senior couple reviewing finances / Dean Mitchell

This article appears in the November issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.

A client’s best RRIF withdrawal strategy depends on several factors, including their annual income, their cash-flow needs and whether or not the client prefers to leave a larger estate for heirs.

“I’d be hesitant to rely solely on the age 71 RRIF [mandatory] conversion and the minimum RRIF withdrawal [rates] to be your guideline in terms of how much you should take out of your tax-sheltered accounts,” said Jason Heath, managing director of Objective Financial Partners Inc. in Markham, Ont. “Look at it more holistically.”

Some retirees withdraw only the RRIF minimum amount each year, hoping to keep their total annual income low to minimize taxes and maintain access to government benefits such as the age amount and old age security (OAS), which are clawed back above certain income thresholds.

Others choose to withdraw more than the minimum, or make RRSP withdrawals before converting the plan to a RRIF to smooth out income levels over retirement, reduce the average effective tax rate over time and leave a larger estate.

“Unless [retirees] have a really high income and a lot of assets, most people should consider some early RRSP withdrawals” despite the withdrawals being taxed as regular income, Heath said, adding that most clients would be better off deferring their Canada Pension Plan (CPP) and OAS benefits.

Retired clients in their 60s who draw down from TFSAs and non-registered accounts rather than their RRSP may find themselves paying tax at higher rates, and more tax overall throughout retirement, if the RRSP/RRIF significantly increases in value by the time clients are forced to make withdrawals.

Withdrawing early from an RRSP, then, may allow a client to leave a larger after-tax estate to heirs, Heath said.

RRIF annuitants must withdraw a minimum amount, set by a schedule or formula according to age, from their plan every year. RRIF withdrawals are taxable income.

Clients with large pensions or those who generate significant income from non-registered investments may find that the RRIF withdrawals push them into a higher tax bracket and jeopardize access to income tax credits and benefits, including OAS.

Mandatory RRIF withdrawals can “drastically increase your effective rate of tax on your income because not only are you paying tax but you’re also paying [OAS] clawback,” said Darren Bastarache, director of tax and estate planning with IG Wealth Management in Edmonton.

Clients who are married or in a common-law partnership with a younger spouse can elect to use their spouse’s age, and the lower associated minimum withdrawal rate associated with that age, to calculate minimum withdrawals, thereby decreasing the amount the older partner would otherwise have to withdraw from the plan.

The annuitant makes the election prior to receiving their first payment from their RRIF. Once the election is made, it can’t be changed, and it continues even if the couple separates or divorces, or if the younger spouse dies first.

Clients also may consider lowering their income levels to mitigate any negative tax implications associated with making the mandatory RRIF withdrawals, said Wilmot George, vice-president and team lead of tax, retirement and estate planning with CI Global Asset Management in Toronto.

“If they have systematic withdrawal plans on non-registered investments, for example, they can consider turning those off if they don’t need the income,” George said.

Clients also could switch from holding income-producing investments in non-registered accounts to ones that favour capital appreciation, George said.

RRIF withdrawals allow for some tax-saving opportunities, including the ability to split eligible pension income. Clients who are at least 65 years old can split up to half of the amount of their yearly RRIF withdrawal, mandatory or otherwise, with a lower-income spouse or partner, allowing the couple to reduce their overall tax liability.

“You can take advantage of two sets of graduated tax brackets and rates as opposed to one,” George said.

Also, for clients 65 and older, up to $2,000 of RRIF income is eligible for the 15% federal pension income tax credit. Therefore, converting a portion of an RRSP to a RRIF before the mandatory conversion age would allow a retired client to take advantage of the pension income tax credit, said Heath: “It basically makes $2,000 of eligible pension income tax-free.”

Many clients, however, remain reluctant to draw down their retirement accounts before they must, Heath said.

For example, some retirees in their 60s prefer to spend their non-registered assets and TFSAs first, leaving their RRSP to grow. However, by not drawing down on their RRSPs earlier, these retirees may end up with relatively larger RRIFs and corresponding mandatory withdrawal amounts.

Paying little or no tax in early retirement “might feel good in the short term,” Heath said, but may result in less flexibility later in retirement.

For example, a retiree who emptied their TFSA in early retirement will be unable to take full advantage of the tax-free withdrawal benefits later.

“You could have built up and maintained your TFSA better if you were taking some RRSP or RRIF withdrawals in your 60s,” Heath said. “I find sometimes people can be shortsighted in terms of wanting to pay less tax today even though it might result in paying more tax in the future.”

RRIFs and RRIF withdrawal rules

An RRSP can last only until the accountholder turns 71. Before the end of that year, the RRSP must be converted to a RRIF or an annuity, or withdrawn as taxable income. Mandatory minimum RRIF withdrawals must begin by the end of the year following the year in which the RRIF is established. There are no caps on the amount that can be withdrawn from a RRIF.

The minimum withdrawal amount for the year is based on the value of the RRIF on Jan. 1 multiplied by a prescribed “factor” or rate.

The rate is set by regulation or, for ages below 71, calculated by dividing 1 by the result of 90 minus the age of the annuitant or their spouse or partner at the beginning of the year.

The rates increase with age. For example, at age 60, the rate is 3.3%; at age 72, the rate is 5.4%; at age 82, it’s 7.38%, and at age 95 and above, it’s 20%.

A client with more than one RRIF must withdraw at least the annual minimum amount from each of their RRIFs, as opposed to across all RRIFs.

RRIF withdrawals may be made in-kind, which means your client can meet the minimum withdrawal requirement without having to sell an investment.

There is no withholding tax on the minimum withdrawal amount for the year. Withholding tax is applied to amounts withdrawn above the minimum amount. CPP, OAS and guaranteed income supplement benefits are paid without a withholding tax.

New retirees, particularly those accustomed to tax being withheld at source during their working life, may be unpleasantly surprised by their tax bill the first time they report their RRIF withdrawal amounts on their tax return.

In addition, the CRA requires taxpayers to begin paying tax in instalments when more than $3,000 of tax is payable in two consecutive years, which also may be an unpleasant surprise.

Advisors should alert their clients to their potential tax obligations and provide estimates of any amounts to set aside for paying those obligations, said Jason Heath, managing director of Objective Financial Partners Inc. in Markham, Ont.

And for clients who find saving more difficult, appropriate strategies might include having a financial institution withhold tax on their RRIF minimum withdrawal amount and to have Service Canada withhold tax on government payments, even if that means prepaying taxes, Heath said.

“You’re still paying the same total tax, but you don’t feel like you’re paying it because it’s coming off before you get the money,” Heath said.