Under certain circumstances, those who take strategic early withdrawals from a registered retirement savings plan may find tax and other financial advantages, experts say.
In the decade prior to the absolute deadline when 71-year-old Canadians must turn an RRSP into either a registered retirement income fund (RRIF) or an annuity, it may make sense to withdraw some RRSP funds, but the raids should be carefully executed.
"If you're talking any kind of significant withdrawal, you're probably going to be looking at doing a staged amount involving smaller lump sums over five or six years, as compared to doing one larger one where a great portion of it might be taxed at the highest tax rate," says Jason Kingston, a principal with DSK LLP in Kitchener, Ont.
Mr. Kingston describes one hypothetical scenario, involving a combination of RRSPs and potential payments of CPP and OAS – Canada Pension Plan and Old Age Security – between the ages of 65 and 71.
"Let's say the individual is retired, but they have significant RRSPs. They don't want to convert to a RRIF yet, because they want to remain flexible. We wouldn't want them having just CPP and OAS for six years, potentially paying no income tax due to the personal exemption and age amount tax credits, until the year they turn age 71 and then convert to a RRIF and have huge minimum RRIF withdrawals," he explains.
Under those circumstances, it would make sense to make extra RRSP withdrawals in those low-income years, as the long-term tax savings can be substantial, he elaborates.
A common tax strategy involves converting a small portion of an RRSP into a RRIF as early as age 65, when a taxpayer becomes eligible to apply up to $2,000 of eligible annual retirement income toward a 15-per-cent federal pension credit, plus applicable provincial or territorial credits.
A RRIF provides a source of pension income that can be especially valuable if the taxpayer has no other income to apply toward the pension credit. A RRIF can also enable a taxpayer to create pension eligible income for their spouse when he or she turns 65, experts note.
"Quite often what we'll do is just establish a very small RRIF so that a client will get that $2,000 per spouse, because otherwise you're just kind of giving away a tax credit," Mr. Kingston notes.
However, this strategy is not necessarily beneficial for everybody.
For example, if somebody is still working and making $150,000 a year, "I'm not going to add $2,000 of income on to them, just to get a tax credit that equates out at a 15-per-cent federal tax credit, when they're going to pay 53 per cent – the top marginal combined federal and Ontario rate – on that additional income," Mr. Kingston explains.
Heather D'Arcy of Ottawa, who is on leave from her job, has chosen to withdraw a small amount of her RRSP, following a strategy of paying tax on that amount now, rather than waiting until her work pension plan kicks in at age 60 and puts her into a higher tax bracket. This increases liquidity and reduces taxes, she says.
Essentially, "it smoothes out my income as well as my income tax," Ms. D'Arcy adds.
Glenn Fiddy, 70, an accountant based in Toronto, withdrew $20,000 from his RRSP in 2017 – one year earlier than the deadline he will face to terminate his RRSP at the end of 2018 – to pay back personal expenses on his line of credit. Although the RRSP withdrawal will bump up his 2017 income by $20,000, there was a tax strategy involved.
"I'm already in one of the middle tax brackets, so my plan was to take just enough out so that I don't go into a higher tax bracket," says Mr. Fiddy. "The general philosophy behind this strategy of using RRSP money to pay back personal expenses is, 'I'm not going to live forever, and I can't take it with me.' So I'm going to spend some money," he adds.
(The upper limit of the low-tax bracket in Ontario is $42,201 for the 2017 tax year. The combined federal/provincial tax rate on that amount of income is slightly more than 20 per cent. For taxable income above $45,915, the combined tax rate is just over 29.65 per cent, and this rate continues to go up as income increases.)
Idan Shlesinger, a senior partner with Morneau Shepell Ltd. in Toronto, says there might be an argument to cash out RRSPs early if someone has a very short life expectancy. The money could be used to cover medical or other expenses, he says.
Todd Sigurdson, director of tax and estate planning for Investors Group Financial Services Inc. in Winnipeg, adds that sometimes people want to withdraw money early from their RRSPs so that it doesn't result in an OAS clawback later on. (Once you're 65, OAS benefits are reduced when annual net income reaches $74,788 for the 2017 taxation year.)
Taxpayers who do decide to withdraw more than the $2,000 that can be applied toward pension income eligibility have several options with respect to how those funds can be reinvested.
"Maxing out the tax-free savings accounts is definitely the first place I would put the money," says Mr. Kingston.
"It can make sense to utilize middle tax brackets between ages 65 to 71 by increasing the RRSP withdrawal even if it creates excess cash for the client. The excess cash should then be invested in the TFSA since TFSA earnings attract no tax or income upon withdrawal," he elaborates.
For someone who doesn't have the TFSA contribution room to deposit all of the funds withdrawn from an RRSP prior to age 71, tax-advantaged funds such as corporate class mutual funds might be beneficial, says Mr. Sigurdson.
"Due to the fact that corporate class funds may result in reduced distributions, they could be an excellent alternative for retirees who have used up all of their TFSA and RRSP room, especially if they are concerned about clawbacks of income-tested benefits," Mr. Sigurdson explains.