The best part of a Registered Retirement Savings Plan (RRSP) is the deferral of income and growth, which helps to build up a nest egg for retirement.
Apart from emergency needs or infrequent lump sum amounts, withdrawals from an RRSP should be kept to a minimum. When ongoing income is needed from the account, it’s best for it to be first converted to a Registered Retirement Income Fund (RRIF).
But some caution when it comes to deferral, especially for widows and single people: If you die without having a spouse to name as the beneficiary, the entire value of your RRSP or RRIF account would be brought into income in that tax year, which would likely result in a good portion of the account being taxed at the top combined marginal tax bracket of 47.7 per cent.
After taxes, executor fees, probate fees, accounting, and legal fees it would not be unrealistic to see half of the value of the registered account disappear.
Couples have the ability to name each other the beneficiary on an RRSP, reducing the risk.
There are a few different approaches when it comes to RRSP/RRIF accounts. You could take the regulatory approach of waiting until age 71 to convert your RRSP to a RRIF. You could then begin taking out minimum payments annually beginning at age 72. This is a common approach and the belief is that the most likely outcome is that you’ll be able to deplete your savings in retirement over time.
One reason I think it’s a common approach is that many people have not gone through the exercise of determining if the other alternatives make better sense.
One of the key drivers for getting people excited about contributing to an RRSP was the initial tax benefits. The tax approach is my favourite when deciding the timing of conversion from an RRSP to a RRIF. It involves preparing a financial plan, projecting future income, and smoothing out income in lower income tax brackets.
If taxable income is reasonably low before the age of 72, then I’m typically supportive of beginning the process of earlier withdrawals. This is especially the case if individuals are able to tax shelter a portion of those withdrawals into a Tax Free Savings Account. Other tax factors include the ability for individuals 65 and older to claim up to $2,000 as a pension income amount, effectively allowing each individual to pull $2,000 out of their RRIF tax free.
Another very important factor is that couples can income split RRIF income beginning at age 65.
When all of these factors are analyzed, the conclusion is that at least some funds are drawn out earlier than age 72 for most people. Individuals in the top tax bracket are often encouraged to wait until age 72. For this smaller portion of the population, if you cannot avoid tax, you want to defer it as much as possible.
The third approach is the cash flow approach. Having an understanding of both your outgoing and incoming cash flows into your bank becomes essential once you stop working.
Simplifying your finances by having one chequing account can make this easier. Outgoing cash flows starts with preparing a budget of your regular monthly expenses. The second step is to map out the other goals (i.e. new vehicle, home renovations, travel) and the estimated costs. The third step is to communicate those goals with your financial advisor to ensure you have the funds in your bank account when you need them. If there is a shortfall, the discussion typically leads to converting the RRSP account to a RRIF account and mapping out withdrawals to fund the short fall.
In our last column, we talked about how investors could consider having a greater portion of their RRSP investments within lower risk equities.
RRIF accounts are slightly different in that you have to map out the need for annual cash flow. Having a year, or possibly even two years, of investments in cash equivalents or short term fixed income will create the pool of capital that can be accessed regardless of the volatility in the equity markets in the short term.
We often refer to this pool as a wedge.
Periodically, it is important in RRIF accounts to map out your wedge to earmark those funds you will be pulling out within the next 12 to 24 months.
Kevin Greenard CPA CA FMA CFP CIM is a Portfolio Manager and Director, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the TC. Call 250.389.2138. greenardgroup.com