January 2009

Creditor-proof RRSPs

New legislation gives all RRSP’s the same protection from creditors that Registered Pension Plans and insurance-based RRSP’s already enjoyed.

After more than a decade of government discussions, Law C-12 came into force last summer, exempting all Registered Retirement Savings Plans from bankruptcy proceedings.

Under a typical personal bankruptcy, all of the person’s assets become the property of a bankruptcy trustee. The trustee in turn uses those assets to pay off creditors. Some assets, such as company pension plans and insurance-linked RRSP’s, were previously exempt from bankruptcy proceedings under a patchwork of federal and provincial regulations.

Not all RRSP's were created equal

But that left holders of other RRSP types, such as those held by banks, brokerages or mutual funds, out in the cold if bankruptcy, or even a serious personal debt crisis, appeared on the horizon. Over the years Saskatchewan, Prince Edward Island, Manitoba and Newfoundland moved to protect all RRSPs, but a blanket Canadian law failed to materialize.

The issue first appeared at the federal government level in 1996, when the Bankruptcy and Insolvency Advisory Committee unanimously recommended all RRSP’s be exempt from seizure. A year later a Senate committee made the same recommendation.

But the issue was not without its opponents: Naturally such protection means lower returns for creditors, who often must absorb a certain amount loss anyways; and there were fears based on the fact that many RRSPs can be used for non-retirement purposes, and can be redeemed at any time. Fears were that some people might try to use them to hide money from their creditors, and then cash them in once the coast was clear.

Changing economy

However, the face of the Canadian workforce has changed over the years. Fewer people stay in the same job for most of their careers, so a company pension is no longer the retirement tool it once was. More and more Canadians are self-employed or work for small businesses that turn to group RRSPs to provide future pension income. In today’s world RRSP’s are increasingly used either as the central element or as an addition to a well-rounded retirement strategy.

Legislation was introduced on several occasions over the last dozen years to address the issue, but the gears of the Canadian government ground to a halt each time. Bill C-55 stalled in the Senate. Amendments to the Bankruptcy and Insolvency Act were struck down when it was found they encroached on provincial legislative jurisdiction. Bill C-62 died on the order paper in June 2007, but was reintroduced a year later as Bill C-12. It was passed into law in December 2007, but only came into force in July 2008.

Here’s a quick look at some of the main provisions of Law C-12, which is complementary to provincial laws already in force:

  • assets held in registered retirement savings plans (RRSPs) and registered retirement income funds (RRIFs), as defined by the Income Tax Act, cannot be subject to seizure or an enforcement action against the bankrupt person; this applies to all personal bankruptcy actions filed after July 7, 2008;
  • an exception is made for contributions made in the 12 months prior to the bankruptcy claim, or any other delay established by the Court when it is clear that the bankrupt person made a deliberate effort to avoid their creditors ;
  • in addition, the Wage Earner Protection Program ensures workers get paid wages owed them before the creditors are paid, up to a maximum of $3,000 per person if their company goes bankrupt; the rule applies to unpaid salaries in the six months prior to the bankruptcy application.

All of this makes RRSPs – which were already popular investment vehicles for Canadians planning their retirement – even more attractive. When the unexpected happens investors can rest assured their retirement savings will be safe from creditors.

New challenge

But with the economic downturn a new RRSP issue is on the horizon: Retirees must convert their RRSPs to RRIFs by age 71. For those about to reach that age the recent drop in the stock markets means having to convert their RRSP – and the obligation to start making significant withdrawals – at a time when their RRSP has lost as much as 40% of its value.

Some Canadian Premier’s are calling for the mandatory conversion age to be raised to 75, allowing pensioners to wait until the markets recover. But judging from how long it took to enact full RRSP protection, it may be quite awhile before that change sees the light of day.