Debt sidelines RRSP contributions
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,” says Doug Porter, chief economist with Bank of Montreal.
A recent poll from Bank of Nova Scotia finds only 31 per cent of Canadians plan to contribute to an RRSP, down from 39 per cent just a year earlier. The same poll found 74 per cent feel they can’t afford to make a contribution.
“There is a just a lack of money,” says 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 per cent feel they can’t afford to make a contribution this year, that percentage is down from 84 per cent a year ago. “It’s a bit of a head scratcher for us,” says 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 per cent of people in the province. The study further found 40 per cent 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 per cent 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,” says 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 Maurin. “You have credit card debt, you should absolutely focus on that. But mortgage? So many people have bought or refinanced in or around three per cent, 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 per cent of respondents had made an RRSP withdrawal, which was up from 36 per cent the previous year.
Of that 40 per cent, 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,” says 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 per cent of Canadians say maintaining their current lifestyle was a priority, compared with 31 per cent 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 one per cent 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,” Lorentz says.
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 per cent and registered education savings plans were at 28 per cent.
Kurt Rosentreter, a financial adviser with Manulife Securities Inc., says 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 mega-debt, 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.”
When debt is not a threat, he starts to look at a more mathematical approach when it comes to making an RRSP contribution.
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 Rosentreter.