As part of an ongoing effort to prepare employees for life after work, employers across the country have made group RRSPs available to their staff. In theory, a group RRSP should play a key role in ensuring working Canadians are financially ready for retirement. And while group RRSPs are often immensely successful, reality shows that many Canadians approaching retirement have not yet built up adequate nest eggs. While there are many factors why this is the case, early RRSP withdrawals are undoubtedly one of the key causes.
High withdrawals in group RRSPs are common because there are often no restrictions or penalties in place that would discourage early withdrawals. With that in mind, there are many things plan sponsors can do to address this phenomenon. This blog will explore some of those options.
Communicating with plan members
Regardless of what type of plan is being sponsored, it’s important that employers regularly communicate with plan members on why the plan is in place and reiterate the fact that the ultimate goal behind the plan is to ensure that employees save enough to have a comfortable retirement. The tax advantages of an RRSP as well as the tax penalties associated with making early withdrawals could also be highlighted. These messages can be communicated in various formats such as company-wide emails, posters, etc.
These communications ultimately serve two purposes. First, they emphasize to employees that their employer cares about them and is invested in their well-being. Secondly, it’s a way of regularly putting the plan in perspective and reminding plan members that it’s not a mere savings account but a retirement plan. The latter is particularly important considering the fact that some plan members might wrongly perceive a group RRSP as a type of bonus or income supplement.
Communications in themselves however will only go so far. One of the simplest ways group RRSP sponsors can discourage withdrawals is by putting in place withdrawal penalties. These can be done in different ways. One of the most commonly applied penalties is that employer contributions would be withheld for a predetermined amount of time (often 1 year) should an employee making a withdrawal from the RRSP. This can be a very powerful deterrent for plan members who generally view employer contributions as a key component of their benefits package.
Alternatively, the penalty could take the form of a match reduction. For example, if a company offers its employees 4% matching contributions (as a percentage of salary), this can be reduced to 3% for a year for those who make withdrawals. While this approach may not be as effective as the first at discouraging withdrawals, it also ensures that plan members would continue to benefit from most of the match even after they had made a withdrawal. It may however overcomplicate plan administration.
Whichever penalty a plan sponsor chooses to utilize, it is critical that it be communicated to plan members clearly and in full detail. Announcing the implementation of withdrawal penalties may result in some push back from staff and this is why it is essential that the plan sponsor include in the communication, an explanation of why these penalties have been put in place (i.e. to discourage plan members from making early withdrawals that can impact their well-being in retirement). These communications can be accompanied with examples of the effects early RRSP withdrawals can have in the short and long-term. For instance if an employee were to withdraw $1000 from their RRSP today, they would have to pay a withholding tax on that amount as well as a higher income tax. They would also not benefit from compound growth. Assuming average investment returns of 6%, that $1000 could have grown to $5,743 over a thirty year period.
To maintain some flexibility and minimize backlash, some sponsors can choose to add an emergency clause whereby some withdrawals would be exempt from a penalty if a plan member can demonstrate that the withdrawal is needed to meet an essential expense.
Deferred Profit Sharing Plans
Another option plan sponsors may want to consider is to set up a Deferred Profit Sharing Plan (DPSP). This can be paired with a group RRSP whereby all employer contributions would go into the former while employee contributions go into the latter. Unlike a group RRSP, a DPSP gives sponsors more control over being able to restrict withdrawals. And although the plan members can withdraw from the RRSP, the same type of penalties discussed above can be implemented for the employer contributions going into the DPSP. This results in a more robust plan overall with more mechanisms in place to limit withdrawals.
DPSPs however do have their limitations. As their name implies, they can only be implemented by for-profit companies. And while plan sponsors can restrict withdrawals during an employee’s tenureship with the company, this no longer holds should they leave in which case they would be able to convert it into an RRSP.
Defined Contribution Pension Plan
This brings us to Defined Contribution Pension Plans (DCPPs). These are without a doubt the most robust among all capital accumulation plans. DCPPs by default do not allow plan members to make withdrawals (all contributions are locked in). And even if an employee were to leave an organization, they would either have to transfer the assets to another DCPP (at another employer) or convert it to a locked-in RRSP. In that sense, DCPPs are the best choice for plan sponsors who want to ensure that all contributions made are going towards funding retirement.
All that being said, DCPPs do introduce an inflexibility that may be unappealing for younger employees. Group RRSPs for instance allow plan members tax-free borrowing from their accounts to fund the purchase of a home (as part of the Home Buyers’ Plan) or continue their education (as part of the Lifelong Learning Plan). These are obviously not possible under a DCPP. This has led some sponsors to offer both a DCPP as well as a voluntary group RRSP (with only employees contributing) to their staff. A TFSA could also be used to supplement a DCPP.
Plan sponsors have the opportunity to raise morale and improve retention by demonstrating to their employees that they care about their well-being and retirement readiness and have taken the time to structure a more robust outcome-oriented retirement plan. With that in mind, there are many different levers plan sponsors can use to curb or eliminate early withdrawals. As outlined above, these levers can be used in combination with each other. While there can be no doubt that early RRSP withdrawals is a harmful phenomenon that requires immediate action from sponsors, identifying the best approach requires considering various factors such as staff demographics, size of average withdrawals, as well as the goal behind offering the retirement plan. Open Access’ team is available to help plan sponsors interested in a consultation. If interested, simply post “consultation” in the comment section below and one of our team members will get in touch with you.
Open Access is a discretionary manager of group retirement plans. Being a fiduciary, we are legally and structurally bound to act in the best interests, and only the best interests, of our clients. This means no proprietary products, no conflicts of interest, and no hidden fees.