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Are million-dollar RRSPs a looming tax problem for soon-to-retire baby boomers or simply a nice problem to have?
My latest Globe & Mail Wealth column has just been published on page B9 of the Tuesday paper and online, which you can access by clicking on the highlighted headline here: The secret to paying less tax in retirement.
As one expert cited — Doug Dahmer, who often guest blogs here at the Hub — tax is perhaps the single biggest expense in Retirement. This often becomes apparent when those growing RRSPs the Boomers and others have been accumulating are forced to become RRIFs or Registered Retirement Income Funds at the end of age 71, at which point they become taxable at your highest marginal rate, just like interest or employment income. Million-dollar RRSPs are not that uncommon, according to the sources consulted for the column, whether individually or shared by couples.
(I say”forced” but of course there are two alternative options: annuitize or cash out. Very few people choose the latter option, while annuitization or partial annuitiization is certainly a valid option as you progress through your 70s, although ideally when interest rates are higher.)
The initial RRIF withdrawal percentage is 5.28% at 71 but minimum withdrawal rates rise steadily over time, hitting 6.82% at age 80, 10.21% by 88 and reach 20% by age 95 and beyond.
Draw down RRSPs/RRIFs early, delay CPP/OAS to 70
As the article notes, this has two implications: one, since it’s unlikely most investors with balanced portfolios will generate returns as high as the withdrawal percentages, most RRIF recipients will start breaking into capital. Second, they may be forced to withdraw more than they need to live on, and pay tax as they do. For many clients, Dahmer suggests withdrawing from RRSPs earlier than necessary — or starting a RRIF early — may be the thing to do if you find yourself in a lower tax bracket in your 60s: typically after full time employment. And if possible, he suggests deferring Canada Pension Plan (CPP) and/or Old Age Security (OAS) benefits until age 70.
Dahmer has created an app called the Retirement Navigator, to help investors optimize withdrawals of various retirement income sources with their taxes. Sounding like the Fram Filter advertisements, he says: “It usually means paying a little more taxes sooner to pay a lot less later on.”
Dahmer says if you can’t earn more than 8% a year in your RRSP, you’re better off drawing it down and enjoying the 8.4% guaranteed annual improvement on your CPP each year you defer it. This also gives you more of an inflation-indexed guaranteed recurring income you can’t outlive.
Dahmer gets some support from retired actuary and pension expert Malcolm Hamilton, who says because of the way the math works even if an RRSP earns just 6%, deferring CPP can work, and with less risk. “Until interest rates move up to 5 or 6%, deferring the CPP looks like a good choice.”
Another regular Hub blogger, Adrian Mastracci, provides a dissenting view. He’s all for making RRSPs and RRIFs as large as possible and paying whatever tax is due, quipping that a huge RRSP is “a nice problem to have.”
Discussing this Tuesday night on CBC On the Money
PS: I discussed the G&M article on Tuesday evening after 7 pm on CBC On the Money. The link to the full show is here: my segment is about 20 minutes in.
I realise it’s not for everyone but the tax rate on RRSP’s withdrawals for non-resident Canadians is between 15% and 25%. One can save hundreds of thousands if living outside Canada for a minimum of 2 years is an option, recognizing this strategy need the advice of a tax expert.
How do we access the “Retirement Navigator” app?
Try http://emeritusfinancial.com/cpp-optimizer
I am on the fence about whether my husband should take CPP early. Every time I read an article, this one included, it gets me thinking about something that I hadn’t considered. Here is my thinking.
Pro 1. “Free money” (or not lost money) for 3 years (he’s 62, that equals $30,000 to him). 100% of this money would be saved and generate a low/no tax impact in the form of eligible dividends,
Con 1. I’m taking money out of his/my RRSPs anyways to minimize tax rates (at 65 he’ll add OAS) so we could live off that money and any excess (likely) could be invested to generate more dividends. I like this because it provides a little more inflation security. Especially since we have no pension or secured income except for CPP and OAS (and I don’t have much CPP as I’ve only worked for 8 years, plus 7 for raising kids).
Pro 2. Any survivor rates would not be impacted by when he claimed CPP. Note that this is of importance as I am 17 years younger than my husband and we have young children.
Con 2. We pretty much have enough money to live on now and are making lifestyle changes (selling our house and renting) that will enable us to invest even more money, which will generate income. It also doesn’t assume any passive income or inheritances which are both likely. So technically, we don’t NEED the money (once OAS kicks in, we’ll be fine).
I need to call CPP again and make sure that the fact that my husband hasn’t been taking a salary for three years (non-eligible dividends, which have recently changed too so I need to look into that, meeting with the accountant next week), won’t negatively impact his numbers. I spoke with CPP 5 years ago and based on the information at the time, it wouldn’t, but better safe than sorry.
Any feedback on my assumptions or links to additional information would be greatly appreciated.
Besos Sarah.
Another thing to consider is CPP Survivor Benefits. If both spouses have max CPP, survivor benefits may disappoint. Chalk one up for early CPP if that’s a concern.
Clicking on the navigator link went to a 1 minute podcast, not an app. After listening to the podcast, it asks you to click the continue button but no such button appears. There is a glitch in the works.