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financial planning

As the deadline for 2010 RSP contributions approaches, many of our clients have been asking if they should start taking money out as opposed to putting it in.

The reason is that they have now hit that point where they are on the other side of the retirement mountain. They have spent all of their working years putting money away so that they would have enough to draw on when they retired.

Let's look at Joe and Mary. They both recently retired, and are both 60 years old. Technically, they don't have to draw any money from their RSPs until the year after they turn 71. In many cases, Canadians don't touch RSPs until they turn into a RIF and are forced to start drawing at that age. But this can be a mistake.

Joe and Mary require $55,000 a year to live comfortably. They have both taken their CPP early, and will each receive roughly $7,800 each this year. Joe has a pension that will pay him $26,000 this year. Mary has none. In simple math, they will earn $41,600 from pensions this year.

Joe and Mary have $200,000 in RSPs, $30,000 in TFSAs and $170,000 in non-registered investments. For now, let's leave real estate out of the equation.

Should Joe and Mary use RSP money to make up the difference? Because they can split the pension income, after tax, the $41,600 will be about $37,400. As a result, they need to draw $17,600 to meet their expenses. If they draw it from their RSPs, they will pay 20 per cent tax on that withdrawal. But it still may be a smart thing to do.

How do they make the decision? First, they need to consider a few questions:

1) Are they likely to have more than $150,000 in their RSP/RIF after they both pass away? If so, it will be taxed very heavily, possibly over 45 per cent tax on a large RSP. It will mean that they were not able to spend the money on themselves, and their beneficiaries will get far less. If this is the case, it is better to draw RSP assets down earlier over time. It isn't easy to know this answer, but a detailed financial plan will help. It will give an indication of your likely RSP/RIF size at age 85 or 90 if you only draw down the minimum along the way.

2) Old Age Security considerations: Are you single or married today? Will you be single at some point in retirement? Will forced RIF withdrawals cause Old Age Security clawbacks. If your income is likely to be over $67,668 once you hit age 65, then OAS clawbacks will kick in. The OAS will disappear entirely if your income is over $109,607. Maximum OAS payment is almost $6,300 a year per person. If you are a married couple and can fully split income in retirement, in most cases you can receive full OAS. The problem is when one passes away, and the RIF/RSP income can no longer be split. If this is a potential issue in your case, or if your retirement incomes are high enough, it helps to start drawing money out of RSPs up to age 65, and possibly right through to age 71, as long as you can draw RSP assets out to an amount that doesn't clawback your OAS from age 65 to 71.

3) Can TFSAs help with this? The short answer is yes. The goal for Joe and Mary is to ensure they will never outlive their money. They also want to pay the least in taxes - not just this year, but over their lifetime. The goal for Joe and Mary is to be able to draw out their RSPs at a low tax rate that maintains OAS and to have almost no RSP/RIF balance when they both pass away. The TFSAs can play a big role in this process, as they shift money from their non-registered investments to TFSAs every year. Any dollar drawn from registered accounts that they don't need to spend can be put in their TFSA accounts. This can make sense if the tax rate is low enough on the RSP withdrawal. The hope is that most of their investment assets are in TFSAs in the last years of their life.

As you can see, the best answer takes some work. In our analysis, an early RSP withdrawal probably does not make sense for Joe and Mary. The reason is that they are not likely going to approach the OAS clawback if they wait until 71, and given that their RSP is $200,000 today, if at least one of them lives into their mid-80s, they will probably be able to draw it down at a low enough tax rate so that there is little RSP left at the end.

One way to get a sense of your likely lifetime tax bill (possibly much of it from RIF taxes at life expectancy), along with a sense of how much you might have left over at the end, is to use a retirement calculator.

Follow Ted Rechtshaffen on Twitter: @TriDelta1