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. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. My posts are blunt, opinionated and even have a twist of humour/sarcasm. You've been warned. Please note the blog posts are time sensitive and subject to changes in legislation or law.

Monday, January 10, 2022

RRSPs and Corporations - Your Silent Creeping Tax Liability

Happy New Year and I hope 2022 brings you and your family good health and a quick return to something resembling normality. This is my first blog post since December 31st when I officially retired from my public accounting firm. The term “retired” is used loosely. I look at it as a bit of a sabbatical after almost 40 years in public accounting. I will be looking for a new opportunity outside the public accounting realm in accordance with the terms of my retirement agreement, possibly in the family office, multi-family office or investment manager space; I am too young (at least in my own mind) to full stop retire.

Back to the topic at hand. In late December I was updating a retirement spreadsheet I have for changes in my current circumstances and future income tax minimization. 
 
In reviewing the income tax section of the spreadsheet, the quantum of my future or "deferred" tax liability struck me once again. Whether you are currently working, near retirement or in retirement, you have silent creeping tax liabilities accumulating in your Registered Retirement Savings Plan ("RRSP") and/or corporation [for me, in my professional corporation ("PC")]. In my experience, we tend to "forget" or minimize this tax liability, so I though I would discuss it today.

RRSPs are Great while you are Working, not as Great when you Retire


I think most readers will know this, but to quickly recap, contributions to a RRSP result in a tax deduction in the year made (or subsequent year if you don’t fully claim the contribution) and your RRSP grows tax-free until you convert the RRSP by the end of the year you turn 71. For most people, a RRSP works well as their contributions are made at a time their marginal tax rate is higher than they expect in retirement, so they have an ultimate tax savings. Despite the tax effectiveness of your RRSP, the value is somewhat of an illusion, as you are also accumulating a large, deferred tax liability, as the entire value of your RRSP will be taxable in your retirement.

There are a couple options for a RRSP when your turn 71, including a lump sum withdrawal, the purchase of an annuity or the option most people select, converting their RRSP into a Registered Retirement Income Fund (“RRIF”).

Once you convert your RRSP into a RRIF any future withdrawals are subject to income tax (you are now paying tax on your accumulated lifetime contributions and earnings that were tax-free in your RRSP) a sometimes nasty surprise in quantum for some people. You must start drawing your annual minimum RRIF payment by December 31 of the year following the year you establish your RRIF. Since you will typically still be 71 the year following the establishment of your RRIF, the minimum withdrawal will be 5.28% (you may be able to use your spouses age to lower the withdrawal rate) and will rise each year to around 10.2% by 88 and the withdrawal rates will continue to rise dramatically after age 88.

Each year this minimum withdrawal will be taxable on top of any old age security, CPP, pension income and any other investment or other type of income you earn. The marginal tax rate on these RRIF withdrawals can be substantial depending upon your financial circumstances. Luckily for many, you can elect to split your RRIF pension income with your spouse (Form T1032 -Joint Election to Split Pension Income) and thus, you can often lower your effective family tax rate through this election. However, even with the election, the deferred tax hit on your RRIF withdrawals can still be substantial.

Corporations – You have only Paid Part of the Tax


As noted above, I was struck by the quantum of my tax liability for not only my RRSP, but the investments retained in my PC. For purposes of this discussion, consider a PC to be the same as any corporation you may have. Most active companies will have paid corporate tax historically anywhere from say 12% to 26%, depending upon the corporate province of residence. You have thus deferred anywhere from say 20%-40% in tax by keeping the earnings in your corporation (again depending upon the province). Assuming you need to take money from your corporation in retirement, you will then have to deal with this deferred tax liability when you take the money (typically as a dividend).

Similar to a RRIF, you will owe income tax on this deferred tax (the deferred tax is less than your RRIF, since the corporation paid some tax, whereas you paid no tax on your RRSP). If you have been earning investment income in your corporation, you may have some tax attributes like refundable tax to reduce your tax liability, but the original money earned and deferred by the original active company is still subject to a tax hit even though it is now co-mingled with investment income earned on these deferred earnings. Without getting technical, you still have a large, deferred tax liability as you withdraw funds from your corporation.

Income Taxes and Your Retirement Withdrawal Rate


I have written a couple times on how much money you need to retire. In 2014, I wrote an extensive six-part series titled How Much Money do I Need to Retire? Heck if I Know or Anyone Else Does! (The links to this series are under Retirement on the far-right hand side of the blog). 
 
I updated this series between January and March 2021. Most of my various retirement articles and series revolve around the 4% Withdrawal Rule, which is one of the most commonly accepted retirement rules of thumb. Simply put, the rule says that if you have an equally balanced portfolio of stocks and bonds, you should be able to withdraw 4% of your retirement savings each year, adjusted for inflation, and those savings will last for 30-35 years.

In Part 1 of the original 2014 series, I had a section on some of the criticisms of the 4% rule. The first and the most impactful limitation being the model does not account for income taxes on non-registered accounts and registered accounts Note: many of the studies I discuss in both 2014 and again in 2021, still support that the 4% withdrawal works despite any income tax limitations, but I thought it important to reflect this limitation of the rule.
 
I plan to write a future blog post on possible tax planning that you can consider to minimize the tax hit from your RRSP/RRIF and corporation in retirement.
 
As discussed above, where you have a RRSP and/or corporation, income taxes are a creeping liability. Thus, it is important to ensure that when you are younger, you are cognizant of these taxes and as you get closer to retirement, you ensure you have a financial plan that accounts for these deferred/creeping taxes.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

11 comments:

  1. Mark, great article. Always topical. I have 63 years of age and should average 10% earnings per year on my RRSP investments. I can withdraw from my RRSP without moving into a higher tax band, pay tax now on the withdrawl and add to my TFSA. I should average 10% per year on my RRSP investments, meaning a higher miminum withdrawl and taxes, risk of OAS clawback and down the road, higher final taxes. Does this make sense?

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    1. Hi John, personally I would not be counting on a 10% return going forward, but that is me. As noted in the above blog I will be writing in the future about minimizing these taxes, that would include drawing down RRSPs where it results in overall tax minimization.

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    2. I look forward to the upcoming blog, Mark. I appreciate the point re 10%, however even if I achieve a 7% annual return over the next 8 years, my minimal RRIF withdrawl - obviously taxable - would be considerbly larger. The strategy I am thinking about is pay tax now vs. pay tax later. Thanks for this.

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  2. Welcome to retirement or semi retirement! It's the best.

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  3. The other thing to think about is whether you can structure your taxable income in order to receive OAS. The OAS clawback starts around $80,000 and is fully gone around $130,000. People may think it is best to keep money growing in their RRSP as long as possible, but doing so may push your withdrawls at age 71 to a point where you do not receive OAS. You should consider withdrawing money from your RRSP, even below age 65, in order to reduce this tax liability if it will affect your OAS. Money invested in a non-RRSP, non-TFSA account can bet controlled as to equity sales in order to manage taxable income.

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    1. Hi BB, I agree, as noted in my comment to John above. I will be writing on this in the future and including a discussion on RRSP withdrawals. Where withdrawals result in reduced taxes overall, including taking into account OAS, it makes sense - your tax planning needs to go out many years as possible to determine the most effective use of your marginal rates and RRSP and RRIF draw-downs and withdrawals.

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  4. Mark: Congratulations on your retirement from public accounting!

    Without your posting/nagging I would not have a Will. It took your repeat post before I took action. Maybe a 3rd repeat would be worth it, as it is so important. Facing one's mortality is so difficult but a Will is a loving/responsible thing to do.

    Keep up your clear concise blog in semi-retirement.
    You provide a valuable service by sharing your knowledge.

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    1. Lucy, thx for the kind comments and glad you got your will drafted

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  5. Is there anything you can do about these accruing tax liabilities?

    Say you decide to retire some number of years before you're 65/70, so RRIF withdrawals and OAS clawback haven't started yet. And you have four account types: non-registered, TFSA, RRSP, and your corp. Assume each account type has the same investments, but in different amounts, that pay the same ratio of capital gains, dividends, and interest. Which account(s) should you draw your income from to reduce your total taxes paid? I realize there is no one correct answer but the process to figure this out is interesting.

    Bonus points if you also consider the lower end of the income spectrum, where GIS and many other benefits for low income seniors come in. :)

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  6. Hi Unknown, as noted in a couple comments below I will be writing on this topic. However, there is no one shoe fits all solution, as you need to prepare a detailed forecast of your income out to say 95 and review how each account you hold fits into the picture to minimize your taxes. It can be complicated and you may want a financial planner or accountant to help. Unfortunately, as my header states, this blog is intended for high net worth individuals but I try to write to everyone. Sorry, but GIS would not fit into such a post other than a quick mention.

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