The Senior's Benefit - What Benefit?

Country Routes - April, 1998

The battle continues for changes to the proposed Seniors Benefit, slated to come into effect in the year 2001.

The Seniors Benefit proposals have forced many people to reconsider their RRSP strategies. For some, retirement planning has suddenly been turned on end.

The big criticism is that the thinkers in Ottawa - which will provide a minimum of $18,440 annual income for a retired couple and $11,420 for a single person - will penalize those who have saved for their retirement and reward those who haven't. This somewhat backward thinking stems from the Seniors Benefit's harsh clawback provisions: people with family income of more than $25,921 will lose 20½ of tax-free benefit for each additional dollar they earn.

The effective tax rate on such additional income would be about 62%, depending on the province, for someone in the middle tax bracket (income between $29,591 and $59,181). The benefit disappears entirely for singles with income of more than $51,721 and couples with income of more than $77,521.

The Seniors Benefit has been likened to a double taxation for the thrifty and prudent. Because of this it has drawn a lot of criticism. CARP founder and president Lillian Morgenthau calls it "a minimal welfare system for poor seniors" and "a throwback to the Depression years." Malcolm Hamilton, an actuary with pension consultants William M. Mercer Ltd., predicts the rules will lead to advisers resorting to "juggling tricks" to maximize their clients' retirement prospects. Many advisers suggest clients forgo RRSP contributions, convert their RRSPs to RRIFs right away, or make RRSP withdrawals before they retire. By reducing retirement income, they can increase their tax-free Seniors Benefit entitlement.

Those who have done an extensive analysis of the clawback's effect on RRSP planning have found many people could benefit by making early RRSP withdrawals.

Everyone should review their RRSP strategies in light of these rules. Generally, the closer you are to retirement, the more likely [it is] you can benefit from early withdrawals."

The key factor is how long your RRSP money can compound tax-free, before it is required as income, as well as the yield it can earn? Someone in the middle tax bracket, now and in retirement, would need to leave funds in an RRSP (or RRIF) earning 6% annually for between 12 and 18 years to offset the eventual clawback cost. At an 8% yield, the payback period would be between 10 and 14 years.

As long as you have income from other sources and don't need the money right away, that's how much longer it would need to stay in a sheltered plan. That's the break-even point. The time horizon depends on what you do with the money you withdraw - invest it and pay tax on its earnings, or spend it. Although the rules are not carved in stone it appears the details may be massaged a bit, but the structure is going through intact.

There are plenty of advisors suggesting people consider reducing or depleting RRSPs before 2001. Of course withdrawing this money can create a huge tax liability, in hopes of receiving what amounts to a bigger welfare payment down the road. What can you do when caught in this catch 22 dilemma? If done properly with the right financial advise from professionals, there is a way to lessen the tax blow while withdrawing funds from your RRSP. Please refer to my article on "Tax-Free Withdrawals From Your RRSP " Feb 8, 1995. We have been employing this strategy for years and found it useful in other situations.

If I have made it appear a little complex, it is. There are many possible scenarios, any change in circumstances can alter the equation. What if a source of income drops off? What happens to your calculations then? I have two excellent articles on the subject that gives you more information. "Senior's Benefit May Deter Some From Using RRSP's" & "Complex Seniors' Clawback Makes An Easy Target For Some."

If you have any questions, please call Reg Borrow at (519) 855-6639. He is an Independent Financial Consultant for Regal Capital Planners.