By Arthur Pinkasovitch
Planning for retirement involves a wide range of considerations – from determining the ideal types of accounts and investments to be included in a retirement plan, to budgeting for future vacation travels. Another essential consideration is one’s desired retirement destination; while weather and entertainment facilities are definitely worth considering, the types of financial and health care incentives that governments provide to their retirees also carry significant weight. American and Canadian governments provide many of the same types of services to those planning for retirement. Yet, the subtle differences between the two countries are worth noting.
RRSP vs. Traditional IRA
The Canadian government offers several unique alternatives that individuals can take advantage of in order to avoid paying excessive taxes. Registered Retirement Savings Plans (RRSP) allows investors to receive a tax deduction on their yearly contributions, resulting in time value of money advantages as tax efficient growth advances the benefits of compounded returns. Contributions can be made until the age of 71, and the government sets maximum limits on the amount of funds that can be placed into a RRSP account. Withdrawals can occur at any time, but are classified as taxable income, which becomes subject to withholding taxes. In the year in which the taxpayer turns 71, the RRSP must be either cashed out or rolled over into either an annuity or Registered Retirement Income Fund (RIF). (Increasing your savings will provide tax benefits – and peace of mind. Check out Maxing Out Your RRSP.)
For American taxpayers, a Traditional IRA is structured to provide the same sorts of benefits, whereby contributions are tax-deductible and capital gains are tax deferred until distributions out of the account are realized. Age stipulations are similar; investors can contribute into their Traditional IRA until they reach 70-1/2, at which point mandatory distributions are required. Additionally, in contrast to a RRSP account, which has a maximum contribution of $26,010 for 2017, the IRS states that “the maximum contribution that can be made to a Traditional or Roth IRA, is the smaller of $5,500, or the amount of your taxable compensation for the taxable year.” People over the age of 50 can sock away an additional $1,000 per year in their IRAs. Despite that RRSPs allow for greater contributions, wealthy Canadians tend to pay more taxes than their southern neighbors.
TFSA vs. Roth IRA
Canada’s Tax-Free Savings Account (TFSA) is fairly similar to Roth IRAs found in the U.S. Both of these retirement-focused vehicles are commonly known as tax-exempt accounts, meaning that they are funded with after-tax money and provide growth tax free, even when funds are withdrawn. TFSAs allow for long-term retirement planning, as Canadian residents over the age of 18 can contribute $5,500 annually to this account, according to 2017 limits. On the other hand, almost anyone can contribute to a Roth IRA regardless of age, but, more importantly, maximum contributions are also $5,500, and $6,500 for those over the age of 50. Another similarity between these accounts, which differentiates them from tax-deferred plans, is that there is no limit on when one must stop contributions and begin withdrawing money.
TFSAs offer two significant advantages over the American alternative. Young Canadians saving for retirement are able to carry over their contributions to future years, while such an option is not available with Roth IRAs. For example, if a tax payer is 35 years old and is unable to contribute $5,500 into their account, due to an unforeseen outlay, next year the total allowable amount accumulates to $11,000. The contribution limits have changed year-to-year since the TFSA was first introduced in 2009, with the limit sometimes set at different ranges between $5,000 and $10,000; the current cumulative limit for 2017 is $52,000. Secondly, distributions out of Roth IRAs must be classified as “qualified” in order to qualify for the preferential tax treatment. Qualified distributions are those made after the account has been open for five years, and the taxpayer is either disabled or is over 59.5 years of age. Canada’s plan does offer more flexibility in terms of providing benefit for those planning for retirement. (There are advantages and disadvantages to both types of savings accounts. Find out which one is right for you. See Retirement Savings: Tax-Deferred Or Tax-Exempt?)
Old Age Security vs. Social Security
American Social Security is remarkably different from Canada’s Old Age Security (OAS) programs. Although Canada also has such retirement savings plans, such as the Canadian Pension Plan (CPP), they will not be compared with Social Security in this article. Financed by Canadian tax dollars, OAS provides benefits to eligible citizens 65 years of age and older. Although there are complex rules to determine the amount of the pension payment, typically a person who has lived in Canada for 40 years, after turning 18, is qualified to receive the full payment of $583.74 per month, according to the latest 2017 estimates. Additionally, Guaranteed Income Supplements ($871.86) and Allowances ($1,108.59) are provided for pensioners making less than $17,688 and $38,736 annually. Much like with Social Security, OAS beneficiaries who choose to delay receiving benefits can get higher payouts; currently, benefits can be delayed for up to 5 years. OAS benefits are considered taxable income and carry certain payback provisions for high income earners.
Social Security, on the other hand, does not focus exclusively on providing retirement benefits, but encompasses such additional areas as retirement income, disability income and Medicare and Medicaid. Social Security income tax issues are slightly more complex, and depend on such factors as the recipients’ marital status and whether or not income was generated from other sources; the information provided in the IRS Form SSA-1099 will determine the tax rate for the benefit. Individuals are eligible to receive partial benefits upon turning 62, and full benefits ($2,687 per month is the maximum as of 2017) once they are 66 or 67, depending on the year of birth. Eligibility is determined through a credit system, whereby qualified recipients must obtain a minimum of 40 credits, and can earn additional credits to increase their payments by delaying initial benefit payments. Generally, Canada’s retirement programs are considered safer as there are continuous looming debates that the U.S. will eventually deplete its Social Security funds. (You’ve probably contributed to this fund, but will you reap the benefits? Find out here. Refer to Introduction To Social Security.)
Quality of Life
Both Canada and America typically rank near the top of the human development index, which integrates such factors as life expectancy, education and standard of living. However, Canadian retirees find life after work to be much less stressful, as fears of running out of money are not as prevalent. As a result, more often, American retirees tend to find alternative sources to supplement their retirement incomes. The major benefit for Canadian retirees is the publicly-funded healthcare system, which provides essential services to its residents. The private American system, on the other hand, puts a much greater burden on retirees. A study by the Employee Benefits Research Institute estimates that a 65-year-old couple, without employer health coverage, will require approximately $700,000 to comfortably cover the out-of-pocket medical expenses not covered by Medicare.
The Bottom Line
Regardless of the retirement destination, the same basic rules apply to both countries: do not wait until the age of 50 to begin planning – focus on safe investments, save a substantial portion of your monthly income, build an emergency fund and use the financial services provided for the purposes of tax-efficient retirement investing.