Study: Cracking the RRSP nest egg

2001 and 2002

Canadian seniors are required to “crack” their RRSP nest egg at the age of 69 resulting in small increases in average income and taxes, according to a new study published today in Perspectives on Income and Labour.

Registered retirement savings plans must be converted into an annuity or a registered retirement income fund (RRIF) in the year in which the taxpayer turns 69. Prescribed minimum withdrawals start the following year, and income tax is paid at the applicable marginal rate.

This study, which assesses the impact of this process on income and taxes, showed that in 2002 conversion provided a net income boost of about $1,600 for 70-year-old seniors. This was equivalent to about 6.6% of their 2001 income.

This net increase is going up over time, indicating that successive cohorts of Canadians have higher levels of RRSP savings.

However, the taxable income of these individuals increased by only $800, or 3.2%. So the boost from mandatory conversion represented only a temporary upward shift in a generally declining age-income profile for seniors.

The findings also give a first glimpse of the consequences of mandatory conversion on income taxes. Average taxes paid increased from $4,000 in 2001 to $4,200 in 2002, or about $40 million for the entire cohort.

Although the gain in taxes paid nudged the average tax rate only from 16.1% to 16.3% in 2002, it represented an effective tax rate of 25.0% on the $800 increase in taxable income.

The tax-sheltering features of RRSPs have made them very popular investment vehicles. The foregone tax revenue on RRSP deductions and the income generated by this wealth has been estimated to be more than 1% of GDP annually, about $10 billion.

The study showed that high-income earners were much more likely to have significant income gains as a result of conversion. Among low-income earners, a small percentage lost some of their Guaranteed Income Supplement entitlement as a result of RRIF income coming on stream.

The study divided the entire cohort of 69-year-old taxfilers into five equal groups based on income. It showed that about 3% of the group with the lowest income experienced more than a 5% increase in income at the age of 70. In contrast, 43% of the group with the highest incomes experienced more than a 5% gain.

This suggests that much of the outflow from RRSPs will be taxed at relatively high marginal rates.

In 2001, nearly one-third of 69-year-old taxfilers (32.3%) relied on public pensions for at least three-quarters of their income. One in five of these individuals had some employer-pension income in that year, averaging $1,800. After mandatory conversion, almost a third (31.8%) collected pension income averaging $2,600.

Although average effective tax rates were low among taxfilers relying on public pensions, 1.2% in the year they turned 69. This rate rose to 1.7% the following year, representing an effective tax rate of 12.0% on the increased income after mandatory conversion.

Seniors who earned more than 60% of their total income from employment tended to be high-income professionals who brought in an average of $78,400 from all taxable sources in 2001, of which only $2,200 came from employer-pensions.

These individuals saw their pension income after mandatory conversion more than quadruple to $9,600. Although other sources of income dropped somewhat, their average total income still increased by $5,100, adding $1,500 to their tax bill.

Definitions, data sources and methods: survey number 4107.

The article “Cracking the RRSP nest egg” is now available in the April 2006 online issue of Perspectives on Labour and Income, Vol. 7, no. 4 (75-001-XIE, $6/$52).

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