March 2001

Tax-Prepaid Savings Plans
Generally Better Than RRSPs

© Talbot Stevens

RRSPs are one of the best strategies for Canadians to save for retirement.

But a new study by the C.D. Howe Institute recommends the creation of Tax-Prepaid Savings Plans, or TPSPs, which are even better for many investors.

The concept behind TPSPs is borrowed from similar plans in the United States and England. The U.S. equivalent of our RRSPs is the IRA, or Individual Retirement Account. Like RRSPs, these plans allow tax-deductible contributions to grow tax-free until withdrawn when they are taxed.

In 1997, the U.S. introduced the Roth IRA. Contributions to a Roth IRA are not tax deductible, but withdrawals are tax-free. The proposed TPSPs would operate in the same way, allowing tax-free growth and withdrawals, but no tax deductions.

While investors desperate for tax relief might not value trading immediate tax savings for tax-free withdrawals, a closer look at the numbers shows how most investors will benefit from the new approach.

Readers of my new booklet Dispelling the Myths of Borrowing to Invest know that there are at least 5 different RRSP refund strategies.

How RRSP refunds are used is an overlooked behavioural parameter that has a significant impact on how much retirement income RRSPs produce.

Consider Rob, in the 40% tax bracket, who like most Canadians, spends his RRSP refunds. Investing $1,000 in an RRSP produces a $400 refund that reduces the after-tax cost, and Rob's real after-tax investment to $600. If Rob invested $1,000 in a TPSP, his after-tax commitment to his retirement would be $1,000. Even if Rob was disciplined and reinvested all of the refund back into RRSPs, his after-tax commitment would still only be $840 (60% of $1,400).

By eliminating the possibility of spending the refund, using TPSPs automatically results in a higher after-tax contribution and a corresponding increase in after-tax retirement income.

The TPSP system also produces a fairer tax system and more incentive to save for those who later have government benefits clawed back. Higher-income seniors can lose some of their OAS payments. Worse, clawback of GIS for 1.2 million lower-income seniors can result in tax rates of over 75%. For these Canadians, RRSPs are the worst way to save, which is the opposite of conventional wisdom and the government's intention to encourage retirement savings.

Creating more tax-assisted retirement savings options only benefits investors. Increasing the fairness of our tax and clawback systems, while benefiting both high- and lower-income savers, also satisfies the agendas of all political parties.

Talk to your federal representative about making TPSPs a reality in Canada. Contact your local media to start a public discussion, so we can all start to benefit from the new systems already in place in the U.S. and U.K.

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