For most of one’s adult life, the money-related message about retirement is: save. Make sure you’re going to have enough squirrelled away for when you’re going to have neither a salary — nor, ever more often, a workplace pension — to sustain you. Don’t let younger you spend the money that older you is going to need.
But when you finally reach the mythical life threshold of retirement, the financial headaches are hardly over — even if you do have a sizable amount of money socked away.
One of the chief problems of the golden years is how much to take out, financial advisers say. And while many worry about running out of money, taking out too little can also be a costly mistake, especially if you have considerable funds stashed in a registered retirement savings plan (RRSP) or registered retirement income fund (RRIF). (By the end of the year in which they turn 71, Canadians must convert their RRSP into annuities or RRIFs, which come with mandatory and taxable minimum withdrawals every year.)
The latter issue, in particular, is coming up “more and more” in conversations with clients, said Matthew Ardrey, a wealth adviser at Toronto-based TriDelta Financial. With a wave of boomers now retiring who’ve been told all their lives to save into an RRSP, it’s not uncommon to see retirement accounts worth $1 million, he said. The challenge now becomes what Ardrey calls “decumulation,” or taking the money out in a tax-efficient manner.
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For some with a plump RRSP, the instinct is to take out as little as possible in order to let the capital grow tax-free as long as possible, said Clay Gillespie, managing director at RGF Integrated Wealth Management in Vancouver.
Some believe they shouldn’t touch their RRSPs until they have turned them into RRIFs and make only minimum withdrawals after that, he said.
The trouble with that is that the value of an RRSP or RRIF when you die is generally included on your final tax return, which can lead to a massive tax hit and leave significantly less money for your family. For example, an account worth more than $210,371 in British Columbia would be taxed at a combined federal and provincial marginal tax rate of 49.8 per cent.
The idea isn’t to spend everything you take out but rather to put the surplus in a tax-free savings account (TFSA) or a non-registered account, Gillespie said.
With a TFSA, your designated beneficiaries would only have to pay tax on any income earned by your investments after the time of your death. The rest can be paid out tax-free.
And even in a non-registered account, you can significantly reduce your final tax bill by choosing investments that receive preferential tax treatment, Gillespie noted.
In theory, one way to avoid your RRSP or RRIF balance ending up on your tax return is to transfer the account to financially dependent children or grandchildren. But your descendants would still have to pay tax when the money comes out of the fund. Gillespie argues there are better ways to pass on your wealth.
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The more common way to temporarily defer a hefty one-time tax bill is to transfer your RRSP or RRIF to your spouse or common-law partner. Eventually, though, there will still be a final tax reckoning.
That’s why couples should develop a withdrawal strategy together, Gillespie said. When he does the math for clients, he usually assumes the younger spouse will live to age 95, which is the average life expectancy for men and women in Canada plus a buffer of several years. He then works back from that to make sure the pace of the withdrawals guarantees there’s enough money to cover expenses for the entire period while minimizing the overall tax.
The right strategy depends on a variety of factors, including other sources of retirement income, government benefits, when retirement starts and the couple’s age, according to Gillespie.
For example, at 65, RRIF income qualifies for income splitting, which can lower a couple’s overall tax burden, he noted. But if you’re retiring early and living off your working spouse’s income, the years up to age 65 may be an opportunity to draw down on your RRSP at a low tax rate. The first $12,069 in income, for example, would be tax-free, while annual withdrawals up to around $40,000 would have an average tax rate of only 14.18 per cent, Gillespie said.
Government benefits should be part of the calculation, too. For couples who are splitting the RRIF income, it may make sense to postpone receiving Canada Pension Plan (CPP) and Old Age Security (OAS) benefits until age 70 to be able to draw down on the RRIF account at low tax rates, Ardrey said.
Both CPP and OAS pension payments are considered taxable income, which could bump you into a higher tax bracket. But with OAS, if your overall income for the year reaches above a certain threshold, you may have to repay part or all of your OAS pension, which is the equivalent of paying a steep tax.
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Figuring out the optimal withdrawal strategy can be rather complex, but one rule of thumb to consider is withdrawing as much as you can from an RRSP or RRIF without hitting the next tax bracket, Ardrey said.
For example, if you were receiving around $20,000 a year in CPP and OAS benefits, which is close to the maximum today, it’s good to know that you could withdraw, roughly, another $20,000 and still remain in the lowest tax bracket, he said.
Whether you’re going to pore over spreadsheets yourself or hire a pro to do it for you, the exercise is worth it. It takes a lifetime of savings to get to retirement — it takes careful planning to make the most of every cent you saved.
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