Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 5 - Evidence - April 21, 2010
OTTAWA, Wednesday, April 21, 2010
The Standing Senate Committee on Banking, Trade and Commerce met this day at 4:28 p.m. to study the extent to which Canadians are saving in Tax-Free Savings Accounts and Registered Retirement Savings Plans.
Senator Michael A. Meighen (Chair) in the chair.
[English]
The Chair: Good afternoon. I call the meeting to order.
[Translation]
This afternoon, we continue our study of Canada's pension systems. The Canadian pension system consists of the following pillars: Old Age Security, public pensions, private pensions and private savings. We will focus on tax incentives provided as part of private savings.
[English]
According to the committee's order of reference, the study is on the extent to which Canadians are saving in Tax- Free Savings Accounts and Registered Retirement Savings Plans; federal measures that might be taken to increase the use of these savings vehicles as well as the fiscal cost of increased use; and ways in which the savings in these vehicles might be protected.
We have with us two witnesses who need little, if any, introduction: Mr. Gordon Pape and Mr. David Dodge. We will begin with Mr. Pape, a well-known author of various books on retirement, including 6 Steps to $1 Million, Get Control of Your Money, Retiring Wealthy in the 21st Century, and The Retirement Timebomb. He is also the editor and publisher of the Internet Wealth Builder, The Income Investor and Mutual Funds/ETFs Update. Mr. Pape, you are obviously a very busy man. It is good to see you after a number of years. I understand you have an opening statement. I invite you to proceed.
Gordon Pape, Publisher, The Income Investor, Mutual Funds/ETFs Update, The Canada Report, and the Internet Wealth Builder, as an individual: It is a pleasure to be here. I hope I can make useful contributions to your deliberations and give you a few ideas that, based on the testimony you have heard to date, might be somewhat different.
I stress at the outset that I am not an economist, an actuary or a pension specialist; I am a writer. My thoughts on retirement planning are based on the research I have done for the more than 30 books I have written, to which the chair was gracious enough to allude, and the interaction I have had with many Canadians through seminars I have given, through correspondence and through telephone conversations and personal meetings.
Over time, as I have looked at retirement planning systems, it has led me to the conclusion that in Canada we have one of the best in the world. We are fortunate. That said, I feel it can be better and can be improved. I have some wide- ranging views on this subject, but I have tried to confine my comments today to the specific mandate of the committee, in particular point 3: Ways in which savings in RRSPs and TFSAs can be protected.
Specifically, I would respectfully suggest that the committee consider and, if deemed appropriate, recommend four initiatives: My first initiative to recommend is the creation of a professionally managed national RRSP fund, which any individual Canadian can choose to opt into and which group RRSPs can use as well. The background for this is that, in my experience, the majority of people with RRSPs have little or no investment knowledge. We have provided them with some very lucrative tax incentives to encourage them to contribute to these plans, and then we have left them to their own devices to manage the money intelligently. It is rather like throwing a young child into a pool and hoping he or she figures out how to swim before drowning.
Of course, many people seek the help of professional advisers in managing their RRSPs and, at times but not always, they receive proper guidance. Advisers who sell products are in a potential conflict of interest situation, which might work to the detriment of the client. I would be happy to discuss that further with the committee if it so wishes, but it is not one the main themes I want to deal with today.
Another problem facing individual investors is the high cost. I know from reading transcripts of earlier testimony before this committee that the members have been very concerned about this. Mutual fund management expense ratios, MERs, in this country are significantly higher than they are in the United States. Certainly, there is some debate about this, but they definitely are higher. They significantly erode the returns that investors receive within their RRSPs. That situation will become worse when the HST takes effect in Ontario and British Columbia on July 1, 2010.
The availability of a national RRSP fund would solve all of these problems. First, it would provide top-quality money management to those who want it. Second, it would remove any potential conflict of interest. Third, it would reduce the costs significantly. Last week, one witness told this committee that the cost differential between retail mutual funds and institutional pension plans is 1.6 percentage points per year. A national RRSP fund might be even less expensive than that. I know the committee is interested in the cost. A national RRSP plan would cost governments nothing since the expenses would be paid for by the fund in the same way that mutual fund expenses are paid for now. We already have a prototype for this national RRSP fund in Canada in the form of the Canada Pension Plan Investment Board. The RRSP fund could be run by a division of the CPPIB or a by new agency, but the principles would be the same: no government interference and the freedom to invest anywhere in the world.
As a matter of interest, I have a statistic that the committee will not have heard before because it was calculated at my request. Over the decade to December 31, 2009, the average annual compound rate of return on assets managed by the CPPIB was 5.61 per cent. Considering that we experienced two major market crashes during that time, that is an excellent return, and it is better than most mutual funds produced. It is better than the average annual return for Canadian equity funds, Canadian balanced funds and Canadian bond funds over that same 10-year period. I do not have any statistical evidence but my guess is that the great majority of RRSPs in this country did not do nearly as well as 5.61 per cent over that 10-year period.
I have one more point I want to make on this: Participation in a national RRSP would be optional. There would be no compulsion. If people want to continue to use their own advisers or manage the money themselves, they should be free to do so.
My second recommendation for protecting RRSP assets is to phase out the Home Buyers' Plan and the Lifelong Learning Plan. Although the objective of each of these plans is laudable, the programs divert money from the primary purpose of RRSPs, which is to save for retirement. I will give the committee some numbers that were compiled at my request last week by the Canada Revenue Agency. Since the Home Buyers' Plan was created in 1992, Canadians have withdrawn almost $24.3 billion from their RRSPs for purposes of buying a home. Withdrawals under the Lifelong Learning Plan, which was started in 1999, total almost $866 million. These numbers include tax information processed to date for 2009 up to the end of last week. Combined, we are talking about more than $25 billion that has been taken from retirement savings and used for other purposes. It can be argued that this money has to be repaid, but a portion of it never is repaid. People simply take it into income and pay tax on the repayment amount each year. According to the CRA, more than $4 billion borrowed under the two plans has already been taken into income and not repaid. About $4.7 billion has been repaid. That leaves about $13.6 billion in loans outstanding at this time. Based on the experience to date, about $4.8 billion of that, or 35 per cent, will not be repaid. That would bring the total loss to retirement savings to almost $9 billion.
But that is only part of the story. We also need to consider the loss of growth within an RRSP as a result of these loans. I have looked at this from many angles in my various books. In one of them, I analyze the impact of the RRSP loans on two 30-year-olds, one of whom borrowed $20,000 under the HBP, which was the limit at the time I was doing the analysis, and one of whom did not borrow under the HBP. Assuming a 15-year repayment cycle and an average annual compound rate of return of 8 per cent, the person who used the $20,000 to buy a home ended up at age 65 with an RRSP worth $127,000 less than the one who left the money in the plan. Since the HBP limit was raised recently to $25,000, the potential loss to retirement savings is even greater.
As many members of this committee will remember, the Home Buyers' Plan was originally supposed to be a temporary measure brought in to stimulate a moribund housing market during the recession of the early 1990s. I suggest that it has outlived its usefulness, especially now that people can use their TFSAs to save for a home and for education, if they wish. RRSPs were originally intended to be personal pension plans, especially for those who did not have employer plans. I suggest we get back to the original principle.
My third suggestion is that we end forced withdrawals from retirement plans and let people draw down their savings as they need them, not on a timetable designed to allow the government earlier access to tax revenue. The committee has heard suggestions that the age limit for RRSPs be raised. I would go even further and suggest that we do away entirely with the concept of Registered Retirement Income Funds, RRIFs, and allow people to keep their RRSPs for life and make taxable withdrawals when they choose to do so. Eventually, all of the money will be taxed anyway when the last surviving spouse dies. Ms. Tina Di Vito, Director, Retirement Strategies at BMO Financial Group made this suggestion to the committee last week, as I read in the transcript, and I fully agree with her suggestion.
My fourth recommendation is an end to the practice of treating RRSP withdrawals as income for the purposes of obtaining government benefits, such as the Guaranteed Income Supplement or income-tested tax credits. RRSP withdrawals are not real income any more than a withdrawal from a savings account is income. Yes, I agree that people should pay tax on the withdrawal because they received a deduction when they contributed, but the financial penalties should not go beyond that. I notice that Mr. Richard Shillington, from Informetrica Limited, is scheduled to appear before the committee tomorrow. He has written extensively on this subject, and I expect he will have much more to say about this.
Mr. Chair, those are the main points I wish to bring to the committee's attention today. I will be pleased to answer any questions.
The Chair: I thought there would be a number of suggested recommendations, Mr. Pape, and certainly there are. Thank you for a clear and concise exposé. We appreciate that you limited your comments to the mandate of the committee.
Senator St. Germain: Mr. Pape, thank you for the excellent presentation. It was concise and precise and you hit the nail right on the head in several areas. In support of your proposed national RRSP fund, you said that financial advisers have a conflict. Can you tell the committee how this conflict is arrived at?
Mr. Pape: I would be happy to. I will specifically relate it to mutual funds because they are widely held within RRSPs, and that is quite relevant to the point.
We have a system called trailer fees in this country. Trailer fees basically were created with the idea of compensating advisers for advice they were giving to clients. The trailer fees are paid by the mutual fund companies to the advisers. The trailer fees will vary depending on the type of mutual fund units that are sold and the type of fund that it is.
Just to give you one clear example, and you will find this across the industry, Fidelity will pay to advisers an amount of 1 per cent of the annual value of all equity and balance funds the client holds in the account, 1 per cent for funds purchased on a front-end load basis, 0.5 per cent for funds purchased on a back-end load basis, but the adviser gets more up front on those. If, however, the client opts for a money market fund or a fixed income fund, like a bond fund, the trailer fee is only 0.25 per cent. Therefore, taking the front-end load units as an example, the adviser has a strong incentive to encourage the client to buy the front-end load unit of an equity or a balance fund to receive this 1 per cent trailer and a disincentive to recommend a fixed income fund with a 0.25 per cent trailer, even though that may be more suitable for the client at the time. Also, the adviser has a disincentive to encourage the client to switch to some other kind of security, such as, for example, ETFs, because if the money goes off the books and the Fidelity units are sold, the adviser no longer obtains the trailer fee from the mutual fund company.
Based on the studies I have seen, I would like to believe that most advisers understand that the interests of the client should be paramount, but they have no legal responsibility to do that. We have seen many cases, especially during the market crash of 2008-09, in which older people had too much of their assets invested in equities or equity funds and were hurt financially as a result of that.
This is what I am talking about as the potential conflict of interest that exists when you deal with a financial adviser unless you are on a fee-based plan. In that case, the adviser gets no trailer fees at all. We could say we want to bring in a regime in this country where we encourage all advisers to be on a fee-based plan, but that is not within the mandate of this committee. I hope that answers your question.
Senator St. Germain: You also recommended that the timetable be removed. From your expertise and experience, did the government put timetables to trigger the takeout of the RRSP through a RRIF ahead of time? Was this strictly to generate income sooner than later?
Mr. Pape: That would certainly seem to be the case, although obviously I was not privy to the discussions going on at the time. Look at the withdrawal rates from the RRIFs. For example, a 71-year-old is taking 7.38 per cent in the first year, and that goes up each year, as the committee knows. We are constantly telling people that at that age in life, you should certainly have a large proportion of your assets in fixed income securities. The amount can vary depending on who is giving the advice, but I would generally say to people of that age, 71 and on, that they should have anywhere from 60 per cent up in fixed income securities. You cannot find a fixed income security that is paying anywhere near that these days. The big bank GICs are 2 per cent, and the small financial GICs are 3.85 per cent, and yet we are saying to people you have to take 7.38 out of the fund. Bang, you are automatically eroding the assets.
Senator Gerstein: Mr. Pape, in preparation for today's meeting, I read some of the articles posted on your website. I mention the website because, to this point, I have not purchased your book, but I am certainly encouraged to do so after hearing your testimony today. In one of your articles entitled "Retiring Wealthy in the 21st Century," you advise, "Canadians under 40 have a natural aversion to putting aside large amounts of money for retirement that is many years away. Failure to overcome this tendency will be extremely costly." You go on to say, "Diverting retirement savings to some other purchase, such as buying a home, may seem like a good idea at the time, but it will seriously reduce your income once you stop work, unless you take appropriate countermeasures."
You mentioned you were reading transcripts of our hearings last week, and you are aware that one of our witnesses, Malcolm Hamilton, pointed out that buying a house is something that is nearly impossible to defer until later to life and something that most people cannot defer. They must do it when they are young. Furthermore, Mr. Hamilton indicated that the fact that you pay off your mortgage is a help to you, not an encumbrance when you get to retirement age.
How do you respond to Mr. Hamilton's views? Are you saying, Mr. Pape, that young people should not buy a house unless they can also afford to put away money for retirement, as indicated clearly in your key points that I noticed on your website publication?
Mr. Pape: I am certainly not saying young people should not buy a house. I read Mr. Hamilton's testimony. He is extremely knowledgeable, but I do not agree with him about everything.
The point I want to make here, and I want to stay on target, is that we now have an alternative way to save for buying a home, tax sheltered, in the TFSA. That did not exist at the time I wrote that book or made those comments. It exists today. The RRSP was always meant to be for pension purposes. If someone wants to save to buy a home, they can do so now in a TFSA. I am simply suggesting that we should not confuse the two. Let us not divert money meant for retirement purposes into some other form.
Senator Gerstein: You are a very public figure, and you write a lot, and I would like you to deal with the question. Given the facts in the tax act and all we have today, are you suggesting to young people that they should not be purchasing a home unless they can afford to put away other moneys for savings to use in retirement?
Mr. Pape: No, I am not suggesting that at all. That is their decision. That is their call.
Senator Gerstein: It was a little unclear, I thought, when reading your review points here. I guess I will have to buy the book.
Mr. Pape: The book was written 10 years ago, and the Tax-Free Savings Account did not exist at the time. We have a different regime now. I would not come before this committee and suggest we do away with the Home Buyers' Plan if the Tax-Free Savings Account had not come into play. Now we have that, and I think that is a viable alternative.
Senator Gerstein: Again, I refer back to Mr. Hamilton, who seemed to have different views than you on this important subject. He told the committee that Canadians are terrorized by dire warnings of inadequate retirement income and having to eat dog food. He does not believe the warnings are justified. He pointed out that no generation of Canadians has ever saved enough for retirement to replace anything like 70 per cent. You clearly do not agree. Your article, "Retiring Wealthy in the 21st Century," begins with a description of Emma, who is eating half a tin of macaroni for supper and had her phone disconnected because she could not pay the bill. Do you think Mr. Hamilton is missing something in terms of his analysis the situation that you are seeing?
Mr. Pape: I would not want to go on record as saying that Mr. Hamilton is missing something.
Senator Gerstein: What would you like to go on record as saying?
Mr. Pape: There are Canadians today, and I get emails from them frequently, who are in a situation where they are not maintaining the kind of standard of living that we would think appropriate and that they think appropriate. Whether they are eating dog food or one tin of macaroni or whatever, I know there are people who are not in a good financial position. I believe the committee is basically looking for ideas as to how we might help reduce that number of people.
The Chair: Following along on Senator Gerstein's question, one of the things Mr. Hamilton, who we seem to be referring to frequently — I am not sure actually whether it was him or another witness — suggested was rather than an annual limit for contributions to RRSPs we go to a lifetime limit. I believe it was Mr. Hamilton, who pointed out, rightly or wrongly, and it appealed to me I must confess, that people with children and a mortgage, maybe a house, and spending most of their disposable income occasionally get lump sum payments perhaps in the form of something they inherit or by selling their house when they get older and that is the moment when they could invest a substantial amount in their RRSP. However, they cannot because there are annual rather than lifetime limits. What is your position on lifetime limits, and what is your position on the $5,000 cap for TSFAs?
Mr. Pape: As far as lifetime limit is concerned, Mr. Chair, I read that testimony and I know it has come up a few times. I think it is unrealistic basically because how do you determine what the lifetime limit will be? People's income increases as they get older. Will you have a different lifetime limit for someone earning $25,000 a year at age 25 and someone earning $100,000 or $150,000 a year at age 40? I just think that is unrealistic.
We have a carry forward program right now for the RRSPs that is in many cases putting people in a position where they have lots of RRSP contribution room if they get an inheritance or whatever. However, if the committee wants to look at the idea of a lifetime limit, I would suggest that perhaps the committee should consider the idea of no limit at all. Why are we putting a limit on savings at all? Why is there any limit?
As far as the Tax-Free Savings Account is concerned, there was another point I wanted to bring before the committee but I did not want to overburden it with all sorts of ideas. Since you raised the question, yes, I think the $5,000 cap should be reconsidered for people over 50 years of age. We certainly know that the TFSAs are wonderful, perhaps the most powerful savings tool to be introduced in this country since the RRSP, but they benefit younger people potentially much more than they benefit older people. I would very much like to see that taken into consideration and perhaps raise the limit for people born before a certain year.
Senator Massicotte: We receive a lot of documents from the Department of Finance, which you have probably seen, whereby they lump in the organized savings programs, being the pension plans and the Old Age Security, it gives those numbers in relation to what replacement of income they can get. We have a problem where upper middle income earners cannot replace 70 per cent, if that is the right number.
Those numbers do not include home equity. It only includes the organized savings plans. We had a couple of witnesses who mentioned it, and it is a fact that many people have significant savings in their home. In fact, we had one expert saying those numbers are very misleading because many people, when they get to retirement age, have fully paid off their mortgage and there is a lot of equity there. However, we also had another expert saying there is a problem because many people want to live in their homes and they are not prepared to move until much later in their retirement.
We have no relatively inexpensive mechanism in Canada to make use of those savings and allow them to benefit from that equity. Meanwhile, I know you have been the spokesman for what I call the reverse mortgage company in Canada and you propose that. In the United States that is probably more popular than it is here. One could argue that is a very good way to reap the reward of that equity without actually selling your home and the structure I think is attractive.
The comment also was made that in Canada the cost of capital is relatively expensive, and that expert was recommending that the government create another reverse mortgage structure that is less expensive.
What are your thoughts on that? You know the financial markets very well. You represent that company as a spokesperson. Is it inexpensive, or is that the cost of the capital and we simply do not appreciate what that cost is?
Mr. Pape: I will clarify one point. It has been several years since I have had involvement with the Canadian Home Income Plan; at least five and perhaps longer. However, I am familiar with how they operate. I also read the testimony brought before the committee on that issue.
I have always been a believer in the ability to tap into one's home equity. You are absolutely correct; we have an awful lot of money sitting in home equity and that can be drawn on by people, but we have to provide it in a more effective way. There is more than one program now. I think there are two. In any event, it is too expensive. It is a very expensive program. It just happens to be the only one we have.
If there were some way of allowing people to get access to the equity in their home, to a proportion of that as income, a basic consideration is that the money be used in the right way, and this is what I tried to stress during the years I was spokesperson for them. You cannot just take the money out and blow it on a cruise. Essentially, that money should be invested very conservatively. I say "very conservatively" because the way the tax laws are in this country right now the cost of the loan then becomes an investment cost. It is an investment loan and you can deduct the interest paid on it. Therefore you can invest the money conservatively and, in effect, write off the cost of the loan and get the money tax free.
Based on that, I believe these are viable programs as long as the protection is there and the guarantees are there that people do not lose their homes. There should be some mechanism for ensuring that the money is used in the way that I think the committee would want it to be used, and that is to help people who perhaps are in some financial need. The recommendation was that the government do this through CHMC. I did not really go into that in detail in terms of my own thinking simply because it struck me as being somewhat outside the mandate of the committee.
Senator Massicotte: I would like to now talk about the conflicts of investment advisers or brokers. You made reference to ETFs, which are exchange traded funds, which are generally speaking very diversified. If I am correct, the empirical evidence would show that eight out of ten times they actually beat the total returns of actively managed funds. Maybe you could tell the committee the average cost of an ETF, equity oriented, versus the cost of owning and managing the equity oriented mutual fund. What seems to be better in the long term? What is the cost of that versus what most people use, which is the actively managed mutual fund and not ETFs? How many people use ETFs from a retail investment sense?
Mr. Pape: There are a couple of points. First I want to go back to the original statement. I find this very misleading. Standard & Poor's issues a quarterly report in which they assess the performance of actively managed mutual funds against, let us say, the TSX composite, or whatever index the fund is measured against. They always come to the conclusion that the percentage of actively managed funds that outperformed the index is something less than 50 per cent. What Standard & Poor's is not telling us is that every index fund and every ETF underperforms the index by definition, so their underperformance is 100 per cent. I have spoken to Standard & Poor's on a couple of occasions about this, and I have said that what we really need to know is what is the relative underperformance of the actively managed funds versus the index funds, because the way you are presenting the information is creating false impressions in the general public. That is number one.
Your second point relates to the relative costs. The lowest cost ETFs, and these would be, for example, the original iShares and this kind of thing, which are somewhere in the range of 0.2 per cent and go maybe to 0.5 per cent or 0.55 per cent depending on the specific index they are looking at. A mutual fund, on average, an equity fund, will be somewhere in the 2.5 per cent range. There are some companies that have lower MERs on their funds. These would be companies like Phillips, Hager & North, which is now owned by Royal Bank, Leith Wheeler in Vancouver, Mawer Investments and so on, but generally speaking, you are probably looking at a factor of maybe four to five times the annual cost on a retail equity mutual fund as opposed to a broadly based indexed ETF.
There is one other point on the ETFs: They are not all broadly based anymore. Some ETFs have become more specialized. The more specialized the ETF, the more complex it is for the individual investor and the higher the MERs tend to be. Some of these specialized exchange-traded funds are coming in with management expense ratios of over 1 per cent. Investors have to be aware of the cost of the ETFs and have a good handle on comparing apples and oranges with the regular mutual funds.
Senator Ringuette: I would like to go back to the issue of trailer fees for which you gave an example. All the presenters before the committee to date presented that recurring theme: the issue of fees for retirement funds. Correct me if I am wrong, but I believe that financial advisers are licensed under provincial legislation.
Mr. Pape: They come under the authority of the provincial securities commissions.
Senator Ringuette: Exactly. How can we make recommendations in respect of conflicts of interest vis-à-vis trailer fees given their provincial licence to provide advice to customers?
Mr. Pape: First, I was not suggesting that the committee make recommendations in that regard. I was using the example of trailer fees and conflict of interest in the context of the creation of a national RRSP, which would be administered by an independent body and which, therefore, would not have these built-in conflicts of interest. I use the example of the conflict of interest only to show how one of the points of having such a national RRSP could eliminate one of these potential concerns.
Senator Ringuette: I understand. However, in doing so, you have put forth a flag on conflict of interest with regard to financial advisers.
Mr. Pape: Yes. This is not a new issue. It is well known in the financial community and there has been debate on the subject. One of the reasons for the move to fee-based accounts has been to try to alleviate this problem. If an adviser- client relationship is fee based, then the trailer fee disappears. There are no trailer fees paid to the adviser. The client receives a different kind of unit, called an F unit, which does not have trailer fees attached to it. Therefore, the adviser has no bias toward a fixed-income fund or an equity fund or a balanced fund, et cetera.
I do not have any numbers on the percentage of existing fee-based accounts, but I know they are in a minority. I was talking to a broker just last week and asked him about fee-based accounts. He said that he would not consider taking one on that was worth less than $100,000 because it would not be worth his while to do so, charging an annual fee of 1 per cent to 1.5 per cent. In reality, they are for high-income people only.
Senator Massicotte: In the U.K., they are about to pass a law that inhibits all trailer fees and they have to be all fee- based. Do you agree with that?
Mr. Pape: Yes. I would like to see that. Of course, the U.K. can do that but, because of our divided jurisdictions, we are not able to do so in this country.
Senator Ringuette: My second question is on your comment that RRSP withdrawals are not real income. Could you elaborate on that?
Mr. Pape: RRSPs are savings — pure and simple. If you take after tax money and invest it and then draw from it, it is essentially savings. It is income that you have personally set aside and is not income paid to you by a third party. We recognize the principle in a Tax-Free Savings Account that any money taken out of the account should not influence your eligibility for income-tested benefits or tax credits or anything else. As I said in my presentation, I certainly believe that since we have a tax break going in, we need to pay going out. However, why are we penalizing people and taking 50 cents for every dollar off their Guaranteed Income Supplement when they are simply drawing down their own savings. As I am sure Mr. Richard Shillington will tell you tomorrow, because he has done the studies and is the expert, such a system provides a disincentive to low-income people to save in RRSPs.
Senator Ringuette: I agree with you, although you have to acknowledge that at the front end, the RRSP contribution is a deduction.
Mr. Pape: That is why I say it should be taxed coming out, but the financial penalties should not extend beyond the taxation of the money coming out into other income-tested areas.
Senator Ringuette: You are saying that there should be some kind of table provided by the CRA with the amount of RRSP contribution that you have made on a yearly basis and the income tax that you have saved.
Mr. Pape: I am not suggesting that at all, senator. I am saying to tax the RRSP money as income, but do not treat it as income for the purposes of calculating the GIS or other income-tested tax credit. That is all. Tax it normally, but do not extend that into those other areas.
Senator Ringuette: For a few years, I have wanted this committee to look into reverse home mortgages because of my desire to be informed about how they work and whether they are good for Canadians. You mentioned that they are expensive programs for Canadians. Could you elaborate?
Mr. Pape: As I said, I have not been involved for many years in the company that provides such mortgages, so this is ancient history. I know that because they are considered long-term mortgages, nothing has to be repaid against the mortgage until the house is sold or the last surviving spouse dies. As is always the case in mortgages, the longer the term is, the higher the rate is that is charged. The company, Canadian Home Income Plan, has just set up a bank that is federally licensed called HomeEquity Bank, a subsidiary of HOMEQ Corporation. They say that because this is a deposit-taking institution, it will give them access to cheaper money that will enable them to charge less for the reverse mortgages by way of lower interest rates. I do not know whether this is a reality yet. I only know what I read in the press reports on this issue.
Senator Ringuette: Are they a federal chartered bank?
Mr. Pape: Yes. It is called HomeEquity Bank.
Senator Hervieux-Payette: I am curious about your example of two 30-year-old persons, one with $20,000 and one who has a house. When I retire, I will sell my house, move into a condo, make a down payment and make a new budget. After 30 years in the house, the interest rate is probably higher than the one you considered as generous at 5.6 per cent.
The way you presented the situation, putting money into an RRSP versus putting money into a house would be more favourable. In other words, if you have to make a choice, put it in an RRSP. Income-wise, the house is not taxable. Any profit you make when it sells is yours. Upon retirement, you start collecting money from RRSPs, which you add to your other sources of income. You pile it up at a certain point. You may have different sources and end up paying a greater amount of money. Did I understand you correctly? What exactly did you mean with the question about the two 30-year-olds who are in the process of deciding where to put their money?
Mr. Pape: Let me clarify. The point I am trying to make here is that we are diverting assets from RRSPs. One of the mandates that the committee is looking at is how to protect the assets in Tax-Free Savings Accounts and RRSPs. The point I am making here is this is a diversion of retirement savings assets. I am not saying that owning a house is a bad thing. I am saying that if we are saving for retirement in RRSPs, let us save for retirement and not go off at tangents.
The problem with the home is that we do not know what the real estate market will do. We have seen what happened in the United States. Some markets in Canada are not going up at 5.6 per cent a year. Some markets in Canada have been stagnant for many years, and other markets have boomed, Vancouver and Toronto, for example, Winnipeg and the Maritimes much less.
The other problem is the one we refer to all the time. Fine, you can build up your assets in your home, but what if you cannot use that money? You talked about selling the home and moving into a condo. Have you looked at the price of condos lately? They are not cheap. The point is that if you sell your home and take your profit from that, you may end up having to spend most of it to put back in the condo again. There is nothing certain about this.
There is nothing certain about the RRSP either. I am not suggesting that there is. I am simply going back to first principles. What is it we want the RRSP to do? We created the RRSPs way back in the time of John Diefenbaker to save for retirement. We then brought in other programs to do other things, and we have diverted so far something like $25 billion out of the RRSPs to do those things.
We have created another program called the Tax-Free Savings Account, and we are saying to people, "Save over here." They can save over there for a home and an education. Let us get the RRSP back on track. That is the only point I am trying to make, senator.
Senator Hervieux-Payette: I understood that, in order to avoid paying a lot of fees for the administration of a fund, you recommended an independent corporation that everyone could have access to, whether they are self-employed or working for a company that does not have a savings plan, in order to build a RRSP. However, if we look at the market right now, the way I see it, in the coming years and probably for a long time, even 5.6 per cent seems to be high. I do not think we will come back to the 20 or 15 per cent return, or 18 per cent. It was a bubble. It was artificial. From my recollection, when I took my courses, a company that was making 8 per cent profit a year was a great company. Nowadays, people look at that as a low return.
If we go back to basics, how do you expect this national organization to provide for a return for these people? The risk is important. What would you say would be the average return for people over a period of ten years?
Mr. Pape: The 5.61 per cent is the actual number for ten years to December 31, 2009 for the CPPIB. That is a real number. That came during a bad time. The numbers that I tend to use in my own personal estimates for people who are investing conservatively will tend to be 5 to 6 per cent. Obviously, it is great to shoot for 8 per cent, but you will have to take more risk in order to achieve that. Given what has happened over the past ten years, I do not think the 5.6 per cent that we saw the CPPIB achieve is an unrealistic target going forward.
Senator Massicotte: I totally agree with the suggestion of one of the experts that people's psychological behaviour is such that if they do it voluntarily and we do not incite them to get involved, they will not adhere. Do you agree? In other words, there should be automatic application, and you have to do something to get out of it.
Mr. Pape: I would not agree with that at all. I do not agree with anything that would be compulsory in this regard. The testimony you are referring to, at least as I recall it, was a little bit different. It was trying to encourage people to actually invest in the RRSPs.
I forget the actual numbers given to the committee, but I think it was in the order of $600 billion that exists in RRSPs now. A lot of money out there is being incompetently managed. My idea of a national plan would simply be designed to encourage people who are uncomfortable with the way their money is being handled now, whether they are doing it themselves or whatever, to opt into this pool of money. I do not think there would have to be a lot of incentive for people to do that. Many people would recognize the benefit of that immediately, and many group RRSPs would recognize the benefit of that. Where you would run into problems is the opposition from the financial services industry. That is a political issue, and I will let you people deal with that.
The Chair: Thank you for appearing before us today, Mr. Pape. It has been worthwhile. I hope you have enjoyed it as much as we have.
Mr. Pape: I have. Thank you very much for the opportunity.
The Chair: We look forward to seeing you back before us at a future time.
Before I introduce our next witness, we have a document here from the witness that is in English only. May I have your permission — it needs to be unanimous — to distribute this to the committee?
Hon. Senators: Agreed.
The Chair: Colleagues, we are pleased to welcome back one of our familiar witnesses. I hope you feel at home, Mr. Dodge. It is nice to have you back. There is something missing, and I finally realized what it was, the horde of reporters and photographers from your previous life. I do not know why you have gone downhill so far and so fast. However, in our estimation you have not budged at all. You are right at the top of the hill and we appreciate your taking the time to come before us and offer your opinions on the matters of RRSPs and TFSAs.
In his new life, Mr. Dodge is currently senior adviser with Bennett Jones, Chair of the Board of Directors of the C.D. Howe Institute, and Chancellor of Queen's University, which some of you will have heard of. You can see there are lots of admirers in the room.
Welcome back, Mr. Dodge, and please proceed.
[Translation]
David Dodge, Senior Advisor for Bennet Jones LLP, Chancellor of Queen's University, as an individual: Thank you, Mr. Chair. Senators, you have already heard several witnesses who have far more expertise in this area than I do. I am not sure whether I can be of further assistance to you. Nevertheless, I will try to answer your questions to the best of my knowledge.
I would like to begin with a few general and brief comments to get the discussion going. I will keep in mind that your mandate is to consider not only the extent to which Canadians make use of tax-free savings accounts and registered retirement savings plans, but also federal provisions that could be adopted to increase retirement savings, taking into account the fiscal costs of such provisions.
My introduction will touch on five points.
First, while the third pillar of our retirement savings system may be underutilized, it is nonetheless very useful, even though there is no doubt room for improvement.
Second, Canadians have to rein in their consumption significantly while they are working if they wish to maintain a high level of consumption once they retire. In other words, they need to save rather than consume a relatively high percentage of their earnings during their working lives. In addition, the current earnings percentages that must be saved for post- retirement income to amount to a certain proportion of pre-retirement earnings increase significantly in relation to income level.
The report I drafted for C.D. Howe provides estimates of corresponding percentages. You can find that information in Table 1.
Third, Canadian middle or upper-middle income earners are not saving enough, on average, to ensure a 50 per cent or 60 per cent replacement rate for their pre-retirement income — and far less than the 70 per cent gold standard.
It goes without saying that preferences and needs with regards to replacement rates vary according to the individual. There is no definite standard when it comes to the targeted replacement rate, or when it comes to the age at which to retire. In other words, there is no "right" savings ratio.
[English]
While there is no right savings ratio, the RRSP limit of 18 per cent of earnings currently eligible for deferred tax treatment is roughly adequate, or in fact more than adequate, for all those except those in the top 4 per cent or 5 per cent of earned income. Again, you can see on table 1 how that works.
Others who have appeared before you have argued that the maximum earnings limit should be increased, and I would not necessarily disagree with that. However, I think the 18 per cent annual earnings limit, with carry forward of unused room, as Gordon Pape just mentioned, seems roughly appropriate.
Let us remember that this regime was put in place back in the late 1950s and then revised in the early 1970s, to try to allow people to do for themselves what they were doing in defined benefit plans. It was supposed to be roughly equivalent.
Now let me make two final points, because I think these are the ones that the committee may really want to focus in on. While there is no right savings ratio, it is important that people have access to investment vehicles that provide reasonable risk adjusted net returns on their savings during their working years — and that is what you were just talking about with Mr. Pape — but also access to appropriate annuity or other vehicles that provide a lifetime stream of income post-retirement.
I hope we come back to this, Mr. Chair, because I think in many ways our bigger problems lie not in the accumulation process but in the vehicles people have to draw down.
Arguably, the most serious problem with our current RRSP system is that there is a dearth of easily accessible and efficient investment vehicles for individuals and, even worse, a lack of efficient or low-cost annuity vehicles for individuals.
Outside of employer sponsored defined benefit or hybrid plans, there do not exist efficient ways for individuals to deal with the risk of retiring at the wrong time, i.e. when asset prices are depressed or interest rates well below their long-term trend.
In theory, individuals could purchase deferred annuities every year as they go along inside an RRSP, but such products at the retail level come at an extraordinarily high cost. Practically speaking, the main option open to those with RRSPs, or in fact in most DC pension plans, in a period when returns are very low or asset prices are depressed, is simply to delay retirement and wait for interest rates and asset prices to recover.
Of course, some individuals are lucky and they retire at the right time with a lot more assets than they ever thought they would. However, the big problem then is the issue of risk sharing. For the ordinary individual in an RRSP, or indeed even in a DC pension plan, it is very important to find some ways to mitigate this risk of where you will end up, where you actually are in the cycle at the time you are retiring. That, of course, was the great benefit of the DB plans that we had. That risk got mitigated and spread backward and forward across employees, but then unfortunately ultimately rested on the sponsor. However, it was an important element, the risk sharing element, one that I do not think witnesses have paid as much attention to as they might have.
Those are my opening remarks. I am really here to try to answer any questions you may have.
The Chair: Thank you very much, Mr. Dodge. As usual, it was helpful and clear. Can I abuse my position by asking, since you referred to Mr. Pape's testimony, what did you think of his idea of a national voluntary RRSP program?
Mr. Dodge: Absolutely correctly it is trying to address the existing investment efficiency problem. You might go to that sort of partial solution only because, I agree with Mr. Pape 100 per cent, these are voluntary plans. You could also create some sort of hybrid vehicle that does some of the risk mitigation that I talked about, which would be an add-on to the CPP perhaps. Those are nice issues to debate — nice in a dictionary sense of the word "nice." The fundamental issue is that the individual buying the investment management services, the annuity services or the disposition services at retail faces an enormous cost. The individual must put aside much more than would be the case if he or she were in a group arrangement, whether it is Mr. Pape's suggestion or some other.
Senator St. Germain: Mr. Dodge, it is always a pleasure to see you.
Mr. Pape and others have said that there should be no timetable for the withdrawal of RRSPs, versus the 71 years of age when we have to go to a RRIF. He suggested eliminating the RRIF. At 73 years of age, I am looking at that.
Mr. Dodge: I will answer that on the basis of principles because it is difficult to say, whether it is 70, 71 or 72 years of age. What is the real principle? The principle when we created this vehicle was to create something that would enable individuals who were not part of company pension plans or a public service pension plan, something to achieve what could be achieved in that sort of plan. What were those original plans? Essentially, they were deferred income plans. Back in the 1920s and 1930s, you deferred part of your income while you were working, and it was paid to you either by the good graces of the company or otherwise. We put that together in registered plans later on. It was essentially to spread your income over your lifetime. That was the whole idea.
The RRSP as it was conceived and then when Mr. Benson rewrote the tax law in 1969-70 and finally passed in 1971 was seen as a parallel stream. We were very careful in 1975-76 when we redid some of that to try to ensure that it balanced so that no one could double dip. We introduced this idea of a PA so that you could not both get a defined benefit pension and an RRSP. That was the idea. If that is your fundamental concept, then the idea would be that it was paid out over your life however long you lived. Of course, in a defined benefit plan, it was paid out as an annuity. Indeed, you can take an annuity out of your RRSP. The great problem is that you approach the insurance company as an individual rather than as a group. The insurance company has an adverse selection problem, so they charge you a whack of money for it.
Essentially, the idea was to produce an annuity that would live through your lifetime with some sort of spousal benefit after you died. In that context, having an age at which you begin to run this out makes absolute sense. We picked the age of 71. We moved it back to the age of 69 for a few years but we moved it back to 71. I cannot tell you whether that is the appropriate age but conceptually, it is the right thing to do.
Senator St. Germain: How have these low interest rates of 0.25 per cent on savings impacted seniors? They have to spend their principle. We have many people in that category.
Mr. Dodge: I do not know the answer to that question. Obviously, if people had, as Mr. Hamilton recommended, a nicely structured bond portfolio, and some of those bonds were running off every year, certainly the reinvestment would not be at the same rate as the ones that were running off. That is undoubtedly correct.
The bigger problem is for people who are just heading into retirement or would like to retire. These very low interest rates mean that annuity costs are out of sight. First, it is very expensive to buy an annuity today. Second, it has tempted people to go more heavily into equity than they otherwise would do.
When you are at this point in the interest rate cycle, and there are long cycles, you certainly can be caught in a very disadvantageous position.
Senator Harb: Mr. Dodge, going over the paper published by the C.D. Howe Institute, one cannot resist pointing to the fact that there is a small glaring conclusion toward the end where two things pop up. First, the institute and you conclude that there is a need for a vehicle for people to invest their savings. You alluded to that in your remarks. Second, you say in the paper that it is a trade-off when it comes to savings: You can have either less quality in your life now with less money as a consumer and to support yourself and your family so that you can save it to have a better quality of life later; or have less later. You put it on the table for discussion.
British Columbia seems to be embarking on a provincial system whereby they will allow individuals, self-employed or otherwise, to subscribe to such a system that is managed province wide. Do you think that could be a suitable vehicle for the Government of Canada? Should Canadians embrace this approach should the study case in British Columbia prove to be good?
Mr. Dodge: There are two issues. One is the accumulation phase and the other is the exit phase. A vehicle that allows the purchase of an annuity at the end at group rates using population life tables, as opposed to what an insurance company would charge an individual, would be a tremendous help. It is not just the accumulation phase; it is to put something on the exit phase.
I am not blaming insurance companies here. My father worked for Canada Life, and I remember him telling me that the one principle he lived by was that annuitants lived forever and those who buy life insurance die right away. Every insurance company has to take that behavioural thing into account.
Getting into groups is enormously helpful, not only in terms of better management of the assets during accumulation but in allowing for a reasonable cost way to exit. For many people, although not all, annuities, however boring they may seem, are absolutely the right way to exit, because then you do protect yourself for life.
Senator Harb: One of the witnesses said that there is no pension crisis here, and what we have is an economic crisis, a situation where we have a mess, and it happened that much of the money in pension funds and RRSPs and so on got caught up in the economic downturn. Do you agree with that?
Mr. Dodge: I hesitate to use the word "crisis" when there is no real crisis. We have a problem, but it is a well-known problem. Over time, we can look at these cycles, and we have been through several of them since the Second World War. There are periods when interest rates are very low, and there are other periods when they are very high. Whether those are nominal or real, that applies.
When we are talking about people saving for retirement and pensions, we are talking in terms of several decades. An individual, from the time he or she starts working to the time he or she finally dies, will probably go through three or four of these cycles. It is very difficult in the RRSP context or in the defined contribution pension plan context, but we have to try to smooth through these cycles. The accountants and the actuaries, in particular the accounting standards bodies, have made things incredibly worse for us all in doing that. Nevertheless, this is what we know we will face, at least from any history that I have seen, certainly going back well into the 19th century. We do need to think about ways that we can work through that because, quite rightly, the average workers and the above average workers essentially are risk averse, and you really need some way to reasonably distribute the risks.
Senator Massicotte: Mr. Dodge, let me thank you on behalf of all Canadians for remaining involved in public policy and contributing to these issues. We all benefit, and the country owes you a debt for your contribution. It is always appreciated.
Let me get your thoughts on DB and DC, defined benefit and defined contribution. We know that two-thirds of all private enterprise does not have a pension plan and, for those who do, the strong tendency in the last several years is to define contribution and not to define benefit. I would like to hear you thoughts on that. It certainly has influence on the retiree's income security. Does it have significance for us as a country as far as socio-economic certainty, savings rates and long-term infrastructure investments? If it is important, should we be doing something to encourage defined benefit plans? When you have a surplus, there is a debate in court about who that surplus belongs to. Is it is a big issue, and, if so, what should we do to encourage defined benefit programs?
Mr. Dodge: We are a little bit off topic here, but the real issue we are talking about is how we somehow share the risks. The defined benefit program, as originally conceived, actually did that. We now have what we might call hybrid plans, which have large elements of defined benefit but some better element of risk sharing vis-à-vis the sponsors. I am one of the last people around who thinks this is a good idea and benefits workers and, in fact, benefits employers as well.
Let me address it from two points. With respect to the first question you asked and why we got into this issue at all at the Bank of Canada, what does it mean for the efficiency of our capital markets when we do not have pension plans that want to invest in these long-lived assets because they have long-dated liabilities, infrastructure being one, even though the actual market price of those assets may be volatile through time? That really does not matter to them. They know they will have obligations in 40 years, not next year. It seemed to us that there was tremendous benefit in a pension fund system that would take on these sorts of assets and that would improve the functioning of capital markets.
To the extent that we do our accounting on a minute-by-minute basis almost — it seems like that if you are trying to manage a pension year by year — and we market to market make belief every time we go, we create a notional surplus or deficit and then we get all fussed about it. If we create a surplus, we say the tax law says you cannot make any more contributions and have them tax effective. If we create a tax deficit, then you have to pay it all up very quickly. It discourages the very capital market efficiency you would like. That is a different issue than what you are discussing here, but I think it is an important one. We are discussing here whether there is some way within the individual savings system, the RRSP system, that we can develop vehicles to manage those savings efficiently during life and allow you to exit in an efficient way when you retire. In that way, you deal in part with some of these risk elements there and make it very difficult.
Senator Massicotte: I understand Australia developed a program whereby there is automatic enrolment, but everyone has the right to withdraw. The notion is that you must nudge people along with their savings, because they may be financially illiterate or the cost is too complicated, and therefore we should develop a program in Canada patterned on the Australian example where everyone is sort of nudged along. What would be your thoughts on that kind of a program?
Mr. Dodge: I think there is ample evidence, not just in this area but in many areas, that if you put people into something, whether it is a magazine subscription or a cable subscription for your television, where you are automatically re-enrolled rather than having to re-enroll ourselves, that it has a tremendous impact on people's behaviour. There is a lot of evidence that nudging does increase the participation rates in whatever area. Whether that is good or bad is a matter for debate.
I am pretty much a "volunteerist" here and would say that you should really sign up so you know what you are signing up to in the first place, but I do not think there is any question that the evidence would suggest that the nudge really does work.
Senator Greene: I would like to ask about where the 70 per cent replacement rate comes from. We had a very strong presenter last week who argued on behalf of 50 per cent, assuming your house is paid off and you have no children at home. It strikes me that this issue is important for us to consider because if it is 70 per cent that we have to aim towards, then we have to be a lot more creative in our solutions than we would be if we only had 50 per cent.
I would like to know where the 70 per cent comes from and what is behind that.
Mr. Dodge: That number, like beauty, is a bit in the eye of the beholder, but it is adequate. Historically, it was determined that 70 per cent was what you would need to survive on if you were coming out of a factory job. Remember, at that point in time there was no CPP, there was no Old Age Security; you were on your own.
I think that so-called 70 per cent gold standard is kind of entrenched in a lot of history. I do not think there is a right number, and that is what I said in my opening remarks. On the other hand, I think Malcolm Hamilton overstates his case that everyone can make out on 50 per cent. It goes back a little bit to what you were discussing earlier as to whether you can actually liquidate and free up your assets in your house. There is a feeling that when you retire you do not need as much housing. My experience is once you retire you need more because it is not just your kids; it is their children and their spouses and so on that come and fill up the place. The idea of liquidation or monetization is not all that clear. That is to say no one needs more than 50 per cent; I just do not think that is right. Remember, there are a lot of people who never own.
Therefore, I do not think there is a right number. That is why we were quite careful in our paper to say that is a gold standard, and 60 per cent is a silver standard. You are certainly still on the podium. Maybe you are a little step down but certainly still on the podium. For higher income people maybe 50 per cent would be fine. You have a choice about what you want to do when you retire, whether you want to travel because you could not when you were working or because the kids were there; or is it the exact opposite, when you retire you will be happy to sit on your porch in a rocking chair. This is an individual choice. There is no right number.
Senator Ringuette: It is always a pleasure to have you in front of us, although this time for a different issue.
There is a constant theme that we have heard from all the experts in the fact that there is an excessive fee with regard to retirement investment on the retail side, and you have said so yourself.
When I questioned the life and health insurance association, I looked for an average number as to what that investment fee is, and they said it was roughly 3 per cent plus compounded. If you look at an investment at 3 per cent on a yearly basis, your first year of investment by the time you are at year 20, that first year of capital investment is gone because of the investment fees. You say there is another fee that you have to look at, which is the withdrawal, the annuity fee. To your knowledge, what kind of fee is it and how is it based?
Mr. Dodge: Selling individual annuities by an insurance company is a tricky proposition for the reason I just said, that by and large the person who comes to buy the annuity is someone who thinks they will live a long time. If you do not think you will live very long, you do not buy an annuity. When dealing with individuals, they have a real risk and the fees are very high.
Senator Ringuette: Such as?
Mr. Dodge: It comes out in terms of how much you have to pay for $1,000 of lifetime income. A wholesale rate may be something like, at age 65 for a man with a spouse, $12,000 or $13,000 per thousand dollars of income. At the retail level, it might be $17,000 or $18,000 to buy that stream of income. It is quite a big difference.
This is not a knock on the insurance companies. It is a question of putting together a group, and that group has to have enough diversity in it that you can actually get something that can be modelled against a group longevity experience.
There are a number of smaller plans that have exactly the same problem. We are finding, for example, that teachers live a lot longer than the life expectancy in the plan when it was originally set up. We are finding that Queen's University professors live a lot longer after they retire than we thought they would. Groups can get into trouble as well, but you can manage that in some way, shape or form over time. However, for an individual it is very tough.
This goes back a bit to what Mr. Pape was talking about but in a different context: You do need some collectivity here that helps you keep down the costs of management during accumulation and allows you to get the benefit of the group. You are sharing the risk across the group on retirement.
Senator Moore: Mr. Dodge, it is kind of unusual to have you here without your able winger, Deputy Governor Paul Jenkins. We miss him as well.
I want to ask you about your last couple of points in your remarks, when you said there are not sufficient ways for people to efficiently save for their retirement, especially if they retire at the wrong time, such as the current market reduction we are still going through to some extent.
Last week one of the witnesses said there should be some flexibility such that one's RRSP room could be increased so you could contribute more to make up that loss that you might have suffered during of the recent reduction in the market value of your assets.
Do you have any thoughts or ideas with regard to that point?
Mr. Dodge: That is tricky. We know that these cycles will occur. You cannot come along and say: Gee, poor Buggins; he hit the wrong time so we will do a special deal for him, unless you are willing to say at exactly the same time to Joe, who hit it good, that you will take a slice off the top from him. That, of course, is what these big group defined benefit plans do. However, I would not like to be the minister who was in charge of doing that on an individual basis.
Senator Moore: You mentioned that there are not sufficient ways to save for retirement. Do you have any ideas for us? You said that annuities are expensive so it is not feasible for individuals.
Mr. Dodge: You have heard ideas about different types of collective arrangements that might go forward. Any one of them would be an advance over where we are, whether it is the one Gordon Pape talked about or the type of thing that Keith Ambachtsheer talked about when he appeared before the committee. There are numerous ways of doing this. As an individual, you give up some freedom in doing it, but that is not necessarily bad.
Senator Moore: You are spreading the risk.
Mr. Dodge: You are spreading the risk, exactly. However, you need broad-based collectives in one way or another. You could have one broad plan for everyone in the manufacturing industry that they might buy into, but you need a big chunk or one in a province or one like Keith Ambachtsheer's idea.
Senator Moore: When you say a big chunk, are you talking about a collective of a minimum of 100,000 individuals? What is your thinking?
Mr. Dodge: You would need at least that number, in looking at the big plans that have done reasonably well. CN has run a good plan over a number of years. I am not sure that it is quite the numbers mentioned, but the larger the group, the more you can spread the risk.
[Translation]
Senator Hervieux-Payette: Mr. Dodge, welcome. It is good to see you again.
There are two prevailing schools of thought on the issue. Some people believe that the 50 per cent replacement rate is adequate, while others favour the 70 per cent replacement rate. Choosing the one we hold to depends on what we consider to be "our retirement savings." However, the average age of Canadians is increasing rather quickly from one decade to the next. If we have to start withdrawing 7.5 per cent of our savings from the age of 71, I think the money would run out pretty quickly.
I have made some quick calculations. If we withdraw the equivalent of 7.5 per cent every year, we would have very little remaining at age 82 or 83. Keep in mind that, according to the statistics, women live longer.
When should we start considering withdrawing 5 per cent instead of 7.5 per cent, or having the option to begin withdrawing 5 per cent? If we have other sources of income, there is no problem. However, savings might be our only source of income. If we wish to remain in our house, but are forced to keep withdrawing 7.5 per cent, I feel that we might end up very poor at age 85.
Do you think that the 7.5 per cent withdrawal requirement is crucial? Is it a rule from which we cannot deviate? What would be the disadvantages of being able to choose between 5 per cent and 7 per cent?
If, starting at 71 years of age, I only want to withdraw 5 per cent of my RRSPs because I do not need more and hope to live to be a 100, but I do not want to be poor in the last years of my life, would it be possible to withdraw that percentage? The situation I just described might seem hypothetical, but we visit homes for the aged where we come across situations like that. Naturally, residents pay monthly fees. One day, they may no longer be able to afford to live in their current home. Also, they may not have the option of moving to a more affordable seniors residence. They will have to move, and at 85 years of age, that is not an easy thing to do. This is the reality we see when we visit places in our constituency. We may be senators, but we still make the rounds in our constituencies.
These criteria do not seem to fit every one's needs. Why not make them flexible? We could set a floor and a ceiling. In any case, sooner or later, we will have to pay taxes. Is there a rule that says that we must withdraw 7.5 per cent from our RRSPs starting from the age of 71?
Mr. Dodge: I will answer in English because the question is rather complex.
[English]
It goes back to what I said earlier. The original concept was to have a life annuity that would live as long as the annuitant and would take care of his or her spouse after the death of the annuitant at a pre-determined fraction of the rate afterwards. However, for individuals this is not an efficient way, so we invented something as a substitute called the Registered Retirement Income Fund. At the time, we said that we should try to make it parallel the annuity as closely as possible.
Obviously, it is not as good as an annuity. With an annuity, you have laid off the risk — because you paid for it — of when you will die. Should we change these rules for RRIFs? I think you can certainly make an argument. You are taking it farther and farther away from what we tried to create, and perhaps we should do that. My preference would be to try to find ways for people to annuitize their asset accumulation in an efficient way. That is how you protect yourself against the likelihood that you or your spouse will live longer than the 40 years or so when you retire.
However, I do not think there is an easy way to deal with it in the RRIF context because it contains no risk sharing.
[Translation]
Senator Hervieux-Payette: So, we would put this amount in a fund and we would be guaranteed equal payments for the rest of our life, until the age of 100. Is that what you are saying?
When the money is in the RRSP and we administer our plan, we have to withdraw 7.5 per cent automatically in the first year of our retirement, and then continue doing so every year. After 12 or 13 years, the money has run out.
[English]
Mr. Dodge: The principle, and it is important to understand, is there because we tried to approximate, however imperfectly, what an annuity stream would look like. It was not because the government wanted its money back or anything like that. We were trying to have all of these vehicles do approximately the same thing. It is hard, because some are far better than others in actually accomplishing that.
Senator Hervieux-Payette: You have not resolved my problem. I will be poor at 85.
The Chair: There is one way to solve the problem, but you will not like the solution, so I will not mention it.
Mr. Dodge: When you withdraw, it does not necessarily mean that you have to spend it that year. Relatively few of us though will be lucky enough to have that flexibility, because for many people this is it in terms of their private savings.
Senator Murray: Mr. Dodge, I was curious to know what you think, as a matter of both fiscal policy and social policy, of Gordon Pape's suggestion that, while the withdrawals from RRSP ought to be taxable, the income should not count against Guaranteed Income Supplement and other income-tested benefits. Second, his more serious suggestion, if I understood correctly, was that there should be no limits on our contributions to our RRSP. As a former Deputy Minister of Finance, are you horrified by that and, if so, how horrified?
Mr. Dodge: As someone who has been brought up in the Department of Finance, I beg to differ.
These are two interesting questions, and they are quite different. Maybe it is a matter of getting old that I have lived through the history of creation of much of this stuff.
The Chair: The problem is that you remember as well.
Mr. Dodge: Back in 1965, we created the CPP and put in place the modern version of the GIS. From reading Hansard as to what was said then, we had all these veterans that did not have a chance to create much wealth, so we gave them a good deal in these early years of the CPP. However, others would not benefit from that, so we created this Guaranteed Income Supplement program to try to deal with what was at the time a fairly severe elderly poverty issue in this country. The hope was that, over time, as the CPP matured and people would have accumulated CPP benefits, the GIS would kind of begin to wither away. That was the plan at the time, because we would have a CPP benefit which, for the average worker would be much higher than the GIS, and it would be appropriate. The average worker then would have all these years ahead, not having gone through the war, to actually make contributions and build it up. The hope was, back in the 1960s when the programs were created, that in fact, over time, the GIS would go away. Indeed, those two programs were tremendously successful in solving the elderly problem in this country. The OAS, CPP and GIS system has done precisely the job that was envisaged it would do back in the 1960s.
At the same time, we always thought of pensions as deferred income. It was just income, like any other type of earnings, but income that had been deferred from the time you were on the job. You were taking it later in life, and of course it counted as income, just as we count pension income as income for purposes of the GIS today. You may want to change the whole set-up but, on a principle basis, we are doing exactly the right thing in counting the withdrawals from the RRSP as income. Indeed it does reduce the entitlement for credits at the bottom end. We may want to change that, but it is exactly the right thing to be doing, at least in principle. If we start to change it, we will dramatically change the entire old-age system. When you start tampering with the first pillar, you have to be careful as to where you end up. That is not to say do not do it, but you have to understand that there is a logic behind where the situation is now.
Would you remind me of your second point?
Senator Murray: No limit on contributions.
Mr. Dodge: The whole purpose here is, going back to Senator Greene's question, was to try to find something that would allow people to approximate what you could do in a good corporate pension plan, and 18 per cent of income may not be exactly right. Maybe it should be 19. It moves around depending on where interest rates are. It was created by a funny idea we had about the rule of 9s and so on. It turns out, though, if you look at the table, that it is not all that bad. It kind of does its job, and you can accumulate and carry forward. The carry-forward addition to the program was an extraordinarily important and valuable change.
If what we are trying to do here in the RRSP is to provide an alternative to a corporate pension, then I think the 18 per cent limit is good. You do not make it unlimited. It accumulates through time, and it relates to your earnings. It is doing what it is supposed to do.
A couple of people who have appeared before you have raised the issue of whether the effective limit, which is roughly $120,000 worth of income, is too low. It is awful to remember history, but when we started this, again coming out of the 1972 tax act and revisions we made in 1975 and 1976, we were at about five times average earnings. That is about where the limit hit. You could contribute roughly 18 per cent, which was about five times what was then the average earnings. We then froze that limit for a long period of time, and it went down and down and got to just a little over two times the average earnings. We have let it come up a little bit since.
There is some reasonable rationale to going farther up the income scale than where we are now, which is about 2.7 or 2.8 times average earnings. That would be a fairly straightforward thing to do. For many of our professional and technical people, the kind of people in the top 15 per cent but not the top 3 or 4 per cent of income distribution, that would be quite valuable, because they do end up at some point in their career where they may have a few years in which they actually make a couple hundred thousand dollars. The average earnings would not be there, but they may have a few years at that level. To me, that would be consistent with all the principles. It is a political choice as to how far up, but I would be in accord with going farther up.
The Chair: Thank you, colleagues, and thank you, Mr. Dodge. We appreciated, as always, your wisdom. With your institutional memory, you are a national asset. Some of us lived through it but do not have your memory. Others have not lived through it and like to invent history. You, fortunately, combine both the memory and the experience. It is so important, as you have stressed, to give some context and to know how we got to where we are. You have drawn our attention to that very well this evening, and we appreciate it.
We will adjourn now until tomorrow morning at 10:30.
(The committee adjourned.)