February 1998

Seniors Benefit Decreases
RRSP Income 27% to 40%, Part 2

© Talbot Stevens

This is the continuation of last month's Strategy Sheet highlighting my recent research on how the proposed Seniors Benefit (SB) legislation will decrease most Canadians' after-tax income from RRSPs 27% to 40%.

Any single senior who will have total income, not including the SB, of $26,000 to $52,000, will instead find their tax rate after 65 effectively increase 20%. For couples, total combined family incomes of $26,000 to $78,000 will be affected.

Referring to last month's table, anyone facing the 20% SB clawback who was expecting to retire in the same tax bracket is in for a sorry surprise.

Consider someone expecting to stay in the same 40% tax bracket after they retire at age 65. Under the current OAS system, the after-tax income (ATI) from RRSPs that would last 20 years is $16,150. See last month's Strategy Sheet for assumptions used to calculate the ATI.

However, under the proposed SB system, the individual hoping to retire in a 40% tax bracket will really face a 60% bracket. The after-tax income from their RRSPs that can last 20 years now shrinks to $10,750 a year — a decrease of 33%.

For those expecting to retire in the same 27% tax bracket, their ATI from RRSPs decreases 27%. For those expecting to retire in the lower end of the top 50% tax bracket, their ATI from RRSPs drops 40%.

The SB clawback also hurts those hoping to benefit from withdrawing their RRSP funds at a lower tax rate after retirement.

Separate analysis shows that those affected by the 20% SB clawback who would drop to a lower bracket after retiring, will find their ATI from RRSPs also drops by 27% to 33%.

Note that none of this analysis includes the minor tax increase that results from the loss of the age and pension income credits, which everyone will lose regardless of income.

Since the average RRSP contribution for the last two years was over $4,200, the table gives a good idea of the after-tax retirement income that RRSPs could produce if you started today with nothing and invested $4,000 a year for 20 years.

The good news from this analysis is that it is a vivid illustration of the magic of compounding and tax-deferred growth.

If you could stay in the middle 40% tax bracket, investing $4,000 a year for 20 years inside an RRSP growing at 10% would allow you to later draw $16,150 a year of after-tax income for 20 years — four times as much.

For most Canadians, the 20% SB clawback increases their total tax rates 50% to 74% after age 65. The impact on RRSPs from this “hidden” tax, is a decrease in RRSP after-tax income of about 30% or more.

In my opinion, this change is too much, too fast, and one more reason for all concerned to lobby the government to exempt RRSPs from the SB clawbacks.

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