Kevin Greenard: The Greenard Group's optimal RRIF formula

Discussions with our clients revolve around minimizing the amount of tax they pay over their lifetime.

To start the process with clients, we let them know what their estate tax bill will be if they do nothing. Avoiding or reducing a massive estate tax liability becomes a goal when clients become aware of the risk of doing nothing.

Luckily, in the vast majority of cases, we have multiple years to enact a tax minimization strategy. We often say to clients: “Time is your friend.” The more time we have, the smaller the adjustments typically are, and in many instances, the more tax advantageous these adjustments become in decreasing your final tax bill.

For our clients who have no charitable giving plans, are single or widowed, and want to gift their estate to children, family or friends instead of the Canada Revenue Agency (CRA), planning today can result in substantial tax savings in the future! In some circumstances, recognizing more income today can help our clients pay less tax over their lifetime, meaning more is left over to be distributed as part of your estate.

We can run the numbers and illustrate by looking at Mr. Jones, who is 75 years old. He has $1 million in investable assets with $800,000 in a Registered Retirement Income Fund (RRIF), $150,000 in a Tax-Free Savings Account (TFSA) and $50,000 in a non-registered account to meet his monthly cash flow needs. He earns pension income, investment income and RRIF income.

Annually, he tries to keep his income under the Old Age Security (OAS) repayment threshold, which is $81,761 for 2022. Mr. Jones’s spouse passed away several years ago, and they had two children between whom his future estate will be split evenly. Mr. Jones projects that his 2022 income will be $75,000, which is similar to 2021.

Let’s see how recognizing more income today could help Mr. Jones pay less tax over his lifetime, meaning more goes to his children through his estate and less to the CRA through taxes.

Comparing the minimum annual RRIF withdrawal to optimal RRIF withdrawal

When you have a RRIF account, you are required to withdraw a minimum amount each year, commencing in the year after the RRIF account is opened. Clients have the option to withdraw funds out in the year the account is opened; however, it is not required.

For clients under 71, the minimum amount is calculated using the “Age Formula,” which is one divided by 90 minus your age [ 1 / ( 90 - your age) ], multiplied by the market value of the plan as of Dec. 31 of the previous year.

For clients 71 and over, the minimum annual RRIF payment is a set prescribed percentage based on age multiplied by the market value of the plan as of Dec. 31 of the previous year.

At the time the RRIF account is opened, you can elect your younger spouse’s age for purposes of calculating the minimum annual RRIF payment. We always recommend doing this as it provides more flexibility for clients. For reference, we have included a table of the minimum required RRIF percentages at the end of this article.

The government dictates the minimum amounts that individuals must withdraw from their RRIF annually; however, depending on each client’s situation, the minimum amount may not be what’s best for them to minimize the taxes they pay over their lifetime. Through discussions with clients, and preparing a Total Wealth Plan, we are able to calculate an optimal amount to withdraw annually from their RRIF. In more cases than not, we deviate from the prescribed minimum withdrawals and withdraw an amount that is greater than the minimum.

Mr. Jones has a large RRIF balance of $800,000. At the age of 75, he is required to withdraw a minimum of 5.28 per cent, or $46,560 ($800,000 x 5.28 per cent) — refer to the end of this article for the minimum required RRIF payment percentages at each age.

However, since inception, Mr. Jones has earned an average return net of fees on his RRIF account of 7.64 per cent. Since his return is larger than the minimum withdrawal, his RRIF will actually continue to increase in value, rather than decrease.

Both of Mr. Jones’s parents lived to age 85. Based on these life expectancy considerations, we mapped out a plan before meeting with Mr. Jones to wind his RRIF down over a 10-year period. In our meeting, we discuss this plan with Mr. Jones, who is hesitant at first — until he sees the numbers.

The highest marginal tax bracket in British Columbia is 53.50 per cent. As Mr. Jones is widowed, if he were to pass away tomorrow, the full value of his RRIF account would be brought into income. On the passing of Mrs. Jones, her RRIF was rolled into Mr. Jones’s RRIF tax deferred. However, when Mr. Jones passes away, there will be no spousal rollover and the full amount will be brought into tax in his tax return.

Assuming a RRIF value of $800,000 and annual income over $75,000, this equates to $875,000 of income, which has an average tax rate of 48.43 per cent. Of the $800,000 in Mr. Jones’s RRIF, the CRA would take $387,440, leaving only $412,560 of the initial $800,000 for his children.

We calculate how much tax Mr. Jones would pay if he instead systematically withdrew his RRIF over a 10-year period to illustrate how taking advantage of more tax brackets today can help minimize Mr. Jones’s tax over his lifetime. In winding the RRIF down over 10 years, in the first year 10 per cent (one divided by 10 is taken). In the next year, there are nine years remaining, so one ninth (or one divided by nine) is taken. Following that is one eighth (or one divided by eight), and so on until 100 per cent of the RRIF is withdrawn in year 1o. For simplicity, the below calculations also assume that the tax brackets do not change.

We compared this to what would happen if Mr. Jones withdrew the minimum from his RRIF and passed away in 10 years:

The difference in taxes owing over the same 10-year period is $205,690 ($630,976 - $425,286). In conjunction with a Total Wealth Plan and discussions with Mr. Jones, we were able to calculate an optimal RRIF withdrawal based on assumptions which, for example, included life expectancy, taxation, inflation, planning giving, and future cash flow needs.

The above example is simplistic as it does not factor in the indexation of the tax brackets, non-refundable tax credits that Mr. Jones may be entitled to such as the age amount and pension income amount, medical expenses Mr. Jones can claim, OAS lost, or taxation costs from the additional investment income earned from investing the funds outside of the non-registered plan. Despite the simplicity of the above example, it illustrates how there may be a benefit to taking larger sums out of the RRIF account today, to leave more for your estate.

Important points

This strategy may not be well suited for every client. For some, the RRIFs may need to be wound down over a shorter, or longer period. For some, it may make sense to continue taking the minimum annual payment into perpetuity. Regardless, it’s 100 per cent worth taking the time to analyze and discuss the results to make sure, for your specific situation, you’re minimizing your taxes over your lifetime. As every individual situation is different, we encourage individuals to obtain professional advice.

Below we have listed a few additional general ideas and techniques that you may want to consider in your attempt to reduce a large tax bill:

Pension credit — You should determine if you are able to utilize the pension tax credit of $2,000. If you are 65 or older, then certain withdrawals from registered accounts may qualify for this credit. Rolling a portion of your Registered Retirement Savings Plan (RRSP) into a RRIF would allow you to create qualifying income. For couples, this credit may be claimed twice — effectively allowing some couples to withdraw up to $4,000 per year from their RRIF account(s) with less tax (provided they do not have other qualifying pension income).

Single or widowed — Single and widowed individuals will incur more risk with respect to the likelihood of paying a large tax bill. Single and widowed individuals should understand the tax consequences on their passing as no tax deferrals are available, such as Mr. Jones in the above example.

Charitable giving — One of the most effective ways to reduce taxes in your year of death is through charitable giving. Those with charitable intentions should meet with their professional advisers to assess the overall tax bill after planned charitable donations are considered.

Life insurance — One commonly used strategy is for individuals to purchase life insurance to cover their future tax liability. The tax liability created upon death coincides conveniently with the life insurance proceeds. This would enable individuals to name specific beneficiaries on their registered account without the other beneficiaries of the estate having to cover the tax liability.

Estate as beneficiary — If you name your estate the beneficiary of your registered account, then probate fees will apply. An up-to-date will provides guidance on the distribution of your estate.

Life expectancy — Individuals who live a long healthy life will likely be able to diminish their registered accounts over time as planned. Ensuring your lifestyle is suitable for a longer life expectancy is the easiest way to defer and minimize tax.

Funding TFSAs — Growth within a Tax-Free Savings Account is better than growth within a Registered Retirement Income Fund as any future withdrawals have zero tax consequences. If you have not already maximized your TFSA, depending on your tax situation it may be worth your while to pull additional funds out of your RRIF each year to fully fund your TFSA.

Minimum required RRIF payments

The required minimum payments as a per cent of RRIF assets are as follows:

Kevin Greenard CPA CA FMA CFP CIM is a Senior Wealth Advisor and Portfolio Manager, Wealth Management, with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138, email greenard.group@scotiawealth.com or visit greenardgroup.com