RRSP/RRIF and non-registered investments

Drawing from your RRSP/RRIF and non-registered investments.

It often helps to think in terms of family wealth and tax efficiency.

One of the most asked questions the newly retired or those about to retire have is: “When should I start drawing from my registered retirement income fund (RRIF) or registered retirement savings plan (RRSP)?”

It’s a hyper-complex question, innocently disguised as a simple one, that can’t be solved by pen and paper. It needs to be modelled and, ideally, modelled in front of the person asking the question.

Main reasons why this question is asked

There are three main reasons why this question gets asked.

First, there is an endpoint in life, and any remaining RRIF capital at that point, if not transferred to your spouse, is paid out as if you received a hefty paycheque and is fully taxed. In most cases, a large RRIF account will lose about half its value to tax. This is an issue if you’re hoping to leave money to your children.

Of course, you wouldn’t have the same tax worries if you could live forever. You’d grudgingly accept your minimum RRIF payments, let the tax-deferred investment growth offered by an RRIF do its thing, and watch your money continue to grow and compound.

The second reason is taxable RRIF payments will affect their after-tax income, government credits and benefits, including Old Age Security (OAS) and Guaranteed Income Supplement (GIS).

Finally, people often have different investment accounts — RRIFs, TFSAs, non-registered investments and maybe investment holding companies — all taxed differently. This leads to another question: “Can I draw from each account in a layered approach, thereby creating an income stream that combines the different tax characteristics of each type of account and reduces the overall tax?”

Dealing with those issues separately is a little complicated, but it gets more challenging to combine them and then add personal circumstances into the mix. Let’s explore a few examples.

Suppose you have more than enough money and want to reduce the tax on your final return by depleting your RRIF before you die. You would either draw out an extra amount from your RRIF and invest the money in a different type of account, give it away or enhance your lifestyle.

Once you draw money from your RRIF and pay the tax, you have less money to invest in a tax-free savings account (TFSA) or a non-registered account. You’re betting that even if the money you have taken out of the RRIF grows to a smaller amount, the after-tax amount will be more significant.

This is generally true if the money goes into a TFSA because it offers tax-free growth and withdrawals. It is not necessarily true if the money goes into a non-registered account where you are paying tax on interest, dividends and distributions along the way, and then capital gains tax when you and your spouse pass away.

If you don’t have the TFSA contribution room, consider gifting to children because you are already topping them up with your non-registered money. If the objective is to reduce tax so your kids get more, why not give while alive?

You could add the money to your children’s TFSA (and ask for it back if needed), registered education savings plan (RESP) or RRSP (which reduces their taxable income and may qualify them for more government benefits), or help with housing costs, life insurance or to create family memories with a memorable trip.

Now, if you are single or a couple without children, you might not care if your estate has to pay a lot of tax. But why not be as tax efficient as you can and draw only the income you need from the RRIF. If you are leaving money to charity, that might be the best way to do things.

A couple might draw more from their RRIF because if one spouse passes early, the surviving spouse may be forced into a higher tax bracket since pension splitting is no longer an option, and they may start to lose some OAS due to the clawback.

Other reasons they or a single person may draw more income than needed from an RRIF are to prevent them from going into a higher tax bracket at age 72 when they are forced to draw a minimum amount or try to minimize OAS clawback.

If you retire before age 65, it may make sense to start RRIF withdrawals right away. Just remember, you can’t split your RRIF income with your spouse until age 65. After that, you can split the income with your spouse, and it qualifies for the pension tax credit if you have no other pension income.

Some suggestions

Now that we’ve thought this through a bit, what will you tell your neighbour if they ask you about their RRIF strategy?

Here are a couple of suggestions, assuming they have an RRIF, TFSA and non-registered account.

As a starting point, they should draw a consistent income from their RRIF so that it depletes between age 85 and 90. You can take a look at what that does for their taxable income when combined with OAS, CPP, and other government benefits/credits. If it is not enough income, they can use their non-registered investments to top it up.
Suggest that your neighbour only use TFSAs for significant one-time expenses or medical expenses later in life. The beauty of the TFSA is that they can withdraw money and not pay any tax on it. It won’t push them into the next tax bracket. If they never spend this money, it will go virtually tax-free to their kids.
That is probably the safest way to advise someone on drawing from an RRIF when you don’t know enough about them and their lifestyle to give proper advice.

It would help if you also suggested that they go to a planner, model your suggestions, and experiment with different RRIF withdrawal start times. The right strategy will become more evident when they model their situation more closely.

Source: Financial Post

Disclaimer:
This article is provided as a general source of information and is intended for Canadian residents only. It may not apply to your particular situation. We encourage you to contact a financial advisor to look at your specific situation. If you don’t have one, don’t hesitate to contact RGB Accounting by phone at (416) 932-1915 or by email at info@rgbaccounting.com, and we will be happy to refer you to a trusted specialist from our referral network.

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