Developing RRSP withdrawal strategies
Written by Jim Yih •
The RRSP is one of the key pillars of retirement savings. Although many people contribute to RRSPs because of the immediate tax savings, it’s also one of the best accounts for long term retirement savings.
Lots has been written about accumulation and growing RRSPs but as the demographics suggest more and more baby boomers need to pay attention to RRSP withdrawal strategies.
Converting RRSPs to income
When you need income from your RRSPs, you will need to decide on either a RRIF or a Life Annuity. With interest rates at all time lows, the RRIF is by far the more popular choice today.
Related article: How to convert RRSPs to income
With the RRIF, you have a lot of choice and flexibility. You can increase income, decrease income, stop income, make lump sum withdrawals, and change investments.
Related article: Everything you need to know about RRIFs
Life annuities, on the other hand, are simple and management free. Once you purchase an annuity, you get a fixed income for life regardless of what happens to the stock market, economy or interest rates.
When should you convert RRSPs to income?
One of the big tax benefits of the RRSP is tax deferral. In fact, deferring tax is one of the three D’s of tax planning. Deferring of tax simply means instead of paying the tax now, you can pay it in the future allowing you to use the government’s money for your own benefit.
Deferring RRSP and RRIF income is smart, especially in your working years. If you take money out of your RRSPs when you are working you will probably pay more tax because you will be in a higher tax bracket. I’m good with the concept of tax deferrral while you are working but once you are retired should you continue the path of tax deferral?
Aren’t you supposed to spend your RRSPs in retirement?
When you retire, just remember the whole point of putting money into the RRSPs in the first place: To save money to enhance your retirement to make retirement the best years of your life. Despite this common goal, I see far too many people hit retirement and are reluctant to spend their RRSPs and RRIFs because of over generalized advice around the benefits of continued tax deferral.
When should you take money out of your RRSPs/RRIFs?
My advice has always been for retirees to come up with RRSP withdrawal strategies as soon as retirement starts. The point of developing RRSP withdrawal strategies are to help retirees create more income so they can spend it. But for some retirees, they don’t need or want to spend the money or they get so focused on tax deferral so they do not withdraw any money from their RRSPs. Even if you do not need the money, it might make sense to develop a withdrawal strategy for other tax reasons.
Reasons why developing RRSP withdrawal strategies make sense
1. RRSP income can create clawbacks on income-tested programs. RRSP withdrawals are fully taxable and can cause higher incomes, which can lead to Old Age Security (OAS) clawback, and less Guaranteed Income Supplement (GIS). If you know your higher taxable income can create ‘clawbacks’, it can be advantageous to take money out of the RRSPs before you qualify for these programs.
2. Higher incomes in retirement. If you knew you would pay 32% tax on any RRSP withdrawals in the future, would you be willing to take that money out now at only 25% even if you did not need the money? In most cases, people retire with less income than while they were working. However, I’ve run across many examples where people might actually have more income in retirement. This can be more common with people who have defined benefit pensions and others who plan to work in retirement.
3. Deferral of lifestyle. Retirement is not just about money and tax. People who defer their RRSPs to age 71 are also deferring their lifestyle. Think about this . . . if you have not used your RRSPs by the time you turn 71, what makes you think you will need your money after 71? I see so many people deferring RRSPs to age 71 only to find they can’t spend it later. They then take minimum income because they have to but don’t even spend that money. And then they die with too much RRSPs.
4. Taxation of RRSPs at death. I’ve written extensively about why you do not want to die with too much RRSPs. The tax consequence can be too significant. You might wind up paying even more tax when you die than if you developed a withdrawal strategy while you were living because the RRSPs are all taxed at once. If you think avbout it, you would never withdraw all of your RRSPs out at once while you are living because the tax hit would be too severe but that’s exactly what happens when you die. It’s like taking all your RRSPs out at once and taking the big tax hit in one shot. Deferring tax to retirement makes sense but deferring tax to death may actually be counter productive from a tax perspective.
Planning is personal
All the theory in the world is useless unless you can apply it to yourself. I’m always concerned that someone will read this article and then go an take out all their RRSPs out once they retire for all the wrong reasons. Remember that planning is personal. Just because it made sense for someone to defer RRSP income into the future, does not mean you should too. Good planning will make all the difference so take this information and apply it to your personal situation. Look at the merits of developing RRSP withdrawal strategies from many different angles. Run a good retirement plan that projects income and expenses well into the future.