Career moves can hurt nest egg

Money Digest, June, 1997 by Tim Cestnick

I don't enjoy being the bearer of bad news. Next to doctors, tax accountants are probably second in line to have to "break it to them gently" on a regular basis.

Recently I had to explain to a client that he won't be able to make any contributions to his registered retirement savings plan in 1997. He was irate. After all, he's trying to build a nest egg on which to retire in 15 years.

My client discovered a trap that is not only unfair, but is becoming more common all the time -- especially among baby boomers who, by their own choice or otherwise, are making job moves.

Let me tell you about my irate client,Ken. He left his last job on December 31, 1996, and began working for his new employer on January 1, 1997.

He was a member of his previous company's registered pension plan (RPP). His new employer doesn't offer a pension plan, so Ken will spend the next 15 years saving for retirement through an RRSP.

Ken's 1996 earned income was very high at $150,000, so you might expect him to be entitled to make the maximum RRSP contribution of $13,500 in 1997, right? Nope.

Ken won't be able to contribute anything to his RRSP in 1997 because his contribution limit is reduced dollar for dollar by something called his 1996 pension adjustment. The pension adjustment is a complex calculation, but is basically the total of you and your employer's contributions to an RPP in any year.

Ken's problem is not uncommon. If you're a member of an RPP and you're considering a job move, you could face the same situation.

When you terminate your membership in an RPP, you'll still have a pension adjustment amount reported on your T4 slip for that year, so your contributions to an RRSP in the following year will be restricted. Like Ken, you could be left unable to set aside money in any tax-deferred plan the year after leaving your job.

The problem arises because Revenue Canada insists on calculating your RRSP contribution room based on your earned income and pension adjustment for the previous year. There's a one-year lag period.

After spending an hour on the phone with some folks at the Department of Finance in Ottawa, I realized the government does not intend to correct this injustice. In its view, Ken doesn't lose anything because he'll get back this "lost year of contributions" the year after he retires.

He'll get to make RRSP contributions in the year after retirement since he will have earned income the year before -- in his last year of work. He wouldn't have been able to contribute after retirement if he had stayed in his RPP, so he's no worse off, they claim.

Not quite. Ken does lose. He loses the income that could have grown on a tax-deferred basis inside his RRSP from 1997 to the year 2012 when he retires, plus the tax savings from making an RRSP contribution in 1997. Together this amounts to $36,117, assuming an annual return of 9% inside his RRSP and a marginal tax rate of 50%.

What about you? Depending on how long it is until you retire, you'll stand to lose between $12,360 (with five years to go until retirement) and $59,381 (20 years until retirement), assuming a 9% return and a marginal tax rate of 50%.

There are three things you can do to minimize the effect of moving out of a registered pension plan and into an RRSP.

* Find another employer who also has an RPP. In this case, you'll be able to roll the benefits from your old RPP to your new RPP and still contribute to the new RPP in your first year of employment.

* Contribute to your RRSP on January 1 following the year you start your new job. When your new employer doesn't have an RPP, or you don't want to participate in it, be sure to contribute to an RRSP at your first opportunity. (In Ken's case, this will be January 1, 1998, since he started his new job in 1997. His contribution will be deducted on his 1997 tax return.

* Negotiate an extra payment to compensate for the lost growth inside your RRSP. Consider asking for an additional allowance from the employer you are leaving, or for a signing bonus from your new employer. Be sure to have this payment grossed up, so the cash in you hands after taxes represents the true compensation you're looking for.

Tim Cestnick is a partner with Bateman MacKay Chartered Accountants in Burlington, Ont., and author of A Declaration of Taxpayer Rights. (Available at a discount from IAC. See page 14.) Phone (905) 632-6400.

Disclaimer. The views expressed are those of the author and may not represent the views of the firm.