Tax-free saving schemes fail to prepare many for retirement: Don Pittis

The inventor of the tax-free savings account says our schemes to encourage people to save for retirement just aren't working for the people who need it.

RRSP and TFSA need changes to avoid being nothing more than 'tax relief for high earners,' expert says

Tax deductions to encourage retirement saving are not helping the people who need it most, experts say. (Andrew Medichini/Associated Press)

With the RRSP deadline only days away, the inventor of one of Canada's tax sheltered saving plans says there is evidence such schemes have failed to encourage people to save properly, and he warns there are changes afoot.

"A lot of it is tax reduction without necessarily significant — in the aggregate — additional saving," says Rhys Kesselman, one of the inventors of Canada's tax-free savings account.

When he and a colleague first proposed the idea in 2001, Kesselman called it the tax prepaid savings account, and his intention was to create a savings scheme better suited to low-income savers than the existing registered retirement savings plan that had been going since 1957.

Tax relief for the rich?

But since the late Conservative finance minister Jim Flaherty adopted Kesselman's idea and introduced the tax-free savings account in 2009, research shows that neither it nor RRSPs are doing what economists had hoped and expected.

"Is the effect more saving or less saving?" Kesselman asks. Once all the studies are done, the results are "pretty mixed," he says.

Kesselman, who now holds the Canada Research Chair in Public Finance at Simon Fraser University, says the tax-free accounts aren't having their intended effect, with the danger they will once again be perceived, as the RRSP once was, as "tax relief for high earners."

According estimates by Scotiabank, nearly 40 per cent of Canadian adults don't save. (Don Pittis/CBC)

"A lot of it is simply diversion of savings from taxable forms by upper-middle and high-income individuals to less-tax forms," says Kesselman. 

That's not the way it was supposed to work.

To economists, giving people a tax break on savings was intended to remove what they saw as a strong motivation not to save.

Imagine two people with identical incomes, one of whom spends every penny and the other who saves some income. The one who spends it all gets the full current value of that income.

According to economic theory, money spent now is worth more to us than money spent tomorrow or next year. That's why we are willing to borrow for the immediate benefits of having a new car, despite the additional cost. It is why people are willing to pay interest on loans of all kinds.

A penalty for saving

By the same logic, that is why savings are rewarded with interest. People who save some of their income instead of spending it all defer some of that immediate benefit in exchange for the future benefit of investment income.

But if the investment income is taxed, economists say that means spendthrifts who blow their entire paycheque get full benefit of their money while the savers only get part of the benefit.

"Income-based tax penalizes the saver," says Kesselman.

In the past, the government has come under pressure for permitting large RRSP limits because voters saw them as 'tax relief for high earners,' says the inventor of the tax-free savings account. (Don Pittis/CBC)

Even people who think all taxes are bad and government should be small know we need some way of collecting revenue. The battle over the fairest way to collect that tax, whether taxing income or consumption, has been grinding on since the 1920s.

And while people with lots of money are more able to save than poor people, the tax breaks just aren't enough to motivate many with more modest incomes who should be able to save.

"A lot of middle-earners do, but the second car, the speed boat or the additional vacation seem more pressing," says Kesselman.

Inability to save

High property prices mean that even people with good incomes and the best of intentions have nothing left over after buying a house.

The latest data from Statistics Canada shows that in 2013 RRSP contributions were falling. While more people contributed to tax-free accounts, withdrawals were up too. More than half of all people with the accounts removed money in that year.

According to surveys by Canada's big banks in 2016 and 2017, there is evidence Canadians still aren't saving. Those who are saving, aren't saving enough.

Potential car shoppers admire a Chevy Bolt at the Toronto auto show. Even people who can afford to save sometimes find buying a second car a more pressing priority. (Don Pittis/CBC)

The numbers vary according to each bank's statistical methods, but Scotiabank estimates that nearly half of eligible Canadians don't have a tax-free account and nearly 40 per cent aren't saving for retirement at all.

Despite championing tax-free savings accounts more than a decade ago, Kesselman has changed his tune.

Since tax breaks have failed to motivate people to save for retirement, he has now reluctantly begun advocating a compulsory savings plan, under which savers are forced to contribute to a pension big enough to support themselves through their retirement.

Such schemes will require changes to existing savings plans. But any changes must not be seen as discouraging those who do make the effort to save.

One change that is almost certainly coming, he says, is the provision that allows people to accumulate huge tax-free savings accounts, but still be eligible for benefits intended for lower-income seniors.

With assets and income sheltered in a tax-free account, some relatively well-off people will be able to get Old Age Security benefits without paying any tax on those benefits and even collect the guaranteed income supplement intended for low-income seniors.

"That, of course, is stupid, silly, short-sighted," says Kesselman.

"I'm sure the day of reckoning will come when governments do start to somehow factor it in, when more people have TFSAs in the hundreds of thousands and the millions."

Follow Don on Twitter @don_pittis

More analysis from Don Pittis

About the Author

Don Pittis

Business columnist

Don Pittis was a forest firefighter, and a ranger in Canada's High Arctic islands. After moving into journalism, he was principal business reporter for Radio Television Hong Kong before the handover to China. He has produced and reported for the CBC in Saskatchewan and Toronto and the BBC in London. He is currently senior producer at CBC's business unit.