Should clients use the lower RRIF withdrawals?

Organizations like CARP and CPA Canada have been lobbying for years to lower the rate of, or even eliminate, mandatory RRIF withdrawals.

Yesterday, part of their efforts paid off. The federal government announced it would lower the required RRIF withdrawal rate at age 71 to 5.28%, from 7.38%. The rate then increases each year, based on inflation, to a maximum cap of 20% by age 95 — one year longer than what it was before. These rules are in effect for the 2015 taxation year.

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While industry experts agree the move is a victory, it’s a small one at that.

“We don’t see this as a game changer, but an enhancement to the existing strategies advisors have already been using for their clients,” says Gabriel Baron, tax partner, EY’s Private Mid-Market practice. “The plans themselves haven’t changed.”

Bruce Cumming, executive director, Private Client Group at Cumming & Cumming Wealth Management, says, “If seniors take less money out of their RRIFs and die earlier than expected, there will be an extra-large tax bill to pay. The government is not actually giving up a lot of ground by making this change. They will still get all their money when the larger RRIF is included on the senior’s terminal tax return.”

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For clients who’ve already withdrawn at the 7.38% rate, they have the opportunity to recontribute the 2.1% excess by the end of February 2016. The recontribution will be tax-deductible for tax year 2015.

A similar move occurred in 2007, when the age to collapse an RRSP went from 69 to 71. “People had withdrawn money, the rule changed favourably and people wanted to recontribute,” says Baron. “Once the money is recontributed, there will be a physical recontribution of assets [so] you’ll get a tax deduction for that amount. It’ll be as if you only took the net amount — the gross income minus the recontribution amount.”

Should clients recontribute?

Whether or not clients should recontribute depends. Silvia Jacinto, tax partner at Crowe Soberman, says if clients need the funds for living expenses, then “it’s a no-brainer. Don’t recontribute.”

If they don’t need the funds, it gets trickier. “They need to know what type of investments they want to invest [in] inside their RRIFs, and [to find out] what the opportunity is to grow income.”

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Other considerations: What else could they be doing with that cash? Is there an opportunity to invest in something that’ll yield a higher return in a shorter term, since seniors’ investment horizons aren’t long? How long could that income be deferred? Jacinto adds, “If we’re looking at a senior who’s not in the best health, then, potentially, it’s not a good idea to recontribute.”

Also, calculate a client’s tax rate on his total income, and compare it to what it would be if he recontributes, says Kevyn Nightingale, a partner with MNP in Toronto. Then, compare that to what tax rate the client would pay in subsequent years. As long as the future rate isn’t higher than what the client would pay this year, he’s better off recontributing.

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Meanwhile, he says clients who are subject to the OAS clawback might benefit if they recontribute.

Nightingale uses the following example: Say a client has $100,000 in income — $90,000 from interest-bearing investments and $10,000 from a RRIF. His recontribution limit is $2,100. This year, he’s paying 43.5% in taxes and is subject to the 15% OAS clawback. If he recontributes the funds while he’s still in the same tax bracket, he’d get the deferral advantage for a longer period and he’d avoid the 15% clawback on the $2,100 that’s recontributed.

Complications for snowbirds

Retirees living in a country that has a tax treaty with Canada, like the U.S., have additional RRIF withdrawal considerations.

Why? There’s a reduced tax rate, depending on the country, explains Nightingale.

“A standard tax rate on [RRIF] withdrawals is 25%. If you’re living, for instance, in the U.S., the treaty says you can reduce that rate to 15%. But Canada interprets that to say that the reduced rate only applies to two times the minimum withdrawal.”

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So, the lower minimum withdrawal of 5.28% at age 71 means a lowered amount that would be subject to the treaty tax rate. Nightingale adds if the client takes out more than two times the minimum, he’s paying the full 25%.

But that issue only applies to a small segment of RRIF holders, he notes.

TFSA or RRSP?

Along with changes to RRIF withdrawal rates, the budget announced the annual TFSA limit would increase to $10,000. The news might have some clients questioning whether to use RRSPs or TFSAs.

“If you were previously on the fence where an RRSP or TFSA made sense, the fact that the TFSA has been enhanced might push people to TFSA,” says Baron.

Also, if you have clients who are considering taking their extra RRIF income and putting it in the TFSA, he suggests, “You should always maximize your TFSA for income-producing assets. That’s going to happen independently of whether the money comes from a RRIF or not. Now that you’ve got the option of socking away more in a TFSA, there’s no penalty in putting it there. Even if you don’t need the money, you might as well let it sit in a tax-sheltered vehicle.”