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Too many financial advisers take the Peter Pan approach to planning for their clients. They latch onto a financial strategy-of-the-day. Some of these strategies Peter out, and some Pan out. Too often, little or no careful analysis is done ahead of time to determine whether the strategy actually makes sense for a client.

You see, most of the strategies have merit in the right circumstances. But rarely are these strategies good for all clients all the time. Today I want to take a look at a strategy known as the registered retirement savings plan meltdown.

The strategy

When you die, there's generally going to be tax to pay on your registered plan assets (with some exceptions, most notably when you leave the assets to your spouse). The value of your RRSP or registered retirement income fund (RRIF) is often fully taxable in the year you die. It would not be unusual for the full value of your plan to face tax at the highest marginal tax rate - say, 46 per cent (close to the Canada-wide average).

The meltdown strategy in its most basic form suggests it makes sense to make withdrawals from your RRSP earlier in your life if you'll face tax at a lower rate than you expect to face in your year of death.

The analysis

Let's assume you have $200,000 in your RRSP today. Also assume that you'll make withdrawals at the rate of $30,000 a year and earn 8.15 per cent annually in your plan. We'll assume that you don't need the cash you're taking out of the plan, and will invest the after-tax dollars you take out of the plan in a non-registered investment account, earning the same rate of return largely in the form of capital gains. Finally, let's assume you'll pay tax at 31 per cent on withdrawals from your plan during your lifetime - much less than the 46 per cent at death.

If you were to die in 10 years, you will have depleted your RRSP to zero. The amount you'd leave to your heirs (from your non-registered investment account) after taxes would be $277,720. This is a 17.5-per-cent improvement over leaving your RRSP untouched, dying in 10 years, and paying tax at 46 per cent at that time.

If you were to die in 15 years, you will have depleted your RRSP to zero by the end of year 10, but will leave your heirs (from your non-registered investment account) an after-tax amount of $382,130. This is a 9.2-per-cent improvement over leaving your RRSP untouched and dying in 15 years.

A few observations come to mind: The longer you live after you make early withdrawals from your plan, the less sense the meltdown strategy makes because you're giving up the tax deferral that comes from leaving the assets in your registered plan. The closer you are to dying, the better - well, as far as the strategy goes. As a general guideline, the strategy likely makes little sense if you think you'll live for another 20 years or more.

Keep in mind that taking money out of your plan early can trigger the claw-back of Old Age Security benefits as your income rises - a cost to consider. And if your tax rate today is not significantly less than it will be at death (at least 10 to 15 per cent lower), the strategy may not make sense.

Another version of the meltdown strategy involves borrowing money to invest, to create an interest deduction that offsets the taxable RRSP withdrawal. But this is a topic for another day.

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