Hobbling investment: The 20% foreign content rule for RRSPs should be abolished
Quebecers and Canadians have been putting a great deal more of their savings into Registered Retirement Savings Plans (RRSPs). These private retirement funds surged a whopping 253% between 1979 and 1996!
The government currently limits RRSPs to a 20% foreign (non-Canadian) equity ceiling. Revenue Canada taxes the difference on those who fail to comply.
A recent study by Jason Clemens for the Fraser Institute clearly demonstrated how this rule has the perverse effect of boosting risk by putting all of one’s capital eggs in one basket – while cutting returns. Any financial adviser will tell you the secret to a good retirement portfolio is diversification. But the Canadian government effectively compels Canadians to hold more than 80% of their assets in a market representing less than 1% of the world’s funds.
In addition, this system condemns investors to returns far less than they could expect with unrestricted international investment ability. The Clemens study shows how a 25-year-old who starts investing in an RRSP today is likely to save no more than half a million dollars by the time he or she retires.
However, the Conference Board of Canada estimates the 20% foreign fund cap will affect a mere 30.3% of all Canadian savings in 1996 (Maximizing Choice: Economic Impact of Increasing the Foreign Property Limit, p. 2).
The RRSP is thus not a tax shelter of choice for the very rich and well endowed. Because of limits on contributions, it is mostly taxpayers earning less than $75,000 annually who use it for their retirements.
Then why impose such costly limits? Those who designed the system claim it brings more investment to our local market. Were it abolished, our savings would flee to foreign markets, they say. This probably is not true. Such barriers to free investment could have the reverse effect. In late 1998, 25.6% of all money invested in mutual funds went to Canadian companies. Of this percentage, the very large majority was actually placed in blue-chip Canadian firms. Small business clearly did not reap the windfall of foreign investment restrictions.
Even if the 20% rule were eliminated, investors would largely continue to place their funds here because this is the market and these are the businesses they know best. Economists call such a phenomenon “home bias.” We naturally prefer to invest in companies we know best because we trust them more.
We should seriously consider changing the 20% rule because the current system actually creates less investment, less return on investment, and ultimately less retirement income. Such reform becomes even more imperative since the federal and provincial governments will not be able to handle the financial needs of hundreds of thousands of retirees generated by an inverted population pyramid.
Michel Kelly-Gagnon is President of the MEI.