By Tim Paziuk
Special to the Financial Independence Hub
In the recent Federal Budget, the government listened to seniors and advisors and reduced the minimum withdrawal amounts for RRIFs (Registered Retirement Income Funds). But did they go far enough?
If you’re not familiar with minimum withdrawal amounts, here’s a quick overview:
Up until the time you’re age 71 (or if your spouse is younger, their age 71) and you’re earning an income, you can contribute money on a tax deductible basis to a personal or spousal RRSP (Registered Retirement Savings Plan).
When you reach age 71 you have a decision to make. The decision is, do you convert your RRSP to a RRIF, an annuity, or do you cash it out (or a combination of the three). If you choose to convert it to a RRIF, the income payments cannot be deferred any longer than the following year (age 72).
Under the current rules, the government sets the minimum amount a person must take from a RRIF in each year. The actual minimum amount varies from person to person because it’s calculated based on the December 31st closing value of the RRIF account and the withdrawal percentage provided by the government.
For example, based on pre-budget percentages, if a person age 75 had exactly $100,000 in their RRIF account on December 31st, 2014 they would be required to withdraw a minimum of 7.85%, or $7,850/year.
The rules do allow you to take more out of your RRIF than the minimum, but what if you don’t need the $7,850/year? Or what happens if you’re only earning 3% (or less) on your investments?
If we examine these two issues one could argue that not needing the income is a nice problem to have, but for most, the real problem lies with the rate of return in relation to the minimum amount.
When the government is forcing you to remove 7.85% of what you have and you’re only earning 2.5%, you’re going to run out of money pretty quickly.
Under new rules, still likely to deplete RRIF capital
When the budget was announced there was some sense of relief, but how much is it actually going to help? Under the new schedule, that same 75-year-old would now be required to withdraw a minimum of 5.28%. The new limits reduce the minimum income amount by about 26% (moving the rate from 7.85% to 5.82% is roughly a 26% decrease), but I still don’t think that goes far enough if someone is earning less than 3%.
If you adhere to conventional industry wisdom (a topic for another post), a person age 75 should have 75% of their investments in fixed income and a maximum of 25% in equities. If you had your money invested this way, in a combination of 75% term deposits (say with an average interest rate of 2.75%) and 25% in an S&P/TSX index fund (which yielded about 7.4% last year), your total income in 2014 would have been $3,912.50 on a $100,000 portfolio. Under the new RRIF withdrawal rules you’re still required to take out $5,820.00 in 2015, which is almost 49% more than you earned!
Ottawa should eliminate minimum withdrawal limit altogether
What I think the government should do is eliminate the minimum withdrawal limits and let individuals manage their own finances. When the time comes (and it will) and both spouses have died then the entire amount in the RRIF would be taxed at one time, and the government would finally get their hands on the tax revenue.
I realize that the only reason we even have minimum RRIF withdrawal limits is to collect taxes sooner rather than later, but if we’re going to maintain a marginal tax system, then maybe a little short term pain by the government could lead to a huge long term gain.
It’s something to think about.
Tim Paziuk is a Lecturer, Financial Advisor, and author of Professional Corporations: The Secret to Success & The Financial Navigator – Managing Your Success. He is also the president of TPC Financial Group, a fee-for-service planning company based out of Victoria, BC.