At the end of each year, we ask our clients to provide an estimate of their income.
The income sources we want to approximate are those that we may not be aware of, such as Part-time work, full-time work, Registered Pension Plan payments, Canada Pension Plan, Old Age Security, and any other sources of income outside of what we know.
This is especially important if it is a new income source in the current year. We can easily estimate what the taxable dividend or interest income from non-registered accounts will be. All of this information helps us calculate the projected taxable income for each client for the current year.
Refundable and non-refundable tax credits
Clients can subtract both refundable and non-refundable tax credits from the income taxes they owe. If the non-refundable credits exceeds the amount of taxes owed, the excess is a lost opportunity. The more refundable and non-refundable tax credits a client has the higher the taxable income we can recommend by increasing registered account withdrawals. For example, if I know a client qualifies for the disability tax credit, a non-refundable tax credit, then we are able to pull more funds out of an RRSP or RRIF then a client that does not qualify for the disability tax credit to create comparable taxes payable. Other common non-refundable tax credits are the age-amount tax credit, donation tax credit, pension income amount and tuition and education amounts. Another common non-refundable tax credit is medical expenses. If a client communicates to us that they have $20,000 in medical expenses during the year, we can certainly factor that in when providing suggestions on registered account withdrawals.
Taking advantage of the lowest tax bracket
In 2019, the top of the first federal tax bracket is $47,630. For some of our clients, this is a preliminary bench mark for taxable income to work toward. We are often able to smooth out our client’s taxable income by using their registered accounts as the variable that may change year to year. In a year where you have large capital gains, and no tax credits, we would not recommend pulling extra funds out of the registered plans, if additional funds are not needed for cash flow. Years where you have capital losses and lots of tax credits would be the years where we may recommend pulling extra funds out of registered plans.
After we know the income levels and tax credits available, we can quantify with respect to the appropriate dollar amount to pull out of an RRSP or RRIF account, if any. There are many things to take into consideration when deciding whether it makes sense to pull funds out of your RRSP/RRIF. For some individuals, they do not have a choice. They have to pull funds out of a RRIF for regulatory reasons.
Mandatory RRIF minimum payments
When you turn 71, you have three options: Collapse your RRSP (fully taxable and not normally recommended), convert it to a RRIF account (most common option), or purchase an annuity.
You do not have to take a payment in the year you turn 71, or the year you create a RRIF if earlier than age 71. The year you turn 72 is the first year where you are required to make a withdrawal from your RRIF account (if the RRIF account was opened at age 71), also referred to as the minimum required payment. The amount you are required to withdraw each year is based on the Dec. 31 market value of the preceding year.
Below, we show the percentage withdrawal required. If you have a younger spouse, you can elect to use your younger spouses age. There is also the option to convert your RRIF before the age of 71. If you convert early (before age 71), or have a younger spouse, the age formula applies, calculated as follows: 1/(90 – age). For example, if you converted to a RRIF early, and your age is 65, your required percentage withdrawal is 1/(90-65) = four per cent. If both you and your spouse are older than 70 then the table below applies.
Using the table as a reference, if you are 77 years old and the market value of your RRIF on Dec. 31 of the preceding year was $600,000, your minimum required payment for the current year would be $37,020.
Ratio of registered to non-registered funds
If the majority of our clients’ investment funds are in RRSP or RRIF accounts, they are running a larger risk of paying a significant estate bill. Single people also have a larger risk of paying a significant estate bill as they have no ability to roll-over registered accounts to a surviving spouse. The ratio of registered to non-registered funds is a factor we consider in the delivery of the financial plan to our clients. We also feel that single individuals may consider withdrawing funds from their registered plans at a faster pace to avoid the potential large final tax bill.
When you decide to withdraw funds from a registered plan, you are also lowering the amount that will be taxed upon death. You likely will pay a little more tax in the year of withdrawal. With registered plans (excluding the TFSA) the year you pass away, all those funds are deemed income unless they are rolled over to your spouse. This is the tricky part of the calculation as we do not know our clients’ life expectancy. I have seen situations where clients worked hard to save a million dollars in an RRSP, pass away and have half of their hard-earned dollars go back to Canada Revenue Agency and probate fees. One has to decide whether they want to focus on minimizing tax in the current year or mapping out a plan that avoids paying half of the value of your registered account in taxes and fees.
Taking advantage of Tax Free Savings Account (TFSA)
One of the main benefits of RRSP and RRIF accounts is the ability to defer taxes. With the introduction of the TFSA in 2009, our clients had the ability to not only defer, but to avoid taxes on funds invested. In cases where clients do not have savings outside of a registered plan to fund the annual contributions we will often do the math and map out a strategy to take advantage of the TFSA. Growth in an RRSP and RRIF account will be taxed dollar for dollar that you pull out in the future. Growth in the TFSA will not be taxed. Saving taxes over time should be the goal, not just in the current year.
Old Age Security (OAS) Repayment
Above we mentioned that for some of our clients we work toward creating taxable income of about $47,630. For couples, the total taxable income would be $95,260 for the household. For other clients we set a higher taxable income benchmark, which is $77,580 per individual, or $155,160 for the household. This is the threshold that if a client, who is collecting OAS, has taxable income exceeding $77,580 they will have a portion of their OAS subject to repayment. The repayment is often referred to as the “claw back.” If our clients’ individual taxable income is above $126,058 in 2019, all of their OAS will be clawed back.
Unlike CPP which you apply for, once you turn 65 you will automatically begin receiving OAS. For some of our clients we encourage them to write to Service Canada before they turn 65 to delay receiving OAS if we know that a client’s income is going to be subject to the OAS repayment. Similar to CPP, every month you wait to receive OAS you may receive a greater amount in the future, provided you map out a plan to keep the future income under the claw-back thresholds this can be an effective strategy. Timing of when to collect OAS is one more factor in the decision of how much to pull out of registered plans.
Early withdrawals often makes sense
Although clients who are under 72 are not required to take a RRIF payment, we will often advise them to consider it for different reasons. One of the reasons is to ensure that you receive more of your OAS in the future. To illustrate I will use a 65-year-old client with projected income as follows: OAS at $7,289.52 ($607.46 x 12), CPP $7,972.92 ($664.41 x 12), and Registered Pension Plan (RPP) $38,136 ($3,178 x 12). The total taxable income for the current years is projected to be $53,398. The OAS repayment threshold amount begins at $77,580. This client is well below the threshold and will get the entire OAS ($77,580 – $53,398 = $24,182). If this same client has an RRSP projected to be greater than $447,806 at age 72, then the client may be subject to OAS repayment in the future. If the client waits until age 72 to pull any registered funds out then the minimum amount required is 5.4 per cent of the $447,806, or $24,182. Once this RRIF income is added to the other sources of income then OAS repayments may occur. In these situations we often recommend clients either convert part, or all of their RRSP to a RRIF, early and map out withdrawals that enable our clients to get more OAS longer term.
In order to calculate the recommended RRIF withdrawal, we need to know the client’s age, current taxable income without RRIF payments, and the current RRIF Value. We can do this calculation for any age. Below we used a 65- year-old client with different levels of taxable income to highlight the maximum recommended RRIF withdrawal.
Current RRIF RRIF
Taxable Income Value * Withdrawal **
$45,000 $603,333 $32,580
$50,000 $510,741 $27,580
$55,000 $418,148 $22,580
$60,000 $325,555 $17,580
$65,000 $232,963 $12,580
$70,000 $140,370 $7,580
$75,000 $47,778 $2,580
$80,000 N/A – income already subject to OAS clawback
* At age 72
**Assumes early conversion of RRIF and electing an amount which exceeds the minimum required
• If taxable income is $45,000 and RRIF valued over $603,333, we may recommend an early RRIF withdrawal up to $32,580.
• If taxable income is $50,000 and RRIF valued over $510,741, we may recommend an early RRIF withdrawal up to $27,580.
• If taxable income is $55,000 and RRIF valued over $418,148, we may recommend an early RRIF withdrawal up to $22,580.
• If taxable income is $60,000 and RRIF valued over $325,555, we may recommend an early RRIF withdrawal up to $17,580.
• If taxable income is $65,000 and RRIF valued over $232,963, we may recommend an early RRIF withdrawal up to $12,580.
• If taxable income is $70,000 and RRIF valued over $140,370, we may recommend an early RRIF withdrawal up to $7,580.
• If taxable income is $75,000 and RRIF valued over $47,778, we may recommend an early RRIF withdrawal up to $2,580.
• If taxable income is $80,000 we would not recommend an early RRIF withdrawal if OAS is the only factor.
Income splitting opportunities
Withdrawals from RRSPs are not eligible for pension-income splitting unless the income is annualized. Between the ages of 65 to 71, it is worth exploring the income splitting benefits of converting the RRSP to a RRIF early. RRIF income is considered eligible pension income for income-splitting purposes when the transferring spouse (higher income) is 65 years of age, or older. The transferee spouse can be younger than 65 and you are still able to income split RRIF income. Provided the transferor’s age criteria are met, it is possible to income split up to 50 per cent of the RRIF income. Splitting RRIF income essentially enables you to shift income from the higher income spouse to the lower income spouse. If income-splitting opportunities exist, pulling extra funds out of registered accounts might make sense. If you and your spouse are 65, or older, then it is possible to each claim the $2,000 pension income amount.
Canada Pension Plan (CPP)
With CPP, you must apply with Service Canada when you want to start receiving CPP. Similar to when you take funds out of an RRSP or RRIF account, it requires strategy and integration with the other forms of income. We recommend that you speak with your wealth adviser prior to submitting the application to receive CPP. If you, and your spouse, are both 65 then you are able to make an application to share CPP. In many cases we feel the decisions of when you collect CPP should be integrated with the dollar amount, and timing, of registered account withdrawals.
Listed above are just some of the tax related items to consider when looking at registered account withdrawals. For a plan to be effective you must communicate all tax credits and income sources to your portfolio manager. This information can then be integrated for both short-term actionable steps and a long-term tax minimization strategy.
Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director of wealth management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138.