The RRSP is one of the key pillars of retirement savings, and although many people contribute to their RRSP because of the immediate tax savings, an RRSP is also one of the best methods for long term savings. Much has been written about accumulating growth in RRSPs, but as the baby boomers begin to enter retirement age more attention needs to be paid to withdrawal strategies.
If you have been a good saver and contributed consistently, you should be rewarded with a sizeable six or seven figure RRSP. Savings like that can go a long way towards making your retirement much more enjoyable. The only issue now is addressing how to withdraw money out of the RRSP without paying more tax than you should?
The key benefit of an RRSP is that it allows you to defer taxes based on the assumption of being in a higher tax bracket in your working years and then moving into a lower tax bracket during retirement. At some point however the money must be taken out. The government has made the deadline age at 71 for when you must convert your RRSP into a Registered Retirement Investment Fund (RRIF) or an annuity and start withdrawing money at a government prescribed rate. It is important to note that you do not need to wait until you turn 71 to set up a RRIF, it may be done well before the deadline age of 71. The problem with waiting until then is that you may have little flexibility as to what you can withdraw. In some circumstances the mandatory withdrawal amount may push you into higher tax brackets. That being said, it is key to develop a strategy to ensure that you are maximizing the capital you have available in your retirement years.
Why develop a strategy?
- OAS claw back: As of July 2019, Old Age Security (OAS) claw back begins at a rate of 15% once your worldwide income exceeds $77,580; the claw back becomes 100% once your income reaches $125,937. If you have higher taxable income from other sources, such as a workplace pension or investment income, it could be advantageous to delay taking OAS income and withdraw from your RRSP.
- CPP and OAS deferral: Both Canada Pension Plan (CPP) and OAS allow you to defer receiving payments until age 70. Every month you delay receiving CPP and/or OAS results in an increase in payments (when you do start) of 0.6% per month, up to a maximum of 36%. In the meantime, you can withdraw from your RRSP to fill the income gap with the goal of lowering your future RRIF payments and ultimately reducing or eliminating the OAS claw back. This strategy can become complex and is best addressed through financial planning with your advisor.
- Spousal RRSP: If your spouse’s RRSP value is lower than yours and you still have contribution room available, you could withdraw from your RRSP and contribute that amount to a spousal RRSP. Keep in mind that the withholding tax will still be payable at the time of the withdrawal but will be recovered when income taxes are filed in the spring. This means that for this strategy to be effective, you will need to top-up the spousal contribution by the amount of the withholding tax, which could be up to 30%, depending on the amount withdrawn from your RRSP.
- Deferral of lifestyle: Retirement is not about money and taxes. People who defer withdrawing from their RRSPs until age 71 could be restricting their lifestyle. Focusing on reducing the amount of taxes payable on a yearly basis risks losing sight of long-term planning. RRSP/RRIF withdrawals do not have to be spent and actually do not have to be in cash. Securities can be withdrawn in-kind and remain invested in a taxable account or TFSA, if contribution room is available.
- Taxation of RRSPs at death: Under the Income Tax Act a deceased individual is deemed to have disposed of all assets at fair market value at the time of death; this includes RRSPs/RRIFs. This means that the full account balance of your RRSP/RRIF is fully taxable income. Your estate may end up paying more tax than necessary if you have not taken appropriate steps ahead of time to reduce or eliminate your RRSP/RRIF from being taxed. i.e. an RRSP/RRIF balance of $500,000 results in approximately $230,000 of taxes owing. Naming a qualified beneficiary may allow for a tax-free rollover into their RRSP/RRIF. However, if the beneficiary is not a spouse, such as a son or daughter, than the full amount is taxed in the estate. If no beneficiary is qualified for a tax-free rollover, having a withdrawal strategy while living could ultimately reduce the taxes payable at death. If you think about it, you would never withdraw all of your RRSPs at once while you are living because the tax hit would be too severe, but that’s exactly what happens when you pass away. Deferring tax to retirement makes sense but deferring tax to death may actually be counterproductive from a tax perspective.
- Using the younger spouse’s age for retirement benefits.
If you have an RRSP, you may benefit from a “meltdown strategy” years before you turn 71 so you have time to implement it. My advice has always been for retirees to sit down with a financial planner once they have a retirement date in mind. The point of developing RRSP/RRIF withdrawal strategies is to help retirees achieve their desired retirement lifestyle and minimize taxes over the long term. Some retirees have low spending requirements, but they become too focused on tax deferral that they withdraw very little money from their RRSP/RRIFs. Even if you do not need the money, it might make sense to develop a withdrawal strategy solely for long term tax planning.
Planning is personal
All the theory in the world is useless unless it can be applied in the correct circumstances. I’m always concerned that someone will read this article and then withdraw from their RRSPs that ends up costing them more in the long run. Remember that planning is personal and just because a specific strategy makes sense for one person or couple does not mean it is an appropriate strategy for you. Customized planning can make all the difference, so speak with your accountant and financial advisor regarding your retirement planning sooner rather than later.
Source: Hamed Murad, BA, CIM
Wealth Counsellor with Wealth Stewards