Time To Re-Think RRSP Contribution Room?

Canadian politicians can’t help but tinker. They are always looking for new ways to spin things and to give people incentives to change their behaviour through fiscal policy. Public policy makers are also mindful of larger trends and the need to stay on top of them. In the past couple of years alone, we’ve had a number of changes including annual TFSA contributions increasing from $5,000 to $5,500 annually, a framework announced to phase in a gradual increase in the ordinary OAS age from 65 to 67, and some very public musing about allowing for income splitting of up to $50,000 annually when there are one or more children under the age of 18 at home.

One thing that has always struck me as being a candidate for greater simplicity is RRSP contribution room. A few years ago, the contribution limit was set as being indexed to inflation, so that the current maximum annual contribution room is $24,270—hardly an easy to remember number.

For as long as anyone can remember, the limit has been calculated as 18% of earned income minus any pension adjustments up to the annual maximum. Some organizations, such as the Investment Industry Association of Canada (IIAC) have taken to suggesting that the limits ought to be raised. I agree. I also think they ought to be simplified.

I’d like to propose that the new limit be calculated as 20% of earned income on the first $100,000 and 10% on all subsequent earned income up to $200,000. The maximum annual contribution in this scenario would be $30,000. Here is a quick summary of the benefits:

• The necessary math is both simple and easy to understand
• Most people earning less than the maximum can contribute slightly more annually
• Most people earning more than the maximum can contribute slightly more annually

The contribution number for the status quo earner on the cusp of the current maximum would be similar, but lower. Today, one would need to earn at least $134,833 or more in order to be able to contribute $24,270. Under my proposal, that same person would be able to contribute $23,483 (20% of $100,000 + 10% of $34,833)—a similar number. As a result, people earning in the high $120,000s to mid $130,000s would be very slightly worse off and everyone else would have more contribution room.

Less than 3% of the Canadian population earns enough money to contribute the allowable maximum, so raising the contribution limit (albeit at a reduced rate) is really only of value to the highest income earners. Still, the most recent budget in Ontario raised taxes modestly for people earning over $150,000 and fairly substantially for those earning over $220,000. Giving those people a little more contribution room would remove some of the sting of the tax hike.

Another benefit down the road could be to move to a ‘step up indexation’ program similar to what is being done with TFSA limits. The current system of annual indexation is unwieldy and produces some awkward annual limits. As mentioned previously, TFSA contribution room recently went up by $500. This was the result of the legislation allowing for increases in $500 increments once accumulated inflation from the start of the program increased by 10% (i.e. $500 is 10% of $5,000). The same simple, easy-to-understand bump up could be used with RRSP contributions going forward, perhaps in $1,000 increments. As such, once inflation reached a cumulative 10%, the de facto limit would be raised to $31,000.

My take is that this kind of reform makes for better  public policy because it is relatively easy to understand, easy to calculate and easy to remember. It also allows most Canadians to do slightly more than they can currently to take control of their own retirement destinies.

John J. De Goey, CIM, CFP, FELLOW OF FPSC is a Vice President and Associate Portfolio Manager at BBSL. The views expressed are not necessarily shared by BBSL.