Registered Retirement Savings Plans are the primary retirement savings tool for Canadians and at this time of year, all the attention is on the accumulation stage. But how you eventually decumulate the assets in an RRSP also matters: too much tax deferral and saving too long can be bad things.
RRSP savers should strive to minimize lifetime tax and maximize retirement income over simply postponing RRSP withdrawals as long as possible. In the right circumstances, accelerating RRSP withdrawals can make you better off in the long run.
We will consider two scenarios where early RRSP withdrawals may make sense — one with a single person with a small RRSP and one with a couple with large RRSPs.
The real reason people fail to save enough for retirement — and what you can do to limit the damage
Why retirement planning needs to be a major political issue in 2019 and beyond
For baby boomer couples, synchronize or stagger is the new retirement dilemma
As a refresher, registered accounts like RRSPs, locked-in retirement accounts (LIRAs) and defined contribution (DC) pension plans can have withdrawals deferred until the accountholder’s age 72. By no later than Dec. 31 of the year you turn 71, you need to either purchase an annuity from an insurance company or convert your registered account into a registered retirement income fund (RRIF) or a locked-in equivalent.
Minimum RRIF withdrawals rely on a pre-determined percentage based on your age and increase as you get older. The withdrawal rate can be based on either the account holder’s age or the age of their spouse or common-law partner. If you have a younger spouse or common-law partner, basing your minimum withdrawals on their age will minimize the required withdrawals you need to take. You can, however, choose to withdraw more than the minimum. Locked-in accounts also have maximum withdrawal limits as well as minimums.
Consider an example of a single person in Ontario, aged 65, who owns their home, with $125,000 in their RRSP earning a four per cent return. We will assume they are entitled to 80 per cent of the maximum Canada Pension Plan (CPP) and 100 per cent of the maximum Old Age Security (OAS). They choose to start both government pensions at age 65, receiving roughly $11,000 and $7,000 per year respectively.
If our notional single retiree is spending a modest $25,000 per year, indexed at two per cent annually, their CPP and OAS pensions would come up short of covering their expenses and require annual RRSP/RRIF withdrawals of about $7,000 per year initially. All factors held constant, it is projected that their registered savings would be depleted by age 86. At that point, they would either need to decrease their spending by approximately $11,000 per year, due the impact of inflation, or borrow against or sell their home.
An alternative approach would be to defer their CPP and OAS pensions until age 70. CPP can start as early as age 60 or as late as age 70. Retirees can begin their OAS pension between 65 and 70.
Their CPP would increase by 8.4 per cent per year, plus inflation, to roughly $17,000 at 70. Their OAS would increase by 7.2 per cent per year, plus inflation, to roughly $10,500. Between 65 and 70, they would need to take RRSP/RRIF withdrawals of $25,000 per year to cover their expenses. They would only have about $6,000 left in their RRSP/RRIF by age 70, but CPP and OAS would be enough to cover their $25,000 per year of indexed expenses from age 70 onwards, even if they lived to 110. Remember, this compares to a cash flow shortfall of $11,000 per year starting at age 86 if they began CPP and OAS at 65 and instead defer their RRSP withdrawals.
The added benefit to this early RRSP withdrawal approach is that it minimizes the amount of time our single retiree needs to manage their RRSP/RRIF investments and maximizes their government-guaranteed, inflation-protected CPP and OAS pension income.
It is worth noting that in either scenario, the single retiree would likely pay little to no tax during retirement.
Now, take an example of a 60-year old couple with $1,000,000 each in RRSPs and $1,000,000 in joint non-registered investments. Assume they spend $100,000 per year and take their CPP and OAS pensions at age 65, receiving 80 per cent and 100 per cent of the respective maximums. We will make the same four per cent return assumption on a balanced investment portfolio and assume residence in the province of Ontario.
If they defer their RRIF withdrawals until age 72, and instead withdraw from their non-registered investments in the interim, they will likely not pay any tax from age 60 to 71. Sounds great, right? The problem is at age 72, their average tax rate could be more like 23 per cent.
If they instead began RRSP/RRIF withdrawals at age 60, they would pay an average tax rate of roughly 15 per cent throughout retirement. Their estate value on the second death would also be roughly 20 per cent larger after tax at age 90 because more of their assets would be non-registered and tax-free savings account investments instead of fully taxable RRIF accounts.
The tax savings and estate value would be further magnified if one of the two spouses died young, leaving the survivor with a massive RRIF with all their subsequent withdrawals taxed on one tax return instead of split between two.
Our retiree scenarios are very different — a single person with modest assets and spending compared to a wealthy couple with a big retirement budget and significant investments. The outcomes, however, are similar.
In both cases, early RRSP withdrawals may help the retirees to come out ahead. Maximizing government pension income, as well as minimizing annual income tax and eventual estate tax may increase your retirement spending potential as well as the ultimate inheritance for your beneficiaries.
Jason Heath is a fee-only Certified Financial Planner (CFP) and income tax professional for Objective Financial Partners Inc. in Toronto, Ontario.