Planning for retirement involves a wide range of considerations, from determining the ideal types of accounts and investments to be included...
American and Canadian governments provide many of the same types of services to those planning for retirement. Yet there are subtle differences between the two countries that are worth noting.
RRSP vs. traditional IRA
The Canadian government offers several unique alternatives that individuals can take advantage of to avoid paying excessive taxes. Registered Retirement Savings Plans allow investors to receive a tax deduction on their yearly contributions, and the tax-efficient income growth raises 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 an 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 a Registered Retirement Income Fund.
For American taxpayers, a traditional IRA is structured to provide the same sorts of benefits -- contributions are tax-deductible and capital gains are tax-deferred until distributions from the account are made. Age stipulations are similar; investors can contribute to their traditional IRA until they reach 70½, at which point mandatory distributions are required.
In contrast to the rules for an RRSP account, which has a maximum contribution just over $20,000, the Internal Revenue Service states that "the maximum contribution that can be made to a traditional or Roth IRA is the smaller of $5,000 or the amount of your taxable compensation for the taxable year." Although 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 is fairly similar to Roth IRAs 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as tax-exempt accounts, meaning that they are funded with after-tax money and provide tax-free growth, and funds can be withdrawn without taxation. TFSAs allow for long-term retirement planning, as Canadian residents over 18 can contribute $5,000 annually.
On the other hand, almost anyone can contribute to a Roth IRA regardless of age. More important, maximum contributions are also $5,000 ($6,000 for those over 50). Another similarity with these accounts, one that differentiates them from tax-deferred plans, is that there is no limit on when you 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 allowed contributions to future years, while such an option is not available with Roth IRAs. For example, if a 35-year-old Canadian taxpayer is unable to contribute $5,000 into his account, next year the total allowable amount accumulates to $10,000.
Secondly, distributions from Roth IRAs must be classified as "qualified" to get 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 59½. Canada's TFSAs offer more flexibility, since the money can be withdrawn at any time without a tax penalty.
Old Age Security vs. Social Security
America's Social Security system is remarkably different from Canada's Old Age Security programs. (Although Canada also has retirement savings plans, such as the Canadian Pension Plan, they will not be compared with Social Security in this article.) Financed by Canadian tax dollars, OAS provides benefits to eligible citizens 65 and older. There are complex rules to determine the amount of the pension payment, but typically a person who has lived in Canada for 40 years, after turning 18, is qualified to receive the full payment of $533.70 per month at age 65.
Additionally, Guaranteed Income Supplements ($732.65) and Allowances ($1,013.54) are provided annually for pensioners making less than $29,904 and $38,784, respectively. 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 and includes additional benefits such as disability income. Social Security income tax issues are slightly more complex and depend on such factors as the recipient's marital status and whether income was generated from other sources. (Information provided in 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 ($2,346 per month as of 2011) once they are 67.
Eligibility is determined through a credit system whereby qualified recipients must obtain a minimum of 40 credits, and they can earn additional credits to increase their payments by delaying initial benefit payments. Generally, Canada's retirement programs are considered more secure, as there are concerns that the U.S. will eventually deplete its Social Security funds.
Quality of life
Both Canada and America typically rank near the top of the United Nations' Human Development Index, which uses such factors as life expectancy, education and standard of living. However, Canadian retirees find life after work to be much less stressful, as fears about running out of money are not as prevalent. As a result, American retirees more often tend to find alternative sources to supplement their retirement incomes.
The major benefit for Canadian retirees is the publicly funded health care system, which provides essential health services to its residents. America's private health care system, on the other hand, puts a much greater financial 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 out-of-pocket medical expenses not paid by Medicare.
Conclusion
Regardless of the retirement destination, the same basic rules apply to both countries. Do not wait until age 50 to begin planning, focus on safe investments, save a substantial portion of your monthly income, build an emergency fund, and use the financial plans available for tax-efficient retirement investing.
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