The bedrock of Canada’s retirement income system is OAS, CPP and a pension. But there are three other important elements of the system: The RRSP, the RRIF, and the TFSA. The following is a parable that explains how they work for rich and poor,
Cinderella’s story
Once upon a time, in a constitutional monarchy called Canada, there lived a young woman named Cinderella.
She worked very hard.
Every morning, she scrubbed floors, carried water, washed clothes and did whatever honest work she could find. She never earned very much, but she earned enough that the Prime Minister took notice.
“He who works should be encouraged to save,” he proclaimed.
RRSPs
So, in 1957, the Prime Minister summoned the Fairy Godmother—known throughout the kingdom as the Queen of Canada—and asked her to create a gift for working people.
The Fairy Godmother smiled and waved her wand. Instantly, a magnificent carriage appeared.
It was called the Registered Retirement Savings Plan (RRSP). It possessed remarkable magic.
Every year Cinderella worked, the carriage grew larger. The harder she worked, the more room appeared inside it. Whenever she placed some of her earnings into the carriage, the Queen rewarded her with a gift of her own—a tax refund.
Better still, every coin inside the carriage multiplied quietly year after year without the tax collector ever knocking on the door. It seemed like perfect magic.
But every fairy tale comes with conditions.
The Fairy Godmother leaned toward Cinderella. “There is one thing you must never forget,” she whispered. “The magic ends at midnight.”
RRIFs
In Canada, midnight arrives at age seventy-one.
For years Cinderella hardly thought about it. The carriage faithfully carried her savings through her working life. But one evening, just as the clock struck midnight, something extraordinary happened. The horses disappeared. The coachman vanished. The elegant carriage transformed.
Twenty-one years after creating the enchanted carriage, the government had anticipated this moment. In 1978 they introduced a second gift.
Every carriage would now become a Registered Retirement Income Fund (RRIF) when everyone in the land with a carriage turned age 71.
Like Cinderella’s coach becoming a pumpkin, the transformation could not be stopped. Only now the journey changed direction. Instead of putting money into the carriage, Cinderella had to begin taking money out. And every coin she withdrew became taxable income.
Curiously, not everyone experienced the pumpkin the same way.
Prince Charming scarcely noticed.
He owned castles, investments and other treasures. If his roof leaked or a horse went lame, he simply paid the bill from somewhere else. The pumpkin behaved exactly as intended. It gradually repaid the taxes that had been postponed during his working years.
Many middle-income retirees lived happily ever after as well. The pumpkin was simply another carriage, travelling in the opposite direction.
But not everyone in the kingdom was Prince Charming. Some villagers entered old age with modest incomes. They qualified for the kingdom’s Guaranteed Income Supplement, a program created so no elderly villager would live in poverty.
For them, the pumpkin behaved very differently. When they withdrew money, they often paid little income tax.
But something else disappeared. Their Guaranteed Income Supplement began to shrink. The Queen was no longer simply collecting deferred taxes. She was reclaiming income support.
The strangest part of the story came when misfortune struck. A roof collapsed. A furnace failed. A spouse became ill. A hearing aid was needed. Long-term care suddenly arrived.
The poorest villagers often had to withdraw the largest amounts from their pumpkins precisely when life became most difficult. Those withdrawals could reduce future Guaranteed Income Supplement payments while also attracting income tax.
Remarkably, the kingdom’s largest recovery often occurred when its poorest retirees faced their greatest financial hardship.
TFSAs
Years passed. Then, in 2009, another visitor arrived.
This one carried no wand. He was an architect. Instead of offering magic, he offered design.
His gift was called the Tax-Free Savings Account (TFSA).
At first the villagers were unimpressed. There were no tax refunds. No glittering carriage. No enchanted horses. Nothing magical seemed to happen at all.
The architect simply smiled. “You will understand later,” he said.
Money placed inside his invention grew tax free. It could be withdrawn tax free.
More importantly, withdrawing it never awakened the tax collector and never reduced the Guaranteed Income Supplement.
There was no midnight. No pumpkin. No transformation.
The account remained exactly what it had always been. Only then did Cinderella understand.
The lesson of the story: Which gift fits?
The kingdom had never given its people one retirement gift. It had given them three.
Each solved a different problem.
The Fairy Godmother rewarded work with a magical carriage.
The pumpkin reminded everyone that taxes deferred are eventually taxes paid.
The architect quietly protected people from future financial shocks.
None of the gifts was perfect. None was right for everyone.
Prince Charming still adored the magnificent carriage. Many middle-income retirees found it served them well.
But many poorer villagers eventually discovered that the plain little invention designed by the architect was often more valuable than the Fairy Godmother’s spectacular magic.
The lesson was not that one gift was better than another. It was that public policy, like fairy tales, has different endings depending on who receives the gift.
For decades Canadians have been told that the RRSP is the gold standard of retirement savings. For millions it is. But for Canadians who will depend upon the Guaranteed Income Supplement, the better question is not, “Which account gives me the biggest tax deduction today?”
It is, “Which account will leave me with the most money when life goes wrong?”
That is a very different question. And it produces a very different ending.
Fairy tales have always warned us that every magical gift comes with conditions.
Canada’s retirement system does too. Unlike Cinderella, however, Canadians know exactly when midnight will arrive. The real challenge is choosing the right gift at the right time.
More: Not a Cinderella story: RRSP chariots turn into RRIF pumpkins