Tag Archives: RRIFs

Retired Money: You can still count on 4% Rule but there are alternatives to settling for less

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MoneySense.ca; Photo created by senivpetro – www.freepik.com

My latest MoneySense Retired Money column looks at that perpetually useful guideline known as the 4% Rule. Click on the highlighted headline to access the full article online: Is the 4% Rule Obsolete?

As originally postulated by CFP and author William Bengen, that’s the Rule of Thumb that retirees can safely withdraw 4% of the value of their portfolio each year without fear of running out of money in retirement, with adjustments for inflation.

But does the Rule still hold when interest rates are approaching zero? Personally I still find it useful, even though I mentally take it down to 3% to adjust for my personal pessimism about rates and optimism that I will live a long healthy life. The column polls several experts, some of whom still find it a useful starting point, while others believe several adjustments may be necessary.

Fee-only planner Robb Engen, the blogger behind Boomer & Echo, is “not a fan of the 4% rule.” For one, he says Canadians are forced to withdraw increasingly higher amounts once we convert our RRSPs into RRIFs so the 4% Rule is “not particularly useful either … We’re also living longer, and there’s a movement to want to retire earlier. So shouldn’t that mean a safe withdrawal rate of much less than 4%?”

It’s best to be flexible. It may be intuitively obvious but if your portfolio is way down, you should withdraw less than 4% a year. If and when it recovers, you can make up for it by taking out more than 4%. “This might still average 4% over the long term but you are going to give your portfolio a much higher likelihood of being sustainable.”

Still, some experts are still enthusiastic about the rule.  On his site earlier this year, republished here on the Hub, Robb Engen cited U.S. financial planning expert Michael Kitces, who believes there’s a highly probable chance retirees using the 4% rule over 30 years will end up with even more money than they started with, and a very low chance they’ll spend their entire nest egg.

Retirees may need to consider more aggressive asset allocation

Other advisors think retirees need to get more comfortable with risk and tilt their portfolios a little more in favor of equities. Adrian Mastracci, fiduciary portfolio manager with Vancouver-based Lycos Asset Management Inc., views 4% as “likely the safe upper limit for many of today’s portfolios.” Like me, he sees 3% as offering more flexibility for an uncertain future. Continue Reading…

Are you tax planning for you …. or for your estate?

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By Aaron Hector, B.Comm., CFP, RFP, TEP

Special to the Financial Independence Hub

“In this world nothing can be said to be certain, except death and taxes.” – Benjamin Franklin

While death and taxes may be certain, the variables in and around them are certainly not. That’s why they warrant attention and planning. The following analysis provides some food for thought when deciding whether to use proactive tax planning to optimize your living net-worth or your after-tax estate.

A tisket, a tasket, a future tax basket

Most retirees have baskets of “future tax” that are just sitting there in abeyance. The most common of these tax baskets is the one that’s attached to RRSP accounts. When you contribute to your RRSP, you get a tax deduction which gives you a break on the taxes payable in that year. But when the time eventually comes to make a withdrawal, each dollar you remove from your RRSP will be fully taxable and increase your income accordingly.

Depending on the situation, there could be several other future tax baskets as well. For example, you might have unrealized capital gains that are attached to a non-registered investment account, or even an additional property. When these assets are sold in the future, the capital gain at that time will be subject to taxation.

Our tax system is progressive, which means the tax rates continue to increase as your income does, thus moving you from a lower tax bracket to a higher one. When you die (without a surviving spouse), all of the remaining tax baskets are dealt with at that time. This often results in a significant amount of taxable income that’s exposed to the highest marginal tax rates which can exceed 50%, depending on your province of residency.

Managing future tax

What can be done to manage this future tax in a way that avoids exposure to such high tax rates? One popular approach is to look at your projected retirement income and identify when in the future there might be years where income is lower than average or higher than average, and then try and shift income away from the high years to fill in the low years. This “tax averaging” often results in an acceleration of income in earlier years, which then lowers the exposure to high tax rates later in life or upon death.

If you think this sounds challenging, remember that any financial planner worth their salt should be able to review your assets and liabilities, then map out your projected income going forward on a year-by-year basis. The low-income years most commonly occur immediately following retirement; the paycheque has stopped, but maybe you have ample cash and non-registered savings that can be used to fund your lifestyle. It’s quite possible that the income you would report on your tax return in these years would be minimal. However, by the end of the year that you turn 71 your RRSP accounts must be converted into RRIF accounts, giving rise to forced annual withdrawals that are fully taxable. These mandatory withdrawals might mark the beginning of your high-income retirement years and may even result in your Old Age Security (OAS) being clawed back. That being said, it really depends on one’s individual circumstances.

The nice thing about the future tax is that, for the most part, you have flexibility in deciding when you convert that future tax into current tax. Just because you can wait until age 72, when you are forced to make your first withdrawal from your RRSP (RRIF), doesn’t mean that you must wait until you are 72. Furthermore, this doesn’t need to be a cash flow decision. If you don’t need the money to fund your lifestyle, then you can simply take the money that is withdrawn from the RRSP and then (subject to withholding taxes) reinvest it back into another account such as your TFSA or non-registered account. The point here is that you have the option of choosing what you believe to be an optimal year to increase the amount of income that will be reported on your tax return.

Similarly, you can choose to trigger a capital gain within a non-registered account at any time. A sale of a stock doesn’t need to be an investment decision – it can be a tax decision. Simply sell the stock, thereby triggering the capital gain, and then immediately rebuy it. The capital gain will then be reported on your tax return in the year it was sold, and your taxable income will be increased accordingly.

In a nutshell, every dollar of income that you accelerate is a dollar of income that you don’t have to report in the future, and you get to choose what tax rates get applied to that dollar; the current marginal rate, or the future marginal rate (which could be higher). It’s easy to see how this process can result in your paying a lower average lifetime tax rate.

How to impact your lifetime assets and estate

Let’s dig a bit deeper. How do these choices carry forward and impact your lifetime assets and ultimately your estate? I’ll begin with some foundational ideas and then provide a real-life example.

Imagine a scenario where your current marginal tax rate is 30% while living, but if you died then the marginal tax rate on your final tax return would be 50%. Continue Reading…

Retired Money: Can an RRSP or a RRIF ever be “too large?”

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MoneySense.ca

My latest MoneySense Retired Money column looks at a problem some think is a nice one for retirees to have: can an RRSP — and ultimately a RRIF — ever become too large? You can find the full column by clicking on the adjacent highlighted headline: How large an RRSP is too large for Retirement?

This is a surprisingly controversial topic. Some financial advisors advocate “melting down” RRSPs in the interim period between full employment and the end of one’s 71st year, when RRIFs are typically slated to begin their annual (and taxable) minimum withdrawals. Usually, RRSP meltdowns occur in your 60s: I began to do so personally a few years ago, albeit within the confines of a very conservative approach to the 4% Rule.

As the piece points out, tax does start to become problematic upon the death of the first member of a senior couple. At that point, a couple no longer has the advantage of having two sets of income streams taxed in two sets of hands: ideally in lower tax brackets.

True, the death of the first spouse may not be a huge tax problem, since the proceeds of RRSPs and RRIFs pass tax-free to the survivor, assuming proper beneficiary designations. But that does result in a far larger RRIF in the hands of the survivor, which means much of the rising annual taxable RRIF withdrawals may start to occur in the higher tax brackets. And of course if both members of a couple die with a huge combined RRIF, their heirs may share half the estate with the Canada Revenue Agency.

For many seniors, the main reason to start drawing down early on an RRSP is to avoid or minimize clawbacks of Old Age Security (OAS) benefits, which begin for most at age 65. One guideline is any RRSP or RRIF that exceeds the $77,580 (in 2019) threshold where OAS benefits begin to get clawed back. Of course you also need to consider your other income sources, including employer pensions, CPP and non-registered income.

Adrian Mastracci

“A nice problem to have.”

But the MoneySense column also introduces the counterargument nicely articulated by Adrian Mastracci, fiduciary portfolio manager with Vancouver-based Lycos Asset Management. Mastracci, who is also a blogger and occasional contributor to the Hub, is fond of saying to clients “A too-large RRSP is a nice problem to have!”

Retirement can last a long time: from 65 to the mid 90s can be three decades: a long time for portfolios to keep delivering. A larger RRIF down the road gives retirees more financial options, given the ravages of inflation, rising life expectancies, possible losses in bear markets, low-return environments and rising healthcare costs in one’s twilight years. These factors are beyond investors’ control, in which case Mastracci quips, “So much for the too-big RRSP.”

 

Retired Money: How retirees can lower RRIF tax shock by taxing “at source” wherever possible

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My latest MoneySense column takes a look at the supposed “tax nightmare” new retirees sometimes face on the forced annual (and taxable) withdrawals of Registered Retirement Income Funds or RRIFs. Click on the highlighted headline for the full article: How to avoid tax payment nightmares when the RRIF withdrawals start.

It’s a simple idea really. Salaried employees take for granted the automatic deduction of income taxes “at source.” They receive their regular paycheque with “net” or after-tax deposits that go directly into their bank accounts.

RRIFs are famously taxable: once you reach the end of your 71styear, you are required to pay an ever-rising minimum percentage withdrawal, all fully taxed like earned income or interest. However, notes Aaron Hector, a financial planner with Calgary-based Doherty & Bryant Financial Strategists, there is no mandatory withholding tax on RRIFs, unlike the 10, 20% or 30% tax that must be withheld at source on RRSP withdrawals (which rises with amount withdrawn.)

Fortunately, you can ask your financial institution to deduct tax at source every time you make a RRIF withdrawal. Alternatively, new retirees or semi-retirees may wait till 71 to start a RRIF but choose to withdraw money from their RRSP whenever they need it during their 60s. Here, the problem is the minimum withholding required can prove to be inadequate if you take out chunks of RRSP cash that are too small. Take them out in $5,000 chunks or less and the 10% (5% in Quebec) withholding tax is unlikely to be sufficient once you file your annual return.

Try and take out at least an amount between $5,000 and $15,000, which results in a 20% withholding tax (10% in Quebec.). Better yet, make the withdrawals $15,000 or more and pay the 30% withholding tax (15% in Quebec). Don’t fret that this may be “too much” tax: if so, it will be rectified once you file your next tax return. You can find a summary of RRSP withholding rates at this Government of Canada website.

Hector says RRIF withdrawals in excess of the minimum annual required payment are treated the same as regular RRSP withdrawals for withholding tax. So if your minimum RRIF payment one year is $50,000 but you withdraw $100,000, the extra $50,000 will be taxed at 30% on withdrawals and come tax time, you’d pay tax on the entire $100,000. You can elect to have taxes withheld at source on the minimum RRIF payments as well: Hector estimates a third of his clients do just that. Others may end up making quarterly tax installments instead.

This situation is aggravated by the fact non-registered investment income is typically taxable.             Fortunately, you can choose to deliberately overtax yourself as you go on many common sources of retirement income: if you receive pensions from former employers and/or the Government (CPP, OAS), you can set things up to mimic the “taxed at source” setup salaried workers have. While not mandatory, pension administrators will deduct whatever percentage of tax you wish to arrange with them, whether a minimal amount or a near-confiscatory 50%, or somewhere between those extremes.

In my case, I set 30% as my withholding tax on corporate pensions, 25% on OAS and eventually the same amount for CPP. You may feel small pensions don’t have to be taxed at source if they are less than the Basic Personal Amount that is tax free to everyone: $11,809 in 2018, $12,609 in 2019.

The alternative is quarterly tax installments. Retired advisor Warren Baldwin says theCRA sends notices for payments based on simple arithmetic applied to the previous year’s taxes. “So if, for example, 2017 was a high-income year and you had a high tax liability on filing, CRA will request large payments in March and June of 2019. If income and the liability declines in 2018/19, then you might have overpaid and need to wait until spring of 2020 for the refund.”

Ideally, things will balance out when it comes time to file your taxes: if you went overboard in taxing yourself at source, you may end up with a refund; if you underestimated your taxes due, you may end up having to cut yet another cheque to Ottawa. Some object to giving the CRA an “interest-free” loan but personally, I’d rather receive a small refund than have to pay still more at tax time.

Retired Money: How the financial industry may use ALDAs and VLPAs as Longevity Insurance

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Finance professor Moshe Milevsky welcomes industry’s implementation of academic longevity insurance theories

My latest MoneySense Retired Money column looks at two longevity-related financial products that the industry may develop after the road to them was paved in the March 2019 federal budget. You can access the full column by clicking on the highlighted headline: A new kind of annuity designed to help Canadian retirees live well, for longer.

Once they are created by the industry, hopefully in the next year, these new products will introduce an element of what finance professor Moshe Milevsky has described as “tontine thinking.” In the most extreme example, a tontine — often depicted in fictional work like the film The Wrong Box — features a pool of money that ultimately goes to the person who outlives everyone else. In other words, everyone chips in some money and the person who outlives the rest gets most of the pot. As you can imagine at its most extreme, this can lead to some nefarious scenarios and skulduggery, which is why you occasionally see tontines dramatized in film, as in The Wrong Box, and also TV, as in at least one episode of the Agatha Christie TV adaption of Miss Marple.

Fortunately, the Budget doesn’t propose something quite as dramatic as classic tontines but get used to the following two acronyms if and when the insurance and pension industries start to develop them: ALDA is an acronym for Advanced Life Deferred Annuity.  As of 2020, ALDAs could become an investment option for those currently with money invested in registered plans like RRSPs or RRIFs,  Defined Contribution (DC) Registered Pension Plans and Pooled Registered Pension Plans (PRPPs).

The other type of annuity proposed are Variable Payment Life Annuities (VPLAs), for DC RPPs and PRPPs, which would pool investment risk in groups of at least 10 people. Not quite tontines in the classic academic sense but with the pooling of risk VPLAs certainly have an element of “tontine thinking.”

The budget says a VLPA “will provide payments that vary based on the investment performance of the underlying annuities fund and on the mortality experience of VLPA annuitants.” That means – unlike traditional Defined Benefit pensions – payments could fluctuate year over year.

There is precedent for pooled-risk DC pensions: The University of British Columbia’s faculty pension plan has run such an option for its DC plan members since 1967.

The budget said Ottawa will consult on potential changes to federal pension benefits legislation to accommodate VPLAs for federally regulated PRPPs and DC RPPs, and may need to amend provincial legislation. But it’s ALDAs that initially captured the attention of retirement experts, in part because of its ability to push off taxable minimum RRIF payments.

Up to $150,000 of registered funds can go into an ALDA

An ALDA lets you put up to 25% of qualified registered funds into the purchase of an annuity. The lifetime maximum is $150,000, indexed to inflation after 2020. Beyond that limit you are subject to a penalty tax of 1% per month on the excess portion. Continue Reading…