This year's retirement savings plan message is loud and clear, consumers say they have too much debt and are focused on paying it down.
Between the finance minister, the Bank of Canada and various experts shouting concern about debt levels, maybe it shouldn't come as too much of a surprise that consumers are heeding the warning. The problem is it's now the No. 1 reason to not make an RRSP contribution.
“In some ways maybe this is the unintended byproduct of some of the constant hectoring we have seen in recent years from various officials in Ottawa about the building up of debt,” said Doug Porter, chief economist with Bank of Montreal.
A recent poll from Bank of Nova Scotia finds only 31% of Canadians plan to contribute to an RRSP, down from 39% just a year earlier. The same poll found 74% feel they can't afford to make a contribution.
“There is just a lack of money,” said Mike Henry, senior vice-president of retail payments, deposits and lending at Scotiabank, about the lack of contributions. “RRSPs continue to be a really important and tax effective way to maximize their retirement savings.”
Interestingly enough, while the Scotiabank survey finds 74% feel they can't afford to make a contribution this year, that percentage is down from 84% a year ago. “It's a bit of a head scratcher for us,” said Mr. Henry.
Part of the issue may be that even as people feel less squeezed than a year ago, the debt bogeyman is preying on their minds. A survey from Meridian, Ontario's largest credit union, found paying down debt was the top priority of 21% of people in the province. The study further found 40% of respondents were foregoing saving for retirement so they could pay down debt.
It seems every quarter there's a new headline stating Canadians are deeper in debt than ever before. Statistics Canada said in December household debt had reached 163.7% of disposable income in the third quarter — a record.
The Bank of Canada said in December “the high level of household debt and imbalances in the housing sector” were leaving Canada vulnerable while the finance minister has tightened mortgage rules multiple times to discourage debt accumulation.
What is a consumer to think in this environment
“Debt has gone up and it's a function of house prices, wage escalation not as robust as usual and a lot of strong consumer spending that might slow down,” said Bill Maurin, Meridian's acting chief executive officer. “People see and read things and perhaps that's why the debt focus is so prominent.”
He says it's important to not go overboard on paying down debt and says the “quality” of your debt is key in determining whether it should rank ahead of your RRSP contribution.
“Debt quality is a function of the interest rate and whether it's tax deductible,” says Mr. Maurin. “You have credit card debt, you should absolutely focus on that. But mortgage So many people have bought or refinanced in or around 3%, they are in a good position at that rate with long term mortgage costs.”
A bigger long-term problem might be that people are withdrawing money out of their RRSP at higher levels and they are not all retirees. The Scotiabank survey found 40% of respondents had made an RRSP withdrawal which was up from 36% the previous year.
Of that 40%, more than half were putting the money into their home but a quarter of the people were using the money to pay down debt. Another quarter were using the cash for everyday needs.
“When you see people making comments like the reason they are drawing out of an RRSP is to cover day-to-day living expenses, that is an opportunity to look at your overall budget and your overall financial plan,” said Mr. Henry.
Canadians do appear to be willing to make some sacrifices to get their economic house in order. A Manulife Financial survey conducted back in May found 22% of Canadians say maintaining their current lifestyle was a priority compared to 31% who cited debt.
“In the past, people were saving for retirement, saving for a home and those percentages haven't changed that much,” says Paul Lorentz, executive-vice-president, retail markets with Manulife.
“What has changed in just six months is only 1% of Canadians say maintaining their current lifestyle is important. Maybe Canadians are starting to appreciate they want to reduce their debt and get their spending under control,” said Mr. Lorentz.
The other big problem for the RRSP continues to be the emergence of tax-free savings accounts. Canadians were able to contribute another $5,500 as of Jan. 1, raising the total amount allowable for contributions since inception in 2009 to $31,000. The annual amount is indexed with total contribution room rising every year.
Manulife found TFSAs ranked as the top investment choice when Canadians were asked what savings vehicle they use. RRSPs were at 41% and registered education savings plans were at 28%.
Kurt Rosentreter, a financial advisor with Manulife Securities Inc., said the question he's asking clients this year is whether they can handle a spike in rates.
“If your debt is so large that if the interest rates were to double, can you survive it, knowing what the impact will be on your payments” he asks. “Folks with megadebt, generally $600,000 mortgages or larger, I emphasize they are in a race to get that debt down to a size where they will ultimately pay it off. You want to prevent them from going bankrupt in the future.”
When debt is not a threat, he starts to look at a more mathematical approach when it comes to making an RRSP contribution.
“Let's say their mortgage is 3%, we all know that's an after-tax cost because you pay your mortgage out of your net paycheque. If you gross up by someone's tax bracket, basically that 3% mortgage cost is more like 4% to 5% cost. So you need to make that much,” says Mr. Rosentreter.
Putting money in an RRSP results in the advantage of deferring taxes and an immediate tax refund. “It only counts for something if you do something smart with the refund,” says Mr. Rosentreter.
Finally, if you are just going to take money and invest it into something as conservative as a guaranteed income certificate, which might net you 2%, you are ultimately going backwards.
“Unless you are going to be a balanced investors and be in the stock market, it probably does make sense to pay off the debt ahead of the RRSP because your interest rates are so low on the return side,” he says.