while TFSAs were a wildly popular innovation, they’re not a quick fix for the retirement challenge. They are designed to help people save for big-ticket purchases, like homes and renovations, not for long-term income replacement. As one well-informed observer recently put it to me: if RRSPs are like marriage, TFSAs are like a one-night stand…no commitment necessary.

It’s true that RRSPs do require commitment. They require foresight, some sacrifice, and certainly some delayed gratification. Back in 1957, it seemed reasonable that a retirement system based on those values could endure and prosper, and for exactly 40 years it did. For 12 years now, it hasn’t.

But the wisdom and generosity of the RRSP haven’t changed. It’s still the envy of much of the world. It’d be an awful shame to let it go to waste.