You may be wondering what the most tax efficient way to get money out of your RRSP is. Well, the trouble often starts when you turn 65. If you have a good pension and other investments to draw from, you might not dip into your RRSPs at all at first. But when you turn 71, the government forces you to start withdrawals, and if your income is high, more than 40% of that money could go towards taxes. To try and avoid the problem of your income ballooning when you hit 71, consider retiring earlier than you planned and taking the money out of your RRSP early so it’ll get taxed at a lower rate.
When it comes to when you should withdraw from your RRSP, a balanced approach is usually best. Conventional advice rightly recognizes the tax sheltering advantages of keeping money in RRSPs and RRIFs for longer. But if you empty your non-registered accounts first and then take concentrated RRIF withdrawals later, that can produce spikes in taxable income. Because of the progressive tax system which taxes higher income at much higher rates, that can create a big tax hit down the road.
While figuring out precisely the optimal balanced withdrawal strategy is no doubt complicated, you can still derive a lot of benefits from a few simple actions. You can get a rough sense of the potential tax spike down the road by projecting out the value of your RRSPs and then applying mandated RRIF withdrawal rates to see what that will do to future income. Combine that with other estimated income and you’ll get a rough sense of what tax bracket you might land in. From that you can assess potential tax spikes and the benefit of avoiding them.
A key tax bump for affluent seniors to keep an eye on is the Old Age Security (OAS) clawback on taxable incomes greater than $70,954*. Above that threshold, seniors give up 15 cents of OAS for every dollar of income until the OAS is entirely eaten up. Smoothing out income to stay just under $71,000 will help you collect your full OAS entitlement every year. Another major tax bump occurs at $43,561*, which is the start of the second federal tax bracket. Incomes above that threshold are taxed at a marginal tax rate that is seven percentage points higher than just below it.
When you are ready to retire, most people decide to change the composition of their investments, now that income and safety are priorities, rather than growth. This can mean adding an annuity, which guarantees a set monthly payment for a set period of time (often for life). Other options included bonds, dividend-paying stocks and even income trusts.
You can also choose at what point you want to start receiving your Canada Pension Plan (CPP). They normally are started at age 65, but you can choose to start them earlier or later. If you choose to start them early at age 60, you’ll receive smaller payments. If you wait until 70, you will receive larger payments.
The rules change when converting your RRSP into a Registered Retirement Income Fund (RRIF). You won’t be able to put any more money in, and you are forced to start taking money out. Your financial institution will send you a notice telling you the minimum amount you need to take out each year.
For couples, the tax hit from RRSP/RRIF withdrawals is compounded if one spouse dies well before the other because these investments are then combined for the benefit of the surviving spouse (if that person is the designated beneficiary). Typically that doubles the survivor’s required RRIF withdrawals, which often bump them up into a higher tax bracket.
*as per 2013 regulations
How To Calculate Yearly Minimum Withdrawals
Under the age of 71 the minimum percentage is calculated as 1 divided by (90-minus-your age) – thus if you are 70 it would be 1 / (90-70) = 0.05, or 5 per cent.
At age 71 the RRIF minimum jumps to 5.28 per cent. As a result, after the age of 71, it becomes increasingly difficult to preserve the capital in your RRIF. It slowly increases over time and at age 75 it is 5.82 per cent, age 80 it is 6.82 per cent and by age 95 and over you need to withdraw 20 per cent per year.
Tips:
- When you turn 71 the government requires you to start withdrawals. If you have a good pension and other investments to draw from and you don’t think you will need your RRSP at first, talk with your financial advisor to be sure your income won’t balloon when you reach that point.
- You are nearing the end of the RRSP life, review and realign the risk in your portfolio. At this point you are looking more for security. It’s time to look at your asset allocation and transition your portfolio for the next stage.
- Smooth out your income to stay just under the next highest tax bracket
- Seniors can avoid paying any federal tax on income up to $19,892* using common tax credits, including the basic personal credit, the age credit for being 65-plus, and the maximum pension income credit that you get as a senior having at least $2,000 in income from a RRIF, registered annuity or employer pension.
- If you’re ready to retire don’t forget, being smart with your money never grows old. Take a vacation or buy that boat you have always wanted, just don’t sabotage all your hard work by racking up a credit card bill.
- Ideally, by this time, financial planning mainly involves avoiding surprises and pinpointing the exact date retirement can occur.
- If debts are still a problem, working a year or so longer than you originally planned may help to pay them down.
- When interest rates rise, comfortable debt burdens can become unbearable. Try and have all of your debts paid off before you retire.
- If you have assets in a TFSA or an unregistered investment portfolio, use them to pay down your debt.
- Working longer than intended can also create a financial cushion and forgo any drawbacks from drawing on your CPP benefits before you hit 65.
- Taking out all the money in your RRSP at once and claiming it as income will land you with a massive tax bill that year. Transfer your assets into a RRIF to convert them into a regular monthly retirement income.
- Not sure if you should withdraw money from your RRIF before you turn 71? If your income is going to fall into a higher tax bracket in the future or if you run the risk of losing government benefits (such as the OAS clawback) consider withdrawing some funds early and putting them in a TFSA. If you are going to be in the same tax bracket and your OAS will not be clawed back then you should leave your funds in the RRIF.
