RRSP withdrawals for TFSA contributions

When, if ever, is this a good idea?

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(Photograph by Raina + Wilson)

(Photograph by Raina + Wilson)

Q: I am 58-years-old in 2015 and retiring with a defined benefit pension plan. My pension will be $60,000 a year receiving 100% increases equal to the Consumer Price Index. I have a modest RRSP of $65,000 and a small TFSA. I have no debt. My question is if it is advisable to begin to transfer money from my RRSP to my TFSA, incurring the tax implications now, or keep my RRSP intact and allow the tax free growth component to thrive and deal with the tax issues when I turn 72?–Joe

A: Retirees are often tasked with choosing different pools of money to fund their retirement. For those like you, Joe, who retire early, it becomes even trickier. That’s because you won’t be forced to withdraw from your RRSP for another 14 years–but should you take early withdrawals?

I’d say your decision needs to be based on a few factors, namely:

-Are you going to need some or all of your RRSP savings to fund your retirement spending?

-What is your investment risk tolerance?

-What is your life expectancy?

If you’re going to need some or all of your RRSP savings to fund your retirement spending, that would make me more inclined to consider early RRSP withdrawals. I’d consider a technique of income smoothing to try to figure out the optimal level of withdrawals to smooth your income over the rest of your life and pay the least life-time income tax. Assuming your indexed pension will cover most of your living expenses, this may not be a factor for you, Joe–but there are also extraordinary expenses to consider like new cars, home repairs or renovations, children’s weddings, etc.

If you have a high investment risk tolerance (and expected rate of return), that would also lead me to consider early RRSP withdrawals. This is because the short-term tax cost of taking early withdrawals may be mitigated by the tax savings on your lifetime RRSP withdrawals and on your death.

If you think you’ll have a long life expectancy, early withdrawals may also be worth considering. A longer timeframe will give you more time to offset the immediate tax implications of early RRSP withdrawals with long-term tax savings of instead growing your savings in your TFSA.

I ran two different retirement scenarios for you, Joe, using conservative assumptions. I found that the early RRSP withdrawal scenario beat out deferring your withdrawals until age 72, but not by much. Your net worth after taxes and probate fees for your estate was about 1% higher at age 90 when you took modest early withdrawals to try to smooth your income over your retirement.

So in your case, while not a slam dunk, I think you might consider some early RRSP withdrawals. I wouldn’t do so solely to make TFSA contributions or specifically to max out, but if a modest level of early RRSP withdrawals allows you to preserve your TFSA or make some contributions, it might result in a higher net worth over time.

You might consider RRSP withdrawals to the point where you are just below the next tax bracket, for example–in particular before your Old Age Security pension starts in 7 years at age 65 and increases your taxable income.

Speak with an accountant or a retirement planner to help you understand the immediate tax implications from early withdrawals as well as the long-term capital accumulation and retirement funding impact. The right course of action will depend on your personal circumstances as well as assumptions about the future. Financial planning strategies are always a moving target.

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.

One comment on “RRSP withdrawals for TFSA contributions

  1. KISS would say to simplify the RRSP and TFSA into only one account. Since everyone needs emergency cash, that would be the TFSA. But …

    TAX RATES; From the info given it seems the person is in about the middle of the second tax bracket now, and will be in retirement, and RRSP withdrawals now or in the future will still be in that same bracket. So the RRSP’s possible Bonus (or Penatly) from lower (or higher tax rates on withdrawal) is not a factor.

    TAX SHELTERED PROFITS: Since the benefits from sheltering profits are exactly equal between TFSAs and RRSPs this is not a factor.

    CONTRIBUTION ROOM; Withdrawing RRSP $$ prematurely to stash in a TFSA will use up the TFSA contribution room. Since RRSP $$ will be withdrawn gradually, the yearly increase in room may be enough. But even so, this will use up that room that might be needed in the future. E.g. In retirement, with CPP and OAS plus the pension, there is a good bet these people will not be needing to spend all their income. They will need unused TFSA contribution room to store the excess …. or else the income earned on the unspent cash will attract tax. So this advocate leaving the $$ in the RRSP.

    OAS BENEFITS: While GIS will surely be completely clawed back, it seems these people will be at the bottom edge of the retirement income subject to OAS clawback. Withdrawing RRSP before OAS benefits start will have no effect, but later draws will effectively add another 15% to the marginal tax rate. That is about $1,000 a year (65,000 * 10%w/d * 15%) So this advocates for withdrawing RRSP $$ early.

    RESULT: the trade off is (i) OAS clawbacks (= $1,000 /yr) vs (ii) unspent retirement income without any tax shelter to stash it in. The full RRSP withdrawn (65,000 * (1-33%) invested at 7% would give taxable income = $3,000 taxed at 33% would equal that same $1,000 extra tax bill. The choice makes little difference with a slight edge toward withdrawing early..

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