My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with a National Accounting Firm in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned. Please note the blog posts are time sensitive and subject to changes in legislation or law.

Monday, June 30, 2014

RRIFs - How they Work and Tax Planning

By the end of the year in which you turn 71, you are required to terminate your RRSP. You have three viable options at that point.

1. You can transfer your RRSP savings into a Registered Retirement Income Fund (“RRIF”).
2. You can transfer your funds into an annuity.
3. You can blend the RRIF and annuity option.

There is a fourth option, which is to withdraw the full value of your RRSP; however, unless you have a very small RRSP, this option is a non-starter.

Today, I am going to discuss the RRIF option. I will likely write about annuities at some point in the future. Many investment advisors suggest that you consider using some portion of your RRSP to purchase an annuity to provide a fixed stream of income in retirement, especially if you don’t have a company pension upon retirement. Rob Carrick wrote this article last week on how you can use annuities in your retirement.

The RRIF Rules

RRIFs are subject to an annual minimum withdrawal, which commences the year after you open your RRIF account. The minimum withdrawal amounts are based on a percentage of the value of your RRIF. The standard percentages are noted below.

after 1992

after 1992
94 or older
* On January 1 of the year for which the minimum amount is being calculated.

The minimum withdrawal rates may force you to withdraw more funds than you need to live and push you into a higher income tax bracket. Fortunately, you can elect to have the withdrawal minimums based on the age of a younger spouse or common-law partner. This election cannot be changed once you select the spousal age option.

If you have a spouse under the age of 71 the minimum percentage is calculated as 1 divided by (90 minus your spouse's age). As per this article by Preet Banerjee, if your spouse is only 50, you would only have to withdraw 2.5% [1/(90-50)].

The website has this excellent RRIF calculator to help you determine your minimum withdrawal rates and whether you should use your age or your spouses. 

Income Tax Planning for RRSPs & RRIFs before Age 71

It may make sense to withdraw funds from your RRSP before you convert it to a RRIF at age 71. You would do this only where your marginal income tax rate will be lower in the years between retirement and when you convert your RRIF at age 71. For example, assume you will have $40,000 of pension and investment income when you retire at age 65. At this level of income, the next $4,000 you earn will be taxed at approximately 24% and the following $27,000 will be taxed at 31%. Thus, you may want to cash in $4,000 and possibly more, since when you must withdraw funds from your RRIF at age 72, you will at minimum be taxed at 31% and possibly higher (depending upon your minimum RRIF withdrawal and your ability to pension split with your spouse).

You also want to manage your total net income so that you will not have to pay back your old age security. The 2014 clawback threshold starts at $71,592 with your OAS being completely clawed-back once your total net income reaches $115,716.

To some, the above may seem simplistic and fairly standard advice. In fact, I was taken to task by a reader for similar advice during my 6 part series on retirement. The reader commented that they "have seen very few models that give a detailed picture of how to manage the drawdown of your RRSP and take into account the minimum RRIF withdrawals". As I like a challenge, I actually attempted to create such a model. Alas, after a couple hours and a brief discussion with Michael James who is a math whiz, I realized this is a herculean task, in which I have little interest in attempting to conquer. Thus, I suggest the only way to deal with this issue is to have your financial planner consider your RRSP drawdown in context of your retirement plan.

As RRIF withdrawals at age 65 and beyond qualify as pension income, they will be eligible for the $2,000 pension income tax credit. Many advisors suggest converting a small portion of your RRSP into a RRIF so that you can claim the pension credit. The pension credit is worth approximately $400 on a $2,000 RRIF withdrawal. Keep in mind you may have to pay an administration fee for your RRIF that could offset some of this benefit.

If you will have earned income in the year of retirement, say 2014, you can make a RRSP over-contribution in December, 2014 (equal to 18% of your 2014 earned income). This will allow you to claim a 2015 RRSP deduction. You will pay a one month over-contribution penalty of 1% for your December over-contribution; however, your RRSP over-contribution will cease January 1, 2015 (i.e. If your 2014 earned income is $100,000, you can make a $18,000 over-contribution in December, 2014. You will owe a $180 penalty, but can deduct the $18,000 RRSP contribution on your 2015 return even though your RRSP is now a RRIF).

If you have a younger spouse and you have RRSP contribution room, you can contribute to a spousal RRSP up to and including the year in which they turn 71.

Most people know they must convert their RRSP to a RRIF by the end their 71st year, but give no heed to any planning before the year of conversion. As noted above, tax planning should begin with your RRSP/RRIF in your early to mid-sixties.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.