How to manage RRIF withdrawals tax-efficiently to avoid ‘a hefty penalty’

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What goes into a registered retirement savings plan (RRSP) must eventually come out and be taxed as income. Often, that happens after the RRSP has been converted into a registered retirement income fund (RRIF), at which point a specific percentage must be withdrawn every year.

Still, advisors employ many strategies to reduce taxes on RRIF withdrawals at or above the minimum – something that may be especially important as retired clients seek more income to meet higher costs driven by inflation.

Andrew Feindel, portfolio manager and investment advisor with Richie Feindel Wealth Management at Richardson Wealth Ltd. in Toronto, recently started advising a physician in his late 60s. This client was still working but had started to reduce his hours. Nevertheless, Mr. Feindel advised he incorporate his medical practice, retain his earnings as a doctor within it, and draw income to pay his living expenses from his RRSP (later converted into a RRIF).

“An RRSP is just future income deferred. Even if you’re working, you can live off your RRSP income. It’s no different than taking a salary,” he explains.

“Fast-forward five years, 10 years [and you’ll have] a lot less money in the RRSP [and] a lot more money in the corporation and that’s better for a lot of reasons.”

In this case, the physician has reduced his RRSP balance (and therefore the income he would eventually take as RRIF withdrawals) by $200,000 and built a corporate investment account balance of $250,000. He will have more control over how the money exits the corporation and pay less taxes on that income. Shifting money out of the RRSP has also reduced projected taxes due on the physician’s estate.

Pay attention to OAS clawbacks

Another benefit was that the physician was able to receive close to $40,000 more in government benefit payments thanks to this strategy. Mr. Feindel emphasizes that planning around Old Age Security (OAS) clawbacks is critical when developing a retirement income plan.

“The OAS threshold in 2023 is set at $86,912, meaning your OAS will be reduced in 2023 if your taxable income is above this amount [by] 15 cents on the dollar,” Mr. Feindel says.

“[That’s] an extra 15 per cent in addition to your current tax rate. That’s a hefty penalty.”

If clients need to withdraw more than planned from a RRIF toward the end of the year, he’ll sometimes advise they borrow from a line of credit to avoid initiating the OAS clawback, then repay the debt with a RRIF withdrawal in January.

“Even at high prime interest rates of 6.7 per cent, paying one month of interest, or 0.56 per cent, is better than paying [that extra] 15 per cent,” he says.

Calibrate withdraws to the marginal tax rate

Taking full advantage of someone’s marginal tax rate can be a way to reduce taxes on RRIF withdrawals over the long term, says Alex Skoke, a senior financial planning advisor with Assante Capital Management Ltd. in Stellarton, N.S. Instead of sticking to the minimum, he often bumps up withdrawals from a RRIF so clients take out as much as they can at their current marginal rate.

For example, in Nova Scotia, the 2023 marginal rate for income of more than $235,675 is 54 per cent – but it’s just 30.48 per cent for income up to $53,359.

“If a client had $35,000 income [from a defined-contribution pension plan] and had a RRIF and didn’t need [more] cash flow in their life … I would say to them, ‘Let’s consider taking an additional $15,000 out at this lower tax rate, pay the tax bill, [then] turn around and put those net proceeds after tax into a TFSA (tax-free savings account) and invest it the same as we’re investing it in the RRIF,” Mr. Skoke says.

This approach eases money out of a RRIF gradually and is often more tax-efficient than deferring taxes as long as possible only to pay the highest marginal rate as someone hits higher withdrawal minimums into their 90s or passes away with a large RRIF balance.

The other advantage, Mr. Skoke points out, is that it builds a supply of tax-free money that helps protect a client’s best-laid RRIF withdrawal plans from an unexpected expense in retirement.

Smooth out ‘lumpy events’

“With regards to making [RRIF] withdrawals as tax-efficient as possible … my initial aim is always to have a good sense of [a client’s] total wealth picture,” says Dalyce Seitz, principal and portfolio manager, private clients and foundations at Leith Wheeler Investment Counsel Ltd. in Calgary.

“What are all of their sources of income? What does the entire asset base look like? That allows us to be as strategic as possible and plan for any contingencies that might come along.”

Her planning for RRIF withdrawals starts the moment clients start contributing to their RRSPs. Throughout those wealth accumulation years, it’s critical to consider when and how much it makes sense to contribute with an eye toward future withdrawals.

Once someone is withdrawing from a RRIF, Ms. Seitz considers how to take advantage of elements such as income splitting, the pension tax credit and OAS clawback thresholds, working in partnership with tax professionals.

Whenever possible, she works to smooth out a client’s income over time, which requires conversations about anticipated expenses and tax-triggering events (such as the sale of a rental property) to allow planning leading up to a “lumpy event.”

“It’s a dynamic process. So much can change over a lifetime or a longer retirement period,” Ms. Seitz emphasizes.

“So for us, it’s all about being able to pivot where we can and keeping in touch with clients to know when those significant changes occur.”

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Editor’s note: A previous version of this story stated an OAS clawback could result in an additional 15 per cent tax. The quote has now been updated to reflect that it is an extra 15 per cent that is not part of the income tax.