You’ve successfully retired. Congratulations. But when it comes time to withdraw money from your registered retirement income fund, do you know how best to manage your account?
“Our industry really sucks at this,” says Daryl Diamond, a Winnipeg-based financial adviser and author of Your Retirement Income Blueprint. Even those who make a living helping people negotiate the pitfalls along the road to retirement admit that after a lifetime of saving, investors are often befuddled when it comes time to make required withdrawals from their RRSPs.
“I speak to heads of insurance companies and business firms here and there’s a huge lack of what we would call acumen in terms of how advisers are helping their clients to efficiently … put their income streams together from all the available sources when these consumers are retiring,” Mr. Diamond adds.
While he is quick to point out that every situation should be judged on its own merits, he says that, generally, registered accounts are widely misunderstood retirement vehicles. When retirees turn 71, they must transform their existing registered retirement savings plan into an annuity or RRIF. While most choose the second option, it also comes with a mandatory minimum withdrawal of 7.48 per cent from the account annually at 72, rising to 19.92 per cent by 93.
Mr. Diamond cites the example of a couple who have half a million dollars in an RRSP, and half a million in non-registered capital. The convention that is often preached, and which Mr. Diamond says still is advocated in Canadian Securities Institute and Certified Financial Planner courses, is to defer tapping into registered assets for as long as possible. But given the undesirable tax implications of withdrawing large sums of money later on, he adds that this is “a very ineffective thing to do.”
He explains that the best course of action is doing exactly the opposite by first “using tax-inefficient money such as money coming from registered accounts, government benefits, interest on non-registered accounts and income from pension plans.
“There’s a very happy blend of using those sources of income at the lower tax rates and then using your more tax-efficient or non-taxable sources of income as you cross into higher tax thresholds.”
Tax-efficient sources of income, according to Mr. Diamond, would include such things as dividends and capital gains income. They are taxed at about half the rate of interest-bearing investments, making them ideal for use in higher tax brackets, thereby controlling the overall amount of tax that is paid out to the government.
Mr. Diamond’s approach is seconded by John Nardi of Edward Jones in Toronto, who describes RRSPs and RRIFs as “your biggest tax liability at death.” In many cases, Mr. Nardi believes that tapping into your registered accounts before turning to non-registered assets is a wise decision.
“If you start taking from the registered accounts sooner, the payments may be a little lower in the future,” he says, “and therefore you avoid crossing over the clawback threshold in the future for OAS [Old Age Security]. So in that case, pulling from the RRSP at an earlier date could make sense for them.”
However, there are exceptions. Mr. Diamond points out that if there is a situation where there is not a lot of registered money, then opting to defer is a perfectly reasonable thing to do.
“Where it doesn’t really affect their taxable income level all that much, and even if one of the spouses passed away and they had perfectly split their assets, and now one remaining spouse at 72 has twice the amount of RRSP and it still doesn’t detrimentally affect a tax bracket, then really it’s not a big issue in terms of deferring it.”
Mr. Nardi points out that planning is everything when preparing for retirement, and he typically would start preparing a client’s portfolio from about the time they’re 55 or 60 for that point when the required RRIF withdrawals kick in.
“Hopefully you’ve built a portfolio that’s going to generate, in terms of interest and dividends, that sort of money for you,” he says. “So if you buy some stocks that are paying you maybe 4 per cent dividends today but those dividends keep rising, you could be in a situation where you’ve got your RRIF payments covered with dividends.
“But if your portfolio is generating a 4-per-cent return, but you need to take out 7.38 in your first year, your portfolio will automatically drop 3.4 per cent in the second year and so on and so forth. Certainly you can get into trouble 10, 12 years in where you’re only earning 4 [per cent] but you’re taking out double that.”
While Mr. Diamond admits that “what we’re trying to do is prevent people from running into this tax trap at age 72,” Mr. Nardi says that given the current state of the economy, with its rock-bottom interest rates, it’s a tough environment in which to minimize the effects of required RRIF withdrawals.
“Part of it is it’s not entirely avoidable,” he says. “Seven per cent, 7.38, is a number that’s going to be difficult to achieve over the next 20 years anyhow so the best bet is to reduce it as much as possible.
“The best way in my mind to be prepared for it is to have a solid basket or slew of stocks and bonds that are paying you 5.25 on a dividend or an interest payment. So if you’re getting that from there and you get 1 or 2 per cent growth from the portfolio, 5 per cent from the dividend, well you’re at 7 per cent right there so your reduction is significantly lower.”
The advent of tax-free savings accounts has also thrown a wrinkle into the proceedings, with Mr. Nardi advocating prudent use of a TFSA for anyone looking to maximize their financial wherewithal during retirement.
“I think the TFSA is arguably the best vehicle out there right now, apart from the RRSP, from the tax-break perspective,” he says. “Let’s say you’ve got a million dollars in your RRIF and you take out your 7.3 per cent, which is $73,000 minus taxes and what-not, and you only spend 30 of that. Well, you can park a little bit inside the tax-free account every single year and it’s a great vehicle to save from that.”
Mr. Nardi’s tips
1. Prepare as early as possible for the RRIF payments withdrawals.
2. Know how much income you want in retirement and then figure out where it’s going to come from. What the combination will be: RRIF, Canada Pension Plan, Old Age Security, etc.
3. Be prepared for lower returns because you should be a little more conservative. Err on the side of conservative returns in your portfolios.
Mr. Diamond’s tips
1. First, people need to be aware that every situation is unique. It doesn’t matter what your neighbours are doing, what your parents did; look at your specific situation.
2. Devise an exit strategy by combining fully-taxable, tax-efficient and non-taxable income streams in the best possible way over time.
3. Be aware that there are lots of investment vehicles that allow people to stream income in an efficient way at retirement and not be in a situation when they’re forced to sell securities to realize their income goals.
Editor's note: A quote in an earlier version of this story said "and therefore you avoid crossing over the clawback threshold in the future for the CPP and OAS.“ There would be no clawback in CPP, just OAS.