Rein in RRIF withdrawals

Many people are retiring with so much money that they’re still in the highest tax bracket when they retire. Here’s what you can do to help your clients mitigate the tax hit.

The world has changed a lot since the RRSP was created six decades ago. Back then, people retired at 65, stock markets weren’t as strong as they are today and most Canadians didn’t make it to 80 years of age.

The original idea behind the RRSP made perfect sense. Invest in your higher earning years to reduce your tax bill; withdraw later in life, when you’re in a lower tax bracket, so the tax is minimal. All the while your savings grow tax-free.

While this is still true for many Canadians, the RRSP is starting to cause some major tax pains for an increasing number of people. Today, more and more investors are reaching age 72 — the age that people are forced to start withdrawing money from their RRIF — with a sizable nest egg that will keep them in the highest tax bracket.

Others are still working at age 72 and their earnings, plus those withdrawals, end up pushing them into the highest tax bracket. In most provinces, that means forking over nearly half of your savings to the CRA.

This is becoming a growing problem, says Peter Bowen, vice-president of tax research and solutions at Fidelity Investments Canada.

“There’s this wave of baby boomers who are hitting retirement that do keep working whether full-time or part-time and some of them have saved up big assets,” he says. “It’s not all, but there are people who will have tax issues that they’ll need to deal with.”

This is an area where advisors can show that they’re providing value, says Bowen. Mitigating the tax hit often requires sophisticated financial planning, and it has to start well before clients have to convert their RRSP into a RRIF.

Withdraw early

One way to reduce the tax payment is to start pulling money out of an RRSP earlier.

In many cases, people retire, take a year or two off, and then go back to work. It’s in those years when people are not earning an income that they should be removing money from their registered accounts, says Bowen.

“There may be a period where their income is relatively low and then they’ll start to earn CPP and OAS and have to take out RRIF payments,” he says. “They should think about taking that money out sooner, when they’re in a lower tax bracket.”

Watch the OAS clawback

Removing savings sooner — and then putting it into a TFSA, where those investments can continue to grow tax-free — will also help clients avoid the dreaded old age security clawback.

Canadians over the age of 65 are entitled to nearly $7,000 a year in OAS pension, but only if that person earns less than $71,592 in a year.

“In a year or two’s time, you’ll know that maturity is coming up and you’ll get that money,” she says. “You don’t have to worry about whether the market is up or down.”

For every dollar of income above that number, the OAS payment is reduced by 15 cents. If you make too much money, or take too much out, then it’s possible for clients to receive no OAS at all.

“Keep those RRIF payments lower and you might keep yourself out of a situation where you’re subject to the OAS clawback,” says Bowen.

Pension income splitting

One strategy that advisors should look into is pension income splitting. RIFF payments are treated the same way as a pension, which means whatever is withdrawn can be split between spouses.

This works only if the person withdrawing is 65 or older and can split up to 50% of the money taken out. This is an important tax-reducing tool for advisors and their clients, says Bowen.

“The ability to do pension income splitting is very powerful,” he says. “If one spouse is in a higher tax bracket than another, anything that person can do to split that income is important to consider.”

In some cases, a client may want to convert their RRSP — or at least part of it — into a RRIF earlier, in order to take advantage of that income splitting as soon as possible, says Bowen.

As more people reach 65 and start withdrawing money while making an income, tax bracket management, as Bowen calls it, will be that much more important.

These are complicated issues, he says, so advisors should be sure to enlist a tax expert to help create a proper plan.

“Individual circumstances matter,” says Bowen. “These issues can get fairly complex fairly quickly and every one is different.”