Sometimes not playing by the rules can pay off.MARK POPROCKI/Getty Images/iStockphoto
Recent changes to registered retirement income fund (RRIF) rules allow retirees to defer tax on more of their retirement savings, because the required minimum withdrawals are now lower than before. But does it always pay to take advantage of the changes?
Under the new rules for RRIF withdrawals announced with the federal budget in April, retirees can now withdraw less from a RRIF and defer tax on more of their retirement savings. The new rules "will help reduce the risk of outliving one's savings," the government said when it announced them, adding by age 90 the new rules will allow almost 50 per cent more capital to be preserved compared with the former rules.
But what if your concern is not making sure you don't outlive your savings, but in minimizing your total lifetime tax bill – including the bill on your final return? Should you still follow the new rules for RRIF withdrawals? Let's look at a case where not following the rules can pay off.
RRIFing now versus later: Rebecca and the rules
Rebecca, age 60, is widowed and developing a retirement income plan to the age of 95. She has a small defined benefit pension plan paying $10,000 per year, she is retired and collecting CPP plus a survivor CPP pension from her husband, and she expects to receive Old Age Security (OAS) payments starting at age 65. She estimates her living expenses at $40,000 per year.
Rebecca's assets include $1,000,000 in an RRSP, $80,000 in a TFSA (including the value of her spouse's TFSA rolled over to her), and a principal residence worth $800,000. We'll assume her investments are growing at a nominal 6.5 per cent per year and her house is appreciating at 3 per cent per year (the same as our assumed inflation rate).
Now let's look at the difference in outcomes if Rebecca defers tax on her registered assets as long as possible by waiting until she is legally required to convert her RRSP to an RRIF and begin withdrawals, about 11 years from now; compared with converting her RRSP to a RRIF now, at her age 60, and beginning withdrawals immediately.
If Rebecca waits to convert her RRSP to a RRIF until she's required to and then withdraws from her RRIF slowly in accordance with the new required minimum withdrawal rules, she will finance her spending needs from her TFSA first and then her RRSP.
If Rebecca converts her RRSP to a RRIF now, she will meet her spending needs by withdrawing from her TFSA and then her RRIF, with any excess recontributed to her TFSA, provided she has contribution room, and to a non-registered investment account if she does not.
Our table compares these two scenarios.
Minimizing the total lifetime tax bill: Should Rebecca start or delay withdrawals from her registered savings account?
Start Withdrawals Now (age 60) | Delay Withdrawals (to age 71) | |
Total income taxes paid from ages 65 to 90 | $1M | $1.35M |
Taxes owing on final return | $327K | $400K |
Lifetime tax bill | $1.327M | $1.75M |
Total estate value | $4.4M | $4M |
With thanks to Jason Pereira, Senior Financial Consultant at Bennett March & IPC Investment Corp
In this case, with these variables, if Rebecca's goal is to minimize total lifetime taxation, she should convert her RRSP to a RRIF now – and avoid waiting until she's required to take income from her RRIF. By "RRIFing" now rather than later, her total estimated lifetime tax bill is 24 per cent lower than if she waits to withdraw from her RRIF; and her estate value, after tax has been paid, is 10 per cent larger.
Additionally, as a result of minimizing her tax and taxable income while alive, Rebecca also maximizes her Old Age Security income if she starts withdrawals now. If she waits until age 71, her registered assets have grown large enough that the required withdrawal amounts push her taxable income far enough above the clawback threshold that her OAS is eliminated completely.
Should you follow Rebecca's lead?
Of course, this analysis assumes Rebecca's main goal is to minimize her total tax payable, as she is not concerned about whether her assets will be sufficient to support her spending needs, even if she lives to age 95 or beyond. (It also assumes she lives to age 95, not earlier, and not later.)
For a retiree worried about ensuring her nest egg lasts as long as she does, even if that is a very long time, sticking to the RRIF schedule and taking only the new lower required withdrawals may be a better strategy.
Now, you may argue that the outcome for Rebecca works only in her specific case, and might be different if any of the details of her situation were changed – but that is, in fact, precisely our point.
The takeaway? Your financial plans in retirement should be governed primarily by your own goals, preferences and circumstances, not by general rules and requirements that set out minimum standards. That is: What makes good public policy may not make good personal policy, and it can pay to contemplate the difference.
Alexandra Macqueen, CFP, teaches and writes about finance in Toronto. She is co-author, with Moshe Milevsky, of Pensionize Your Nest Egg: How to Use Product Allocation to Create a Guaranteed Income For Life. You can follow her on Twitter at @MoneyGal.