How to tap your RRSP

Conventional wisdom says that when you retire, you should wait as long as possible before withdrawing your RRSPs. That advice is wrong

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by

From the September/October 2011 issue of the magazine.

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RRSP_322Kathy and Peter Franklin have figured out all the angles on their retire-at-55 plan. The Toronto couple, currently both 47, know how big a nest egg they’ll need, and how much they can spend in retirement. They’ve built a financial plan to help them save diligently and invest wisely along the way. But one thing has them stumped: “Once we get there, how do we get the money out without the taxes killing us?” Peter asks.

The usual advice is to draw income from your non-registered accounts, such as regular savings accounts, first. When that money runs out, then you can go after the funds in your RRSP or Registered Retirement Income Fund (RRIF). That’s because the money you withdraw from an RRSP or RRIF counts as income, and you have to pay taxes on it. So you want to put off drawing down that money—and paying those taxes—as long as possible.

But the Franklins (whose names we’ve changed to protect their privacy) ran their own figures using that strategy and got dubious results. So we talked to several experts who have thought carefully about the most tax-efficient way to draw down a retirement portfolio—and guess what? It turns out the conventional wisdom is dead wrong. “The conventional advice definitely does not constitute ‘wisdom’,” says Daryl Diamond, a financial planner with Diamond Retirement Planning in Winnipeg. He says retirees need to take a more balanced approach when drawing down their portfolios.

To see why, consider that if you draw down all your non-registered accounts first, you will eventually be left with a nest egg made up entirely of RRSP or RRIF money. Then when you reach 71, you’re suddenly forced to convert your RRSP to an annuity or RRIF and start taking minimum withdrawals. This can drive up your income, and because higher incomes are taxed at higher rates, you are liable to pay much more tax than you would have if you’d spread out your RRSP withdrawals more evenly.

It’s usually especially wise to draw on your registered accounts first if you retire before age 65, since you’ll need to bridge your income needs before Old Age Security and other benefits kick in. This can also help you avoid OAS clawbacks later, says Camillo Lento, a chartered accountant and lecturer at Lakehead University in Thunder Bay, Ont.

The bottom line is, it often makes more sense to withdraw some RRSP money before exhausting your non-registered accounts, even if you take a small hit, because it can help you avoid a much bigger tax bill later. Overall, Canada is quite generous to seniors, thanks to Old Age Security and tax breaks such as the Age Credit. But for higher-income seniors, the system often gives benefits with one hand and claws them back with the other. So any time you consider how much tax you’ll pay when you draw down your portfolio in retirement, you also need to consider the clawback of these benefits.

Determining the right drawdown strategy depends on your personal situation—in particular, the amount of income you expect to receive in retirement. Let’s look at the opportunities for retirees with low, moderate, and high incomes and help you determine what’s right for you.

Low-income seniors

If you don’t have much saved up for retirement and you expect to depend on the Guaranteed Income Supplement, then your best bet is to draw down any RRSPs quickly, preferably before you turn 65 and become eligible to collect GIS. That’s because each $1 of RRSP income after age 65 results in a clawback of roughly 50 cents from your GIS—equivalent to a 50% marginal tax rate. Since this clawback rate is so high, you’re better off pulling out RRSP money earlier, even if you have to pay some tax on it. It will undoubtedly be at a much lower rate than 50%. If you don’t immediately need the money to live on, transfer your early RRSP withdrawals to a Tax-Free Savings Account (TFSA). When you take out TFSA money later, it won’t have costly GIS consequences.

Moderate-income seniors

If you’re a senior with less than about $30,000 a year in income, you can earn a surprisingly large chunk of that income tax-free. That’s because the combination of the Age Credit and the Pension Income Credit (which only seniors get) plus the basic personal credit (which every taxpayer gets) can shield you from federal taxes on the first $19,000 of your taxable income. (The provinces offer similar credits, but their tax-free zone is not usually as large.) Once your income moves beyond $19,000, you leap into the first federal and provincial tax bracket. There you will pay a combined rate of 20% to 28%, depending on your province.

Because of that jump in your tax rate once your income crosses the $19,000 a year threshold, the objective for seniors with moderate income is pretty simple: take out as much of your RRSP and RRIF money as you can while remaining in the tax-free zone.

The following example shows how it can work: Say you’re a retired senior living in a province where the tax-free zone is your first $19,000 of income, and you need $28,000 (after taxes) to cover your expenses this year. You receive $12,000 in income from Old Age Security, the Canada Pension Plan, and interest from bonds and GICs in non-registered accounts. That means you will need to withdraw an additional $16,000 from your portfolio to cover your cash flow needs. So, do you take that $16,000 from your non-registered account (which isn’t taxable) or your RRSP or RRIF (which would be reported as income in the current year)?

If you followed the conventional advice and took everything from your non-registered account, then you’d be passing up a golden opportunity to take out some of your RRSP or RRIF money tax-free. Here’s why: because your income from other sources is just $12,000, you can withdraw up to $7,000 in RRSP and RRIF money and still stay within the $19,000 tax-free zone. If you don’t make that withdrawal now, you may have to pay a substantial amount of tax down the road, when your non-registered funds are depleted and you’re forced to make larger concentrated RRSP and RRIF withdrawals. You can meet the rest of your spending needs by taking another $9,000 from your non-registered accounts.

By taking this balanced approach, you not only pay no income tax in the current year, you also shield yourself from tax that would have been payable on future RRSP and RRIF withdrawals. Pretty neat, huh?

High-income seniors

When you’re a retired senior with taxable income beyond $30,000 or so, you have left behind the pleasant vistas of the first tax bracket and entered more rugged fiscal highlands. Now the tax rates increase, and the clawbacks of government benefits begin.

There are several major tax bumps to look out for. The specifics vary depending on your province, but in most cases you will cross into the second provincial tax bracket somewhere between $30,000 and $41,500, at which point your marginal tax rate jumps two to five percentage points. As well, you will see some of your federal Age Credit clawed back starting at about $33,000. This clawback is equivalent to increasing your marginal tax rate by more than two percentage points. You jump to the second federal tax bracket around $41,500, causing you to suddenly pay an extra seven percentage points in taxes.

In short, the next big income threshold you’ll hit after $19,000 is at $41,500. “That’s a number we want to keep our eye on,” says Ross McShane, director of financial planning at McLarty & Co. Wealth Management of Ottawa. For example, at about $41,500 you go from a 24% to 31% tax bracket if you live in Ontario. In other provinces, your combined marginal tax rate at $41,500 jumps to somewhere between 30% and 38%. So your goal should be to smooth out your taxable income from year to year in order to keep it below that threshold.

Beyond $41,500, there are two more thresholds to keep in mind. The next is when your income reaches $67,700, because that’s when Old Age Security begins to be clawed back. Each dollar of income over that amount results in a clawback of 15% from OAS benefits, so it’s equivalent to adding 15% to your overall tax rate.

The final threshold we’ll look at here hits at $83,000. At that point, you’ll have reached the third federal tax bracket and you’ll begin paying a combined marginal rate of somewhere between 36% and 46%, depending on your province. When you add in the impact of the OAS clawback, you’re in for a shock. At $83,000, you’re effectively paying a 51% to 61% marginal tax rate. “You want to avoid that situation by any means possible,” says Lento.

You may think that you’ll never have to worry about finding yourself in these high tax brackets. But not so fast: if you draw down your non-registered accounts first, then your untouched RRSPs can grow remarkably large. Then you’re forced to convert them to an annuity or RRIF at age 71 and start taking minimum withdrawals. (You have to withdraw 7.4% from your RRIF the year you turn 72, and the percentage rises with your age.) That can easily push you into a much higher tax bracket than you anticipated.

What’s more, when one spouse dies, his or her RRSPs and RRIFs are typically transferred to the survivor. The prescribed withdrawals could now apply to a combined amount that’s suddenly twice as large, which effectively doubles the minimum drawdown. “Many people have large accumulations of RRSPs which they’ve deferred, deferred, deferred, and then bang. They lose flexibility, they lose control,” says financial planner Diamond.

When the surviving spouse dies, then any remaining RRSPs or RRIFs become taxable. If these balances are large, the estate will pay a hefty tax bill.

In the Franklins’ case, drawing down all their non-registered money first before touching their RRSPs and RRIFs doesn’t make any sense. A balanced drawdown strategy will work much better. With two above-average professional incomes, no kids, and moderate spending, they expect to accumulate about $3 million by the time they retire in eight years at age 55. They plan to have about half of their savings in registered accounts. Then they envision spending about $84,000 a year (net of tax, in 2011 dollars) on a very comfortable, but not lavish, retirement. “We’re not big spenders in terms of expensive cars, clothes and jewelry, but we like to spend money on dining, travel, theatre,” says Kathy.

According to Diamond, by adopting a balanced drawdown strategy, rather than drawing on all their non-registered accounts first, the Franklins can expect to save a lifetime total of about $170,000 (in 2011 dollars). The Franklins’ situation won’t be the same as yours, but it’s an example of why it pays to look closely at how drawdowns will impact your taxes. “A lot of people don’t think about taxes, and it is often the largest expense for someone in retirement,” says Diamond.

Whatever your withdrawal strategy, keep in mind that you should draw down your savings in a way that doesn’t skew the asset allocation in your nest egg away from your target by drawing too heavily on stocks or bonds. As long as you keep that allocation where it should be, smoothing out the mountains and valleys in your income could help you save big on taxes—and add tens of thousands of much-needed dollars to your retirement savings.

24 comments on “How to tap your RRSP

  1. There's another way which is much better. Transfer RRSP's to RRIF then make a large investment loan and pay the interest using RRIF withdrawals. One cancels the other and your money accumulates in a tax paid account to use whenever you wish.

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    • Isn't there a tax slap on the RRSP's when you convert them into RRIF. This will probably bring our income tax bracket up to $100k easily. What's your take. It's hard felt of see a big chunk of your saving for all the years suddenly part away. And what is left after tax. And hopefully we make a good investment of the after tax dollar. I have to agree with the investment loan pay with interest using RRIF withdrawals.

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      • No tax on conversion – you are simply moving from a registered savings product (not designed for regular withdrawals) to a registered funding product (designed for regular withdrawals). It's as you take the withdrawals that you get taxed (from the RRSP or the RRIF), but the conversion from an RRSP to a RRIF is not treated as a withdrawal.

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    • It’s satisfying to read articles such as this that give my retirement planning a thumbs up. I retired at 55 after, 34 years with the same company, to begin drawing a comfortable public pension. Like most working persons of the last 40 years, the best retirement saving option for me was a spousal RRSP. It was our choice and my income enabled my wife to be at home to raise the kids. With the advent of pension income splitting right around the time I retired all of a sudden spousal RRSP’s didn’t really work out as well as planned. As it happened I was able to spend the last four years earning as a consultant. This delayed the need to supplement my pension income and enabled me to deposit to my RRSP which has resulted in RRSP’s near equal between my wife and I.
      The plan is to split the pension and each draw from our RRSP’s, to a max income of $44,000 each. TFSA’s are full and will be maxed every year. When CPP and OAS kick in at age 65, RRSP withdrawals will be reduced to maintain annual income levels (indexed of course as the tax dodge level will increase as well).
      The required change to a RRIF will result in a manageable withdrawal requirement.

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  2. Anybody who thinks OAS clawback levels will remain as generous as they are today is living in pie-in-the-sky land. The biggest item on the feds books is payments to seniors in the form of OAS and GIS. With boomers retiring it will be impossible to be so generous in the future. I am sure we won't see 100K couples collecting OAS for e.g..and I can see the time when GIS, which is essential a welfare payment, is treated like other welfare payments to younger people and subject to asset rules.

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  3. Are not the pension income deduction of $1000 available to anyone drawing a pension? Also a spouse can be attributed a part of the pension to also receive the deduction?

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    • First – only available if you are 55 and older. Second, between the ages of 55 and 65 income from RRSPs, RRIFs, Annuities etc. DO NOT count as pension income. Only funds from an actual pension or superannuation fund count (or income from an annuity resulting from the death of your spouse and arising from an RRSP, DPSP or a RRIF). Once you turn 65, even if only for part of a year, the pension credit is available for retirement income from all these other sources (but not for credit against CPP or OAS income).

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  4. Nice article, thanks for the great info.

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  5. What a great article and helpful advice. I cant really think of anything more depressing than when people work their whole life, help their community, pay taxes etc. and then when they get old they are left with nothing! People should spend some time planning how they are going to go about avoiding that and this article goes a long way towards giving people some good ideas to start out with.

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    • Very late reply- but couldn’t agree more. Not only is a great deal of planning required, there is a huge lifestyle adjustment to be crafted. Excellent article and commentary.

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  6. The idea that everyone will be impacted by OAS clawbacks is laughable. Most of us would LOVE to have $60,000 income, even while working.

    The idea that you should NOT draw retirement cash from any taxable account, before the tax-shelters is a very poor idea. For most people in most situations cash should come first from the taxable account. The author has forgotten about the lost benefit of protection from tax of investment income inside the tax-shelters.

    Try your own variables in this spreadsheet http://www.retailinvestor.org/RRSPmodel.xls (the third tab at the bottom). The discussion is at http://www.retailinvestor.org/RRSPmodel.html#earl

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  7. The article stated: "The next is when your income reaches $67,700, because that’s when Old Age Security begins to be clawed back."
    At least the author should get their numbers correct, for the tax year 2011, the clawback only begins once your income exceeds $69,562.

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    • Hi and thanks for your comment. OAS thresholds change every year. In 2009 for instance, the latest year for which information is available on the Service Canada website, the cut off was $66,335.

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      • I meant to come back earlier to comment after realizing the article was written in 2010.
        My bad.

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  8. the government will find a way to screw you not matter what

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  9. This would suggest that if a surviving spouse close to retirement has a good DBP pension as well as RRSPs, would be worthwhile to withdraw from RRSPs before age 65 and lessen OAS clawback – ie, pay more taxes now instead of in later years.

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  10. My Question is somewhat different. My wife is 58 and put all of her RRSP into RRIF at age 55. She would now like to reverse $7000 of her RRIF back into an RRSP, so that she can have the RRSP funds transferred to her work where she can buy into 5 missed years of a defined benefit plan. How does she reverse a portion ofht eRRIF back into an RRSP?

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  11. My wife is 57 and I am 59 and we retired about 1.5 years ago. We had enough of the 35 and 38 years we are both working full time now. We took only 2 vacations of 2 weeks each in this time and we really saved, invested and maxed out our RRSP’s. We both have decent RRSP’s with my wife having $385,000 and I have $475,000.

    We just bought in April-2013, 30 year term certain fixed annuities that pay monthly the following, $1,855.67 and $2,293.78 which is $4,149.45 per month as a couple.

    They are not indexed to inflation but if we do not live 30 years until 86 and 88 respectively, the surviving spouse gets the remaining years at the same annuity monthly amount with no reduction or less like pensions usually cut 35% to 40% leaving the surviving spouse in a tougher, financial situation.

    Any months and years not paid to us will go as a lump sum taxable amount to our 2 adult children as they are the direct beneficiaries.

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  12. We are bot going to get our C.P.P early and we calculated that we will be getting $1,403.50 with me getting in 9 months $700 a month. My spouse will be getting her $703.50 in 29 months.

    This will bring our monthly C.P.P and term certain fixed annuity total income to $5,552.95 in a not so long. We also have $65,200 in TFSA’s which we have bought longer term strip bonds, provincial and corporate, 75% and 25% allocated which is giving us a before compound average 4.77% yield to maturity.

    These will mature in 26, 27 and 28 years worth $228,155.65 when all is said and done. This is our inflation protection money and expenses money for future use. We have set aside as much as we can on a regular basis at least between $300 to $500 a month in a dividend fund that has served us well which has accumulated to a decent amount in our joint non-registered account, $273,116.69 as of last November-21-2014.

    We also have a $25,000 high interest savings account of 1.75% and 5 $10,000 laddered GIC’s 1-5 years maturing yearly ranging from 2.25% to 3.10%.

    This is getting us a decent income of $860 a month with low taxes, maybe 8% to 10% at most per year of this amount. Recently, about 3 years now we did our final plan of getting small life insurance policies and long term care policies of $100,000 and $200,000 each.

    The life insurance policies expires in 2044, 30 years from today.

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  13. We will also be getting combined about $1,250 a month in OAS, old age security pensions when we are both 65 which will help us with monthly expenses and I will be eligible at 62, a small workplace pension of $524.66 per month or I can choose to get a lump sum pension transfer to my LIRA, locked in retirement account of $129,550.

    The $524.66 per month workplace pension is not only 50% indexed to inflation so only $262.33 per month and capped at 3.5% annual rate. We will decide if it is worth to take the lump sump transfer to my LIRA in 5 to 6 years, 2019, 2020 or so based on what GIC and government bond rates are at that time.

    The pension does not look so good even today as I can get longer term GIC’s and provincial bonds of 3.05% to 3.68% rates today. This is a $350 to $400 a month interest income equivalent and we get o keep our $129,550 until upon death which will be about $80,000. If rates rise to even higher 2013 levels, it will boost our income by another $50 a month to $450 a month which is not that far off from $524.66 per month.

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  14. EXCELLENT article. I’ve been looking for this detailed information for months. Everywhere, including banks, govt. websites and other financial publications only reprint articles on ways for young couples to contribute into RRSPs. Nowhere can one find info, strategic or not, on how to extract the money when necessary with a detailed explanation of the advantages and disadvantages. Belated thanks to David Aston for doing the work and writing a clear article.

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  15. My self and my husband are not legally retired,but i am 58 and he is almost 60.He withdrawed his union pension and invested in RRSP’S.Because we are not legally retired but i am no longer working’he is.Can we start withdraws from our RRSP’s??

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  16. Hello, we are trying to determine if the ‘early’ reg. acct. drawdown is appropriate. After a google search of critiques, Retail Investor.org (there is a list of topics) early RSP withdrawal came up and, it is against this strategy. The article is well-written and uses several spreadsheet analysis; I find it a bit difficult to assess on my own. If anyone has the talent required to grasp this stuff, it would be very worthwhile to hear an opinion. Thanks, F

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  17. Good article. Would like to see more.
    The 2nd tax bracket after 19000 is it 42000?
    What can one expect for income from OAS at 65 years?

    Reply

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