As people approach or enter retirement, they begin wondering what they should do with their Registered Retirement Savings Plan (RRSP). Should they start withdrawing funds now, or wait until they are forced to? Should they draw from the RRSP or convert it to a Registered Retirement Income Fund (RRIF) first? And how much is it going to cost them, anyways?
Everyone wants to ensure they are getting good value for their dollar, especially when it comes to paying taxes. Here are some ideas.
Instead of waiting until age 72, people with large RRSPs may want to start drawing from them upon entering retirement. By spreading withdrawals over more years, it may be possible to avoid higher tax brackets, Old Age Security (OAS) claw backs, loss of income-tested benefits, and other potential tax problems down the road. It also helps avoid passing away with a large RRSP or RRIF all of which, if one’s spouse predeceased them, would be deregistered and taxed in the year of death at a rate of up to 49.8 per cent in BC.
Use spouse’s age
Minimum RRIF payments are calculated according to the annuitant’s age and account size. For example, a man who is 72 at the beginning of 2019 with a $500,000 RRIF will have to deregister 5.28 per cent of its value during the year, or $26,400. If he feels this amount is too high and his spouse is younger, he could consider using his spouse’s age for calculation instead.
This can work very well in certain situations. If the annuitant’s income is on the cusp of a higher tax bracket, or if the annuitant has a younger spouse with a longer life expectancy and that spouse’s income will be greatly reduced upon his death, using this measure could be appropriate.
Pension tax credit
Those who do not receive employer-sponsored pensions may want to consider converting some or all of their RRSPs to RRIFs by age 65 to receive the Pension Tax Credit. This credit allows people age 65 and older to deregister $2,000 annually from their RRIF, tax-free. 10 per cent withholding tax is payable at the time of withdrawal, which is refunded when one’s tax return is filed.
Up to 50 per cent of eligible pension income can be split between spouses. This may help reduce income taxes payable, reduce or eliminate an Old Age Security claw-back or even create a pension tax credit for a spouse.
RRIF withdrawals are considered eligible pension income but RRSPs are not, so those wanting to take advantage of pension income splitting will have to convert all or part of their RRSPs to RRIFs in advance.
Don’t need the money?
Those who don’t need their RRIF income to cover living expenses may wish to fund a Tax-Free Savings Account (TFSA) to shelter assets from further taxation. Stocks, bonds and other securities may be transferred in-kind, saving transactional costs. Others may choose to make charitable donations and receive the Donation Tax Credit, offsetting some or all of the tax payable.
RRIF income may also provide an opportunity to gift money to family. There is no gift tax in Canada, plus the money avoids probate fees. The gift may help one’s family pay off debts now, reducing or eliminating interest payments and other charges.
Nobody wants to pay more tax than they should, but people should never let their desire to pay less tax trump sound investment or financial planning decisions. Remember, the entire RRSP or RRIF will be taxed eventually; the challenge lies in finding the best way to do so. Be sure to discuss this matter with your financial advisor or accountant to determine which strategies work best for you.