For some retired clients, taking early withdrawals from an RRSP to smooth out annual income over their retirement years, thereby reducing taxes overall, can make good financial planning sense.
Strategically drawing down an RRSP, particularly when combined with the decision to defer Canada Pension Plan (CPP) and even old-age security (OAS) benefits until as late as age 70, could help a client avoid both a big tax hit and an OAS clawback down the line while maximizing government pensions for life.
"Anyone who retires early, including in their 60s, particularly if they haven't begun [receiving] CPP and OAS benefits, should really be thinking long and hard about taking some early RRSP withdrawals and deferring some government pensions," says Jason Heath, managing partner and certified financial planner (CFP) with Objective Financial Partners Inc. in Toronto.
An RRSP must be converted to a RRIF or an annuity by the end of the calendar year in which the client turns 71. Making decisions about whether to withdraw from an RRSP prior to that deadline and how much to withdraw involves taking into account the individual client's circumstances, including annual income requirements, current tax bracket and total assets - among other considerations.
The key, Heath says, is managing income levels during retirement so that income is spread evenly over the years. "'Can I pay $1 in taxes today to save $3 in taxes tomorrow?'" Heath says.
Indeed, making a larger withdrawal from an RRSP may make sense, even if the income is not needed, if that income will be taxed at a lower tax rate than if the withdrawal is made later.
For example, if your client requires $45,000 a year in income but his or her combined federal/provincial tax bracket tops out at, say, $46,000, withdrawing the extra $1,000 from the RRSP may be beneficial. If this retiree waits until after age 71, at which time he or she must make minimum withdrawals from his or her RRIF, the client may have to pay taxes at a higher rate on the same amount.
"Let's take out whatever we need [from the RRSP]. Then, if there are gaps between what is needed and the bottom of the next [higher] bracket, let's utilize that lower tax rate and pay the taxes [on the RRSP withdrawal] - eventually, the taxes have to be paid anyway," says Sterling Rempel, founder, CFP and principal advisor with Future Values Estate & Financial Planning in Calgary.
Withdrawing funds from an RRSP earlier in retirement may also help your clients avoid or mitigate the effect of the OAS pension recovery tax (a.k.a. the clawback), which begins at a threshold of $74,788 (for the 2017 income year), later in retirement.
"When you combine your CPP, OAS and the required minimum amount you must take from your RRIF, you [ideally] want the total to be below the OAS threshold," says Darren Ulmer, CFP, whose company, Saskatoon-based Darren Ulmer Financial and Insurance Services Inc., operates under Toronto-based Sun Life Assurance Co. of Canada Ltd.
Clients also may be advised to convert a portion of an RRSP to a RRIF well before age 71. Doing so could create pension income eligible for the pension income credit, which provides a non-refundable tax credit on the first $2,000 of eligible pension income. In addition, up to 50% of eligible pension income, including from a RRIF, may be used to split income with a lower-income spouse.
According to Fred Vettese, chief actuary with Morneau Shepell Inc. in Toronto, a retiree typically would have to have at least $200,000 of RRSP savings before being in a position to consider a strategy of funding his or her early retirement years primarily with RRSP withdrawals rather than with government pensions.
Beginning CPP and OAS benefits as late as age 70 will allow your client to increase benefit payouts significantly and provide him or her with two guaranteed streams of income that function as insurance against longevity risk. Deferring the CPP until after age 65 will result in an increased payout of 0.7% for each month of deferral up to age 70. At 70, the CPP payout amount will be 42% higher than the amount would have been had benefits begun at 65. For OAS, each month deferred after 65 results in an increased payout of 0.6%. At 70, the OAS amount is 36% higher than it would have been had benefits begun at age 65.
Expressed as an equivalent investment return, the benefit of delaying CPP payments until age 70 is equivalent to an 8.4% increase in payout per year deferred. So, your clients are better off drawing from their RRSPs first unless they're confident of an equal or better return in their portfolio.
A guaranteed 8.4% increase in CPP payouts "looks extremely appealing if the return in your RRSP is only 1%-2% [annually], which it very well could be," Vettese says.
He recommends clients delay receiving CPP benefits if that strategy makes sense for them. However, he adds, taking OAS at age 65 is OK if desired.
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