CANADA AND U.S. ON EQUAL FOOTING

Most Canadians have the impression that Americans pay a lot less than we do in income tax, but that we have better pensions from government sources. If you subscribe to this tax envy and pension smugness, the reality will come as a surprise.

Consider government pension programs first. A single person who is age 65 with final average earnings of $100,000 would receive a Social Security pension of $2,404 a month in the U.S. while a Canadian with the same earnings would receive only $1,629 from CPP and OAS combined. The reason that U.S. Social Security pays so much more is that the ceiling on pensionable earnings is much higher. Under the Canada Pension Plan, one makes contributions and earns pension on just the first $53,600 of 2015 employment income. The equivalent earnings ceiling for U.S. Social Security pensions is US$118,500. This helps to explain why there is so much ongoing angst in Canada about the need to expand CPP while it is a non-issue in the U.S.

So why is the poverty rate among seniors so much higher in the U.S. (roughly 20 per cent versus Canada’s six per cent)? While higher-income Americans have better coverage than Canadians, lower-income Canadians, who are more likely to retire poor, fare much better than their U.S. counterparts. The U.S. has no equivalent to our Old Age Security pension that depends only on residency, or to our Guaranteed Income Supplement that depends on residency and income.

A comparison of the income-tax burden is equally surprising. Take a higher income household in which the primary breadwinner makes $100,000 and the spouse makes $60,000. Under a certain set of assumptions, the total tax paid in the U.S. would be $48,000 versus just $43,000 in Canada. To calculate these tax bills, I assumed the following:

The U.S. situation is based on residency in New York state while the Canadian couple lives in Ontario. There are no dependent children. The tax calculation includes Social Security taxes and the Medicare tax in the U.S. while in Canada it includes CPP contributions and the Ontario health premium tax. Employment insurance premiums are excluded. Each couple is contributing 10 per cent of pay into tax-assisted retirement vehicles.

You might be inclined to think the example is skewed a little in Canada’s favour for a variety of reasons. Some states levy lower state income taxes than New York and some none at all. The Social Security taxes in the U.S. are higher but so is the pension benefit. Some deductions which are permitted only in the U.S. — a deduction for mortgage interest in particular — are not reflected in this comparison.

On the other hand, some Canadian provinces have lower income taxes than Ontario and most provinces do not impose a separate health premium tax. Canada’s universal access to health care provides broader and more comprehensive coverage than U.S. Medicare. And Canadians have higher tax-deductible limits for RRSPs than the comparable savings vehicles for individuals in the U.S. On balance, I would say that the above comparison of tax burdens in higher-income households is a fair one and that Canadians come out on top. If earnings were much higher, say at the $400,000 level, this would no longer be true, but that situation applies to only a tiny sliver of the Canadian population.

In the case of middle- to upper-middle-income households, the similarities between the U.S. and Canada far outweigh the differences. For example, in both countries we find that:

it is a matter of ongoing national concern that workers may not be saving enough for retirement;

perceptions about the ideal retirement income target are similar, and equally erroneous;

retirees dread the possibility of outliving their savings but do not buy annuities;

extraordinarily low interest rates and longer life spans are presenting similar challenges to individuals and pension plan sponsors;

the choice of retirement vehicles and their tax status is remarkably similar (RRSPs, TFSAs and DC pension plans in Canada versus IRAs, Roth IRAs and 401(k) plans in the U.S.);

the type of pension plan that had dominated the landscape for decades — defined-benefit — is rapidly on the decline and is being replaced with defined-contribution arrangements, and;

the same anxiety prevails about how to deal with the potentially high cost of long-term care.

This leads to the conclusion that whether you are Canadian or American, the really important retirement questions are essentially the same. In particular:

What is your retirement income target and what factors can affect it? How much money do you need to retire comfortably? How do you fit saving into your other spending priorities without creating undue hardship?

Once you have retired, what percentage of assets can you safely draw down each year without running out or leaving too much on the table? Do annuities make sense? What are the chances you will eventually need long-term care and how do you finance it?

These questions will be explored in future instalments in the next few months.