Article content continued

But, have you ever wondered where the 18 per cent contribution limit percentage came from?

It has to do with something called the “Factor of Nine,” a “little-known, outdated ‘equivalency test’ for savings in various retirement saving plans.” The Factor of Nine uses a hypothetical defined-benefit pension plan in which saving nine per cent of an employee’s annual earnings will let an individual buy a retirement annuity equal to one per cent of pre-retirement income.

The Tax Act lets a member of a defined-benefit pension plan accrue a maximum annuity of 2 per cent of final earnings tax-free in the year of accrual, which, over a 35-year working career, would provide a pension equal to 70 per cent of pre-retirement earnings. The Factor of Nine therefore limits RRSP or defined-contribution pension plan contributors to making contributions worth up to 18 per cent of their earnings a year (9 x 2 per cent).

While the Factor of Nine was designed to let RRSP retirement savers achieve an equivalent outcome as defined benefit plan members, the current limit “badly damages their hopes of achieving retirement security like that of members of defined-benefit pension plans common in Canada’s public sector,” Mr. Robson contends.

There are various reasons for this. First of all, the hypothetical defined benefit plan under which the Factor of Nine was based is less comprehensive than most actual defined-benefit plans. Worse still, however, is that in the 27 years since its adoption, the Factor itself has become “badly outdated.” Ongoing improvements in life expectancy combined with lower yields on “retirement-appropriate” assets mean that Canadians must save at least twice as much to replace pre-retirement earnings than the Factor of Nine assumes.