Senior Income Benefit

rge 1:

CARP's analysis contains quite a few major and minor flaws -- and its conclusion is quite wrong. I put their detailed data into my computer and analyzed their exhibit #1. For example, the only tax savings they counted on the RRSP contributions were the upfront deductions; they ignored the value of the tax sheltering on growth which was actually quite more. After correcting the flaws, I compared who got what to what they put in. Interestingly, the hypothetical couple would get back a larger share than they put in...and they would get more spendable money from the Senior's Benefit than from the current OAS system. I also tested two of CARP's recommendations and found they would produce the lowest level of spendable income than six variations on current OAS and the Senior's Benefit. All in all, it was an incredibly sloppy effort.

Bruce, you seem to know what you are talking about, so let me pose a couple of questions to you:

1. Is the criticism of double taxation, i.e. you get taxed on RRIF withdrawals and lose benefits under the proposed scheme, justified?

2. Would a family (husband and wife) with perhaps $50,000 combined retirement income gain or lose under the proposed scheme?

Most comments I have read about the proposed seniors benefit have tended to be negative. Obviously, unless the government was paying less to retirees globally it would hardly be worth their effort to change the system. Who will benefit, and who loses?

I look forward to your analysis.

P.S. You may be elevated to the Bylo-Gummy category if you don't watch yourself!

rge 1:

If you view the tax breaks granted on RRSPs as interest-free loans from govt, RRIF taxation is simply the repayment of those loans. Nothing more, nothing less. Basically, govt foregoes revenue during your working years to help you save for retirement. Then, by forcing RRIF withdrawals, govt forces you to take retirement income and pay off the tax deferral.

Now to the clawbacks. Arguably, this is a welfare issue – not a tax issue. OAS used to be a "universal" program in that everybody aged 65 or older received benefits. In 1989 or 90, the federal government imposed a "high income" clawback on those with net income of at least $50,000. For the first few years, those affected received their OAS payments as normal and then had to pay back all or part when they filed their tax returns. More recently, Revenue Canada has been applying the clawback at source. In any event, OAS is no longer a universal program -- and hasn't been one since the start of this decade. (CARP is actually very much a latercomer to this whole subject)

The proposed Senior's Benefit has two clawbacks. The first simply replicates the current test that confines the Guaranteed Income Supplement to low-income people. As far as I know, nobody has complained about that clawback.

The second clawback kicks in at about 26,000 of income and is quite contentious.

First, unlike the current OAS clawback, it will be based on joint income. On one hand that makes sense. Why should scarce govt money go to the non-working spouse of a rich retiree? (Despite CARP's ill-informed claims, seniors have not "paid" for their OAS; it's funded out of general revenue. There used to be a special old age pension tax but it funded benefits for pensioners at that time -- who tended to be in dire straits -- and the program accumulated a $105 million deficit during its life, from 1952-72. In 1972 it was rolled into the general income tax.) But I digress. While it makes sense to target govt money to those who need it, I'm disturbed that Ottawa will implement joint-taxation when it suits the govt's purposes but not when it suits the taxpayer's purposes. For example, would it not be more fair to allow joint-filing of income tax returns for younger couples -- especially those just starting careers and families?

The second complaint is that this clawback is too high (20%) and kicks in at too low a level. Many of these critics have not adequately considered several points:

A) A couple would have to earn 78,000 to lose all of their Senior's Benefit. Relatively few senior couples are in that category. B) Whatever SB the couple does get is tax-free -- unlike OAS which is fully taxable. C) The SB clawbacks are fully indexed for inflation. The OAS clawback is indexed only for inflation above 3%.

Several critics have simply added the 2nd SB clawback to the regular tax rates and declared that people shouldn't make RRSP contributions because they'll face marginal tax rates of 60% or more. These critics have not fully considered the power of tax-sheltered compounding. Given a set of parameters, you can calculate how high tax rates must rise for an RRSP to become a money-losing proposition. I did that quite a few years ago and found they have to reach truly confiscatory levels. That assumed about 10 years or more of sheltered growth. The SB analysis is more complex because RRSP/RRIF money is withdrawn in such a way that you can't distinguish between old and new money. In any event, most generally healthy people now in their 40s and 50s can look forward to more than 10 years of sheltered growth for most of their RRSP contributions.

I've run calcs only for CARP's example. Steve Salter, who produces the RRIFmetic financial planning software (www.fimetrics.com), tells me he has run calcs for a wide variety of OAS versus SB scenarios and did not find a truly meaningful difference for most "ordinary" people. (Note that, according to Statistics Canada, average income for a retired couple is about 39,600. OAS/CPP account for about a third of that. A bit over 20% comes from other pensions, about 20% from employment, about 15% from investment and about 10% from "other.")

Indeed, the SB has drawn criticism for being too generous. The most prominent member of this camp is Malcolm Hamilton, a brilliant actuary, who has studied income and spending data for current retirees. He complains that the tax-free 18,440 SB for a senior couple with no other income will likely exceed their spending needs. Why should seniors get such largesse when those just starting careers and families don't, he asks.

You asked how a couple with 50,000 of other income would do. In 1996 the National Council of Welfare analyzed the SB by producing tax returns for 16 situations. Unfortunately, they did not break out the loss of the age and pension credits which are indefensible and will be killed no matter what happens. They found that a one-earner couple at the 50,000 level would lose 2,755 under the SB. A two-earner couple would lose 3,346, again including the two lost credits.

That jibes with another, admittedly rough way to look at it. OAS pays a maximum of just under 4,900 per person and is taxable. Let's say one pensioner is in the 40% tax bracket and income for the other falls within the tax-free personal credit. They'll net (4,900 x .60) + 4900. That's 7840. The Finance Dept projects that the same couple would receive 5510 tax-free from the SB in 2001. So the loss is approximately 2330.

But that's only for year-1. When I went through CARP's model, I found that the bracket creep caused by the partially-indexed OAS clawback can tilt the tables as the years roll by -- particularly if the couple's 50,000 is inflation-indexed....arguably the people hardest hit will be retired long-service public employees who collect pensions that are both above-average in amount and inflation-indexed. A cynic might view the SB as govt's way to take back a lot of what it gave away years ago at the bargaining table.

So, the answer to your question is that there is no easy answer to your question. Be aware, though, that Finance is reviewing the SB proposal and considering, among other things, raising the kick-in level for the second clawback and/or lowering the clawback rate. Implementation will also likely occur well after 2001, and might even be phased in.

Bruce,

Just a couple of points to add - YES the tax-deferred growth is extrememly important, but that can also be largely achieved through the use of equity funds. (Not 100%, but close - just another ugly calculation to try and add into the mess.)

Have to agree with you on everything else, though. The calculations I've run through have showed virtually the same thing - the SB isn't all that bad!

Also gotta say, RIFFmetic sure makes the calculating a LOT easier!!

Bruce, thank you for that excellent synopsis. It took a good deal of time to compile (even just to type it in!) so that I. and I am sure others, are grateful.

Excellent postings, great Info.

Personally, I am exciting RRSP's, going into non Canadian markets, will take Capital Gains and Capital as I need.

No longer a slave to a Canadian Dollar, to temporary/permanent surtaxes, to bracket creeep dur to Income Tax changes, or to a Politician who can lock ijnmy cash with one statemet.

If you take anything from this site, DO NOT TRUST POLITICIANS

Oh man, not during lunch.

Now I find our I agree with Howard. (oh my head hurts)

BL ( Keep watchin em, don't trust em, and NEVER turn your back on em (Politicians for those who missed it) )

I agree, there's a lot of good info posted by brucecohen & other here.

Here's an article I wrote re the Senior's Benefit. I'm with Howard about exiting RRSP's & government programs.

---------------

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." ( Local consumption only)

thank you one and all for the input regarding the Seniors income benefit. goldbar.