It may seem a little crazy — perhaps even absurd. But the time has come to give individuals the ability to actually use, in whatever form, all their unused RRSP room. And it’s not only “Joe Canadian” who can profit from this novel approach to investing. The Canadian government can also jump on-board and cash in.
As background, the amount of money that individuals across Canada have contributed towards their RRSPs dropped in 1999, and is expected to continue to drop in 2000. The reason is obvious to average employees across the country: those who have RRSP room do not have money to save, and those who do have substantial disposable income to stash away for a rainy day do not have enough room to do so.
Well, it’s time for everyone across Canada to capitalize on this available space, and one idea to help move this along would be to develop a market in unused RRSP room. Simply put, it’s time to buy and sell.
Here is how the idea would work: individuals could sell their unused RRSP room — actually give it to others who need the extra space. This would be fantastic for poor people, as they could essentially cash in on something that is currently worthless for them. The idea is wonderful for people who have little or no RRSP room, as they can shelter more savings for retirement. It appears to be a win-win situation, except for one possible loser — the government. Sometimes it appears that Canada’s federal command centre gives away RRSP room for free because it knows many people are unable to make adequate use of it.
But don’t despair, there is a way for the government to get the most out of this new method of investing as well. The sale proceeds of the unused RRSP room would be fully taxable, while RRSP deductions that have been purchased (as opposed to those earned in the traditional way) would be a credit rather than an allowance. With this approach, the tax relief is at the lowest marginal rate, as opposed to the highest rate. The pot would become sweeter for the government because RRSP outflows taking place from these contributions would be taxed at a higher rate.
At the outset, it does not make sense that anyone would want to get tax relief at the lower rate and be taxed at the higher rate. This is where the beauty of the new investment opportunity comes into play — in essence, the market will actually determine a price at which this exchange is beneficial.
Suppose you wished to invest $1,000 over a 20-year period and expect to earn seven per cent. If the marginal tax rate during that period is 50 per cent, you end up with about $1,990. If you could tax shelter this money, you would of course be much better off. In fact, assuming your tax rate at the end of the period is 40 per cent, you would only need $857, or $643 after the tax refund at the lowest marginal rate, with a combined federal and provincial tax rate of 25 per cent.
This means you could pay up to $357 — that is $1,000 minus $643 or the RRSP room — and still come out ahead. So if the market settled at, for example, a price of 25 per cent of the unused RRSP room, the seller would get a good price, while the buyer would be at least 10 per cent ahead on his investment.
The government is out in the short-term, but gains in the long-run because the seller gives up some RRSP room he might otherwise have used, while the buyer is taxed at a higher rate when he cashes in.
To sum up the idea, implementing a “buy-and-trade” model would provide additional income for the working poor, who in most cases don’t have the opportunity to contribute to retirement savings. As well, there is increased tax-sheltered retirement savings room available for those currently held back by the RRSP limits. Perhaps even more importantly, the idea can be implemented at little or no revenue loss to the government in the long-run.
Sound too good to be true — maybe even a bit unrealistic? At this point, perhaps. However, it’s not the first time this “sell what you can’t use” idea has been talked about. In fact, international organizations, including the World Bank, have implemented similar ideas to address pollution problems — and it works. Pollution has been reduced overall and poor countries receive funds they would otherwise not get. The question of whether anyone would actually develop a method this revolutionary is perhaps a moot point.
However, by presenting and discussing these types of ideas, Canadians can build awareness, debate and dialogue on the effectiveness of these programs.
Michael Cohen is a retirement consultant in the Ottawa office of William M. Mercer. He can be reached at [email protected].
As background, the amount of money that individuals across Canada have contributed towards their RRSPs dropped in 1999, and is expected to continue to drop in 2000. The reason is obvious to average employees across the country: those who have RRSP room do not have money to save, and those who do have substantial disposable income to stash away for a rainy day do not have enough room to do so.
Well, it’s time for everyone across Canada to capitalize on this available space, and one idea to help move this along would be to develop a market in unused RRSP room. Simply put, it’s time to buy and sell.
Here is how the idea would work: individuals could sell their unused RRSP room — actually give it to others who need the extra space. This would be fantastic for poor people, as they could essentially cash in on something that is currently worthless for them. The idea is wonderful for people who have little or no RRSP room, as they can shelter more savings for retirement. It appears to be a win-win situation, except for one possible loser — the government. Sometimes it appears that Canada’s federal command centre gives away RRSP room for free because it knows many people are unable to make adequate use of it.
But don’t despair, there is a way for the government to get the most out of this new method of investing as well. The sale proceeds of the unused RRSP room would be fully taxable, while RRSP deductions that have been purchased (as opposed to those earned in the traditional way) would be a credit rather than an allowance. With this approach, the tax relief is at the lowest marginal rate, as opposed to the highest rate. The pot would become sweeter for the government because RRSP outflows taking place from these contributions would be taxed at a higher rate.
At the outset, it does not make sense that anyone would want to get tax relief at the lower rate and be taxed at the higher rate. This is where the beauty of the new investment opportunity comes into play — in essence, the market will actually determine a price at which this exchange is beneficial.
Suppose you wished to invest $1,000 over a 20-year period and expect to earn seven per cent. If the marginal tax rate during that period is 50 per cent, you end up with about $1,990. If you could tax shelter this money, you would of course be much better off. In fact, assuming your tax rate at the end of the period is 40 per cent, you would only need $857, or $643 after the tax refund at the lowest marginal rate, with a combined federal and provincial tax rate of 25 per cent.
This means you could pay up to $357 — that is $1,000 minus $643 or the RRSP room — and still come out ahead. So if the market settled at, for example, a price of 25 per cent of the unused RRSP room, the seller would get a good price, while the buyer would be at least 10 per cent ahead on his investment.
The government is out in the short-term, but gains in the long-run because the seller gives up some RRSP room he might otherwise have used, while the buyer is taxed at a higher rate when he cashes in.
To sum up the idea, implementing a “buy-and-trade” model would provide additional income for the working poor, who in most cases don’t have the opportunity to contribute to retirement savings. As well, there is increased tax-sheltered retirement savings room available for those currently held back by the RRSP limits. Perhaps even more importantly, the idea can be implemented at little or no revenue loss to the government in the long-run.
Sound too good to be true — maybe even a bit unrealistic? At this point, perhaps. However, it’s not the first time this “sell what you can’t use” idea has been talked about. In fact, international organizations, including the World Bank, have implemented similar ideas to address pollution problems — and it works. Pollution has been reduced overall and poor countries receive funds they would otherwise not get. The question of whether anyone would actually develop a method this revolutionary is perhaps a moot point.
However, by presenting and discussing these types of ideas, Canadians can build awareness, debate and dialogue on the effectiveness of these programs.
Michael Cohen is a retirement consultant in the Ottawa office of William M. Mercer. He can be reached at [email protected].
