Tag Archives: RRSPs

Retired Money: Americans cashing out of employer Retirement plans could benefit from Canadian approach

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My latest MoneySense Retired Money column, which has just been published, looks at an interesting study on trends in cashing out Retirement savings when American workers leave their jobs. You can find the full column by clicking on the highlighted text here: Should you cash out your workplace pension when you leave a job?

The paper, titled Cashing Out Retirement Savings at Job Separation, is co-written by a Canadian, Yanwen Wang, associate professor at the University of British Columbia’s Sauder School of Business. The study, which is fairly technical, is also featured in a more accessible version in the Harvard Business Review. The article that ran on March 7, 2023 is titled Too many employees cash out their 401(k)s when leaving a job.

Canada and the United States differ in how retirement plans are treated on leaving jobs, so most of the column applies mainly to the United States. But there may be lessons for the US retirement system that can be drawn from the Canadian treatment.

Average American has more than a dozen jobs over a career

In the US, the average American worker will have 12.4 jobs over a career, prompting the report’s authors to write that “Employers should recognize that most people working for them will change jobs before retirement.” Unfortunately, it’s all too easy for their workers to cash out of their 401(k)s when leaving a job, instead of rolling them over and letting the money continue to grow in a tax-deferred manner.

A UBC press release issued early in April carries the alarming headline that “Americans are cashing out the retirement savings at an alarming rate.”  The study identifies a “key” problem: when they switch jobs, 41.4% of employees are cashing out of those funds — even though the U.S. Internal Revenue Service (IRS) imposes a 10% per cent penalty on anyone younger than 59.5 years old.

Here’s what Wang said via email about the implications for Canadian retirement: “Canada has some different fundamental rules around retirement savings withdrawal. It is hard or probably impossible to speak to the Canadian RRSP withdrawal based on our US-based study.”
Canadian plans have locked-in feature

In particular,  many Canadian RRSPs have a locked-in feature, Wang added: “which means that even at job changing cash withdrawals are not allowed unless the individual becomes non tax resident. The locked-in feature is a key feature not present in most US retirement savings accounts. I don’t have data but I believe the illiquidity feature substantially reduces 401(k) leakage. I think the U.S. can learn from the Canadian retirement system and consider something similar — a locked-in 401(k) on top of an emergency savings plan — to satisfy the long-term retirement needs as well as short-term liquidity emergency.”

Unlike Canada, American employees can cash out at any time whether they’re working or leaving a job: the only developed economy that does. As the article points out, “other countries require many months of unemployment and evidence of clear hardship before allowing someone to tap defined contribution retirement savings.”

 Researchers also found an interesting phenomenon whereby the more a generous employer “matches” employee contributions, the more the departing employee is tempted to cash out and spend what it regards as “house money” or “free money.” Thus, the authors write, “Right now, cashing out is the path of least resistance. People choose what is easy, not what is wise.”

The column closes with some findings from a recent H&R Block Canada survey released on April 3, 2023. It  found nearly half of Canadians are unprepared for retirement and more than a third (36%) between ages 18 and 54 believe they won’t ever retire.

3 things that make me want to pull my hair out

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Pexels: Mikhail Nilov

By Bob Lai, Tawcan

Special to Financial Independence Hub

I have been writing on this blog for almost nine years. Over that time, I have learned and gained a lot of personal finance and investing-related knowledge. Whenever I gain new knowledge, I try to share it on this blog with the hope that readers can gain the same understanding as well.

As much as I love sharing new knowledge with other people, there seem to be some deep-rooted misunderstandings, myths, or misconceptions on certain topics. I really don’t understand why some people have these misconceptions and I will try my best to debunk some of the common misconceptions I have encountered, just so I don’t have to keep ripping my hair out.

#1 Don’t want a raise to avoid the next tax bracket

Our tax system is extremely complicated, so I understand there are some misunderstandings here and there. The biggest misunderstanding is that all your income is taxed at your tax marginal rate.

Due to this misunderstanding, people often make such statements like…

“I don’t want a raise just to get taxed more.”

“I am not working overtime to get bumped to the next bracket and lose my income to taxes.”

And so on…

But that’s a very very wrong understanding. Your income is taxed on a tiered bracket system. Below are the 2022 federal tax brackets.

Taxable Income – 2022 Brackets Tax Rate
$0 to $43,070 5.06%
$43,070.01 to $86,141 7.70%
$86,141.01 to $98,901 10.50%
$98,901.01 to $120,094 12.29%
$120,094.01 to $162,832 14.70%
$162,832.01 to $227,091 16.80%
Over $227,091 20.50%

So if you happen to make $90,000 a year, the entire amount does not get taxed at 12.29% tax rate. The first $43,070 is taxed at 5.06%, then the next $43,070.99 is taxed at 7.7%, then the rest is taxed at 10.50%.

Essentially your $90,000 annual income is taxed like below:

Income Tax Rate Tax amount
$43,070.00 5.06% $2,179.34
$43,070.99 7.70% $3,316.47
$3,859.01 10.50% $405.20

You’d be paying a total of $5,901.00 of federal tax on your $90,000 income, or an effective average tax rate of $6.56%. The same tiered tax bracket system is applicable to provincial taxes as well, albeit with different specific percentages for each province.

So no, the $90,000 you received isn’t all taxed at 10.50%. The amount is divided up and taxed at different tax rates.

What if you had an income of $90,000 and your employer decided to give you a $35,000 raise? Should you say no because you’ll move up two tax brackets federally from 10.5% to 14.7% and get taxed way more than your $35k raise?

It’s mind-boggling that some people actually believe this is the case and therefore would say no to any raises!!! Let’s do some quick and easy math to sort this out.

I ran the numbers using Wealthsimple’s 2022 income tax calculator and set BC as the province. Here’s the summary:

Income Federal Tax Provincial Tax (BC) CPP/EI Net
$90,000 $12,643 $5,079 $4,453 $67,825
$125,000 $21,146 $9,320 $4,453 $90,091
Delta $35,000 $8,503 $4,241 $0 $22,266

So, an increase of $35k a year raised your total taxes by $12,744 a year. More importantly, you will be netting $22,266 more than you’d have at the lower income of $90,000 a year.

So ask yourself, would you rather pay almost $13k more in taxes while pocketing over $22k more each year? Or would you rather not get the extra money at all? I think 99.9% of the population – if not more – would want the former.

All things equal, you will always come out ahead with a raise regardless of what tax bracket you end up with.

Fortunately, people that have this misconception are a very small percentage of the population.

#2 “Invest” in RRSP

Every February I hear statements in the line of… “I’m investing in my RRSP.” But when I ask for more clarification, I learn that people are simply transferring money into their RRSPs and letting that money sit in cash. They’re moving money into RRSP simply for the RRSP income tax deduction.

I get the idea of getting the RRSP tax deduction to reduce your overall taxes. But don’t you want your money to compound and grow? Why do you have your money sit inside a tax-deferred account and earn a measly 1% interest rate when you can invest in things like ETFs and stocks?

Some people argue that GICs are way safer than other investment vehicles like mutual funds, ETFs, and stocks because GICs have a guaranteed earning rate and you can’t lose money. Continue Reading…

 RRSP Confusion

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By Michael J. Wiener

Special to Financial Independence Hub

Recently, I was helping a young person with his first ever RRSP contribution, and this made me think it’s a good time to explain a confusing part of the RRSP rules: contributions in January and February.  Reader Chris Reed understands this topic well, and he suggested that an explanation would be useful for the upcoming RRSP season.

Contributions and deductions are separate steps

We tend to think of RRSP contributions and deductions as parts of the same set of steps, but they don’t have to be.  For example, if you have RRSP room, you can make a contribution now and take the corresponding tax deduction off your income in some future year.

An important note from Brin in the comment section below: “you have to *report* the contribution when filing your taxes even if you’ve decided not to use the deduction until later. It’s not like charitable donations, where if you’re saving a donation credit for next year you don’t say anything about it this year.”

Most of the time, people take the deductions off their incomes in the same year they made their contributions, but they don’t have to.  Waiting to take the deduction can make sense in certain circumstances.  For example, suppose you get a $20,000 inheritance in a year when your income is low.  You might choose to make an RRSP contribution now, and take the tax deduction in a future year when your marginal tax rate is higher, so that you’ll get a bigger tax refund.

RRSP contribution room is based on the calendar year

Each year you are granted new RRSP contribution room based on your previous year’s tax filing.  This amount is equal to 18% of your prior year’s wages (up to a maximum and subject to reductions if you made pension contributions).  You can contribute this amount to your RRSP anytime starting January 1. Continue Reading…

$1.7 million to retire: doable or out of reach?

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Front page of Wednesday’s Financial Post print edition.

Plenty of press this week over a BMO survey that found Canadians now believe they’ll need $1.7 million to retire, compared to just $1.4 million two years ago (C$). The main reason for the higher nest-egg target is of course inflation.

As you’d expect, the headline of the story alone attracted plenty of media attention. I heard about it on the car radio listening to 102.1 FM [The Edge]: there, a female broadcaster who was clearly of Millennial vintage deemed the $1.7 million ludicrously out of reach, personalizing it with her own candid confession that she herself hasn’t even begun to save for Retirement. Nor did she seem greatly fussed about it.

Here’s the Financial Post story which ran in Wednesday’s paper: a pick-up of a Canadian Press feed; a portion is shown to the left. The writer, Amanda Stephenson, quoted BMO Financial Group’s head of wealth distribution and advisory services Caroline Dabu to the effect the $1.7 million number says more about the country’s economic mood than about real-life retirement necessities.

BMO’s own client experience finds that “many overestimate the number that they need to retire,” she told CP, “It really does have to be taken at an individual level, because circumstances are very different … But $1.7 million, I would say, is high.”

Here’s my own take and back-of-the-envelope calculations. Keep in mind most of the figures below are just guesstimates: those who have financial advisors or access to retirement calculators can get more precise numbers and estimates by using those resources. I may update this blog with input from any advisors or retirement experts reading this who care to fill in the blanks by emailing me.

A million isn’t what is used to be

Image via Tenor.com

Back in the old days, a million dollars was considered a lot of money, even if that amount today likely won’t get you a starter home in Toronto or Vancouver. This was highlighted in one of those Austin Powers movies, in which Mike Myers (Dr. Evil) rubs his hands in glee but dates himself by threatening to destroy everything unless he’s given a “MILLL-ion dollars,” as if it were an inconceivably humungous amount.

The quick-and-dirty calculation of how much $1 million would generate in Retirement depends of course on your estimated rate of return. When interest rates were near zero, this resulted in a depressing conclusion: 1% of $1 million is $10,000 a year, or less than $1,000 a month pre-tax. When my generation started working in the late 70s, a typical entry-level job paid around $12,000 a year so you could figure that $1 million plus the usual government pensions would get you over the top in retirement.

Inflation has put paid to that outcome but consider two rays of hope, as I explained in a recent MoneySense Retired Money column. To fight inflation, Ottawa and most central banks around the world have hiked interest rates to more reasonable levels. Right now you can get a GIC paying somewhere between 4% and 5%. Conservatively, 4% of $1 million works out to $40,000 a year. 4% of $1.7 million is $68,000 a year. That certainly seems to be a liveable amount. More so if you have a paid-for home: as I say in my financial novel Findependence Day, “the foundation of Financial Independence is a paid-for home.”

Couples have it easier

If you’re one half of a couple, presumably two nest eggs of $850,000 would generate the same amount: for simplicity we’ll assume a 4% return, whether in the form of interest income or high-yielding dividend stocks paid out by Canadian banks, telecom companies or utilities. I’d guess most average Canadians would use their RRSPs to come up with this money.

This calculation doesn’t even take into consideration CPP and OAS, the two guaranteed (and inflation-indexed) government-provided pensions. CPP can be taken as early as age 60 and OAS at 65, although both pay much more the longer you wait, ideally until age 70. Again, couples have it easier, as two sets of CPP/OAS should add another $20,000 to $40,000 a year to the $68,000, depending how early or late one begins receiving benefits.

This also assumes no employer-pension, generally a good assumption given that private-sector Defined Benefit pensions are becoming rarer than hen’s teeth. I sometimes say to young people in jest that they should try and land a job in either the federal or provincial governments the moment they graduate from college, then hang on for 40 years. Most if not all governments (and many union members) offer lucrative DB pensions that are guaranteed for life with taxpayers as the ultimate backstop, and indexed to inflation. Figure one of these would be worth around $1 million, and certainly $1.7 million if you’re half of a couple who are in such circumstances.

Private-sector workers need to start RRSPs ASAP

But what if you’re bouncing from job to job in the private sector, which I presume will be the fate of our young broadcaster at the Edge? Then we’re back to what our flippant commentator alluded to: if she doesn’t start to take saving for Retirement seriously, then it’s unlikely she’ll ever come up with $1.7 million. In that case, her salvation may have to come either from inheritance, marrying money or winning a lottery.

For those who prefer to have more control over their financial future, recall the old saw that the journey of a thousand miles begins with a single step. In Canada, that step is to maximize your RRSP contributions every year, ideally from the moment you begin your first salaried job. Divide $1.7 million by 40 and you get $42,400 a year that needs to be contributed. OK, I admit I’m shocked by that myself but bear with me. The truth is that no one even is allowed to contribute that much money every year into an RRSP. Normally, the limit is 18% of earned income and the 2023 maximum RRSP contribution limit is $30,780 (and $31,560 for the 2024 taxation year.) Continue Reading…