The coronavirus pandemic is hitting older Canadians hard on two fronts: health and wealth. Those with registered retirement income funds (RRIFs) are facing the further problem of the mandated RRIF minimum-withdrawal schedule, which will force them to cash out some of their investments during a serious market downturn.
Canadians are required to convert their registered retirement savings plans (RRSPs) into RRIFs by age 71 and are then mandated to withdraw a minimum amount each year. The minimum required withdrawal rate increases at each age – from 5.28 per cent at age 71, up to 20 per cent for those age 95 and older. The government’s response to the current COVID-19 crisis was to reduce the required minimum withdrawals by 25 per cent for 2020.
There is, however, a way for older Canadians to work around the minimum withdrawal issue if they don’t need all of the money this year for living expenses. According to my research at the National Institute on Ageing, in partnership with FP Canada Research Foundation, seniors in this position can reinvest the unneeded after-tax RRIF income into their tax-free saving accounts (TFSAs). So long as the senior remains in the same income tax bracket, this workaround will deliver the same after-tax money to spend down the road as if they’d never withdrawn the unneeded money from their RRIF in the first place.
If they believe their investments will recover, they could repurchase the same portfolio mix. Should stocks rebound, this strategy could potentially leave them with large tax-free capital gains.
A simpler solution would be for government to suspend the minimum RRIF withdrawal requirements altogether during this volatile financial environment, as the U.S. government has done for its corresponding “401(k)” program. However, this requires forfeiting further tax revenue this year, which may not be feasible for the public purse.
The great RRIF debate
The argument around the right level of minimum RRIF withdrawals is a long-standing one. The schedule was most recently adjusted downward in 2015, recognizing that the minimum withdrawal calculations were out of step with today’s lower investment returns and greater longevity among Canadians. Lowering the required withdrawal rates was a move in the right direction, but perhaps not enough to provide sustainable income throughout retirement.
How many Canadians are grappling with the RRIF minimum withdrawal rules? There is no public data source to answer this question, however, we can piece together government and industry data to get a high-level picture.
Statistics Canada’s 2016 Survey of Financial Security found that 60 per cent of older Canadians have RRSP/RRIF savings, with a median balance of about $93,000. In 2019, Sun Life found that approximately one-third of their universe of retirees takes the minimum payment from their RRIFs each year. Putting these together, it appears as though about one in five older Canadians is affected by the RRIF withdrawal schedule.
The TFSA workaround
According to analytics provider Club Vita, a typical 75-year-old Canadian female (let’s call her Gaby) can expect to live another 15 years. In the current environment of rock-bottom returns on safe investments, if Gaby were to make withdrawals according to the revised 2015 schedule, her annual income would be 40 per cent less at age 90 (her life expectancy) than at age 75. And if she lives longer, that income would be even lower.
However, Gaby could work around the minimum withdrawals using TFSAs. Suppose 75-year-old Gaby is required to take out $10,000 of her RRIF in 2020. Her daily expenses are minimized from being restricted to her home – possibly for many months; therefore, she only needs half of those funds. This leaves $5,000 (less applicable personal income taxes of $1,500) to reinvest in her TFSAs. With that $3,500, she can invest in new securities in her TFSA, or she can hold on to the same portfolio mix as in her RRIF account by taking advantage of an “in-kind” transfer.
Should stocks rebound and Gaby’s TFSA investment doubles, she’ll have $7,000 to spend – tax-free. Had the money been allowed to stay in her RRIF in the same assets, the original $5,000 investment would have also doubled to $10,000. But this money is taxable and, after a 30-per-cent income tax hit, Gaby would again have had $7,000 to spend. In essence, this TFSA strategy works around the RRIF minimum withdrawal and postpones the need to cash out investments until after the crisis.
There are no withdrawal restrictions on her TFSA, meaning she can delay drawing on that income until her RRIF – now reduced because of the larger withdrawals she was required to make – will no longer support her spending needs.
Managing the known unknowns
The right schedule of mandatory RRIF minimum withdrawals is open to debate. And the full financial market implications of COVID-19 – and how they will vary from person to person – are still significant unknowns. But what is clear is that the unpredictable and dramatic markets drops are causing a lot of anxiety, and even panic, among investors.
Worried older Canadians who don’t need their RRIF money at this time should consider reinvesting into TFSAs. This financial strategy can protect their investment portfolio by buying time through the crisis.
Bonnie-Jeanne MacDonald, PhD FSA FCIA, is the director of financial security research at the National Institute on Ageing, Ted Rogers School of Management at Ryerson University, Fellow of the Society of Actuaries, Fellow of the Canadian Institute of Actuaries and resident scholar at Eckler Ltd. The research discussed is co-authored with Richard Morrison and Marvin Avery.