PRPPs should have a prepaid component, urges C.D. Howe

A recent study from the C.D. Howe Institute proposes that Canada's tax rules be amended to allow tax-prepaid savings within Pooled Registered Pension Plans (PPRPs) if, indeed, PRPPs are meant to help low- and middle-income Canadians.

The study, entitled Pooled Registered Pension Plans: Pension saviour ó or a new tax on the poor? demonstrates that many lower-income and middle-income workers who save for retirement should not do so in tax-deferred accounts. "Because,î say the study's authors, James Pierlot and Alexandre Laurin, "they will pay effective taxes on withdrawals at rates that are significantly higher than the refundable rates that apply to contributions.î

They argue proposed tax rules for PRPPs should be amended to create new Tax-Free Pension Accounts (TFPA) and allow PRPP members to contribute to them.

In June, the federal government passed Bill C-25, containing the regulatory framework for PRPPs. The feds have released in stages the proposed tax rules, starting in December 2011 and most recently on Aug. 11 (Knowledge Bureau Report, Aug. 14). They promise one more "packageî of proposed rules. Then it will be up to the provinces to enact enabling legislation.

Using Statistics Canada's Social Policy Simulation Database and Model, Pierlot and Laurin looked at the impact of taxes on two single, 30-year-old Albertans, one earning $50,000 and one $33,000. Assuming a 2.5% annual increase in employment earnings, the authors calculated which savings vehicle would provide the best results at age 65, a Tax-Free Savings Plan (TFSA) or an RRSP. In both cases, the TFSA produced the best result.

"Many workers don't have steady career paths with constant earnings growth throughout their lifetime, as modeled in our examples,î write the authors. "Therefore, it is entirely possible that the best outcome for many would involve switching between a tax-deferred account and TFPA at some points in their careers. It is impossible to model all possible scenarios, but the new regime should allow participants to choose freely at any time how their savings are allocated between both types of accounts.î

That leads to the second proposal ó that PRPP administrators develop the financial planning tools and knowledge necessary to give participants in the plans the guidance they need to make informed choices.

The study's third proposal concerns PRPP members having the option of accumulating "targetî pension benefits. The authors suggest there are two ways to do this:

ï Allow PRPP members to accumulate pensions using the same defined-benefit rules that apply to pension plans offered by federal and other government levels and by a few private-sector employers; or

ï Implement a lifetime accumulation allowance for PRPP members.

The final recommendation is for PRPPs to pay a pension. "It seems almost too obvious to state,î write Pierlot and Laurin, "that a pension plan should pay pensions or ó at the very least ó be able to pay them.î But federal tax rules generally prohibit any pension plan from paying a pension unless it is a defined-benefit plan, subject to grandfathered exceptions. That means PRPPs will be subject to the same "deaccumulationî options as defined-contribution plans and RRSPs, putting the onus on plan members to manage their own retirement savings. "Unfortunately, due to financial illiteracy, especially lack of financial planning ability, many PRPP members will not manage their savings effectively in retirement,î they say.