WEALTH Matters — FALL 2010

CASE STUDY—Taking more than the minimum rrif payment

One conventional ‘rule of thumb’ is that you should maximize RRSP contributions, convert to a RRIF as late as you can, and take only the minimum RRIF income to preserve the tax-sheltered growth. In our Winter 2009/10 newsletter we mentioned that this is not always the case. Here is a case study to illustrate situations in which it’s better to deplete RRSP/RRIF assets quicker.

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An alternative is to draw down the RRSP early instead of the open investments, while she is in the lower tax bracket. She can invest any excess income in her TFSA up to $5000 per year and still get the same tax-sheltering as the RRSP, but no tax on withdrawal.

What’s the benefit? Assuming a 3% rate of return, the table below shows that every $100 in her RRSP will grow to $138 in 11 years, but after 31% tax will net only $95. If instead she removes the $100 from her RRSP now, she will have $79 after 21% tax to move to a TFSA. This $79 will grow at 3% to $108 in 11 years, and this is not taxable when withdrawn. Gail is ahead $13 or 13% - an average annual compound return of 1.1% on top of her 3%.

Gail is retiring early, and she has elected a deferred pension that won’t start until age 65 – 10 years away. She has built up a substantial RRSP and also has enough open (non-registered) investments to provide her required income for the next 10 years. She plans to keep the RRSP growing until she must convert to a RRIF at age 71, and then take only the minimum annual payment (MAP). Because of her limited taxable income between now and age 65, she is in the lowest tax bracket of 21% but once the pension starts she will be at 31%. Also, her later minimum RRIF withdrawals give her more income than she needs.

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Case Study—Taking more than the RRIF minimum payment

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Note in the table that for this 9% difference in tax rates, moving excess RRSP/RRIF money to a TFSA provides a benefit no matter how much later you will need the money. Moving GICs from RRSP/RRIF to open provides a benefit to year 10 but not much longer, because the tax on annual investment income starts to offset the difference in tax rates over time. But moving stocks from RRSP/RRIF to open works much longer because of the inherent tax benefits of stocks.

Gail decides to alter her plan and use the RRSP money first. She saves tax overall, and reduces the amount of money later sitting in her RRIF and subject to high minimum withdrawal rates which cause excess income in later years. It also avoids her having a large RRIF balance on death, when it will likely be taxed at even higher rates.

Are you wondering what to do in your own situation? Give us a call and let us help you make informed decisions about your retirement income.

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Tax Rate

RRSP (NET)

TFSA net

GIC net

Stock net

Today

21%

$100 ($79)

$79

$79

$79

Yr 11

31%

$138 ($95)

$108

$100

$104

Yr 20

31%

$181 ($125)

$141

$121

$130

Yr 30

31%

$243 ($168)

$189

$148

$167