Kevin Greenard: Use caution when reducing RRIF payments

In March 2020 the government announced that the minimum amount that must be withdrawn from RRIFs will be reduced by 25 per cent for 2020 as part of the Covid-19 Economic Response Plan.

The recommendation for most clients we have talked to is for them to take more than the minimum. In only a minority of situations will we recommend clients reduce the RRIF payments by 25 per cent. The money was already earmarked as a “wedge” for the 2020 withdrawal and they are not impacted by volatility in the equity market.

Below we provide some context using a typical conversation that we would have with a client.

The Registered Retirement Savings Plan (RRSP) is intended for “saving.” The savings and tax deferral within an RRSP can continue until the age of 71 — an age recommended by the government, not necessarily the age at which you should continue deferral.

In the year you turn 71, you have to either close your RRSP by either taking the money out, purchasing an annuity, or transferring it to a Registered Retirement Income Fund (RRIF). In many cases we will recommend that our clients convert to a RRIF before the age of 71.

From a taxation standpoint, it is rarely advised to de-register 100 per cent of your RRSP in one year and withdraw the cash. This would only be advised when an RRSP is very small or there is a shortened life expectancy or financial hardship.

Purchasing an annuity as an RRSP maturity option is a final decision that can not be reversed. Upon death, the annuity option often leaves nothing for one’s estate or beneficiaries.

For many reasons, conversion of your RRSP to a RRIF is the most popular and flexible method. Most of your savings will continue to be tax deferred with a minimum withdrawal amount being determined annually based on the previous Dec. 31 value.

In the year a RRIF is set up, there is no minimum withdrawal amount. All RRIFs set up after 1992 are considered non-qualifying.

The following minimum RRIF withdrawal amounts are the non-qualifying annual percentage by age on Dec. 31:

Normal minimum RRIF payment

To illustrate how the above schedule works, we will use a fictional example of 77-year-old Michael who had $560,000 in his RRIF on December 31, 2019. Michael is widowed and also collects CPP, OAS and has some non-registered investment income. He has two children that he would like the majority of his estate to be left to.

Based on the above minimum RRIF schedule, Michael would normally be required to withdraw $34,552 ($560,000 x 6.17 per cent) and have this amount included in his taxable income in 2020. We had previously discussed $48,000 as the elected RRIF amount. Ideally, Michael would like his RRIF account fully depleted by age 90.

2020 reduced RRIF payment option

In March 2020, the government announced that the minimum amount that must be withdrawn from RRIFs will be reduced by 25 per cent for 2020 as part of the Covid-19 Economic Response Plan.

After this announcement, we talked to Michael regarding his minimum required RRIF payment being reduced to $25,914. We also talked to him about taking the unreduced amount of $34,552. Finally, we reiterated the financial plan that outlined the elected $48,000 withdrawal for 2020.

During this same conversation we also mentioned to Michael that the combined provincial and federal income tax rates have once again increased in 2020. If he were to pass away, the majority of the RRIF would be taxed by Canada Revenue Agency (CRA) at 53.5 per cent.

We had created a financial plan when Michael was 60 years old that mapped out the registered account withdrawals to ensure he is paying a reasonable level of tax today to better his chances of not paying a large tax bill in the future. The financial plan recommended that Michael convert his RRSP to a RRIF at age 61. Since age 62, Michael has pulled funds out of his RRIF early and in the early years more than the RRIF minimum.

In speaking with Michael we kept the RRIF payment at the original planned elected amount of $48,000. If we started reducing the withdrawals at this stage, it would be likely result in Michael paying a higher estate tax bill.

We believe it is important for clients to understand the taxation of a RRIF in both a most likely scenario of normal life expectancy and an unexpected shortened life expectancy.

RRIF accounts for couples greatly reduces the taxation risk of shortened life expectancy by being able to name your spouse as the beneficiary and avoid immediate taxation of the full account balance. In 2007, the CRA introduced pension-splitting, which provides taxation savings for most couples with eligible pension income.

Beginning in 2009, the CRA introduced the Tax Free Savings Account (TFSA) that provides tax savings for individuals and couples. The savings is a result of all income (interest, dividends, and capital gains) generated within the TFSA never being subjected to tax. There is no taxation upon your death.

The amount that can be put into a TFSA is limited to a relatively small increasing amount each year. People who are serious about saving for retirement often contribute to both an RRSP and TFSA.

Given the introduction of pension splitting and the TFSA, many people should be looking at converting their RRSP to a RRIF before the age of 71.

When we are helping clients with the optimal time to convert their RRSP, we look at their marital status, health/genetics, and other investments. With other investments, we create two baskets (A and B) to analyse what we call the “bulge.”

A bulge is when you have too much concentration in either basket A or B. Basket A is the total amount in your RRSP and RRIF accounts. Basket B would include bank account balances, non-registered investments, and your TFSA — none of which will attract tax on the underlying equity if used. Basket A may also include your principal residence if the intention is that this will be sold and the capital used to fund retirement.

We caution investors not to create a bulge — having too much in either basket means you may not have the right balance as you enter retirement. Taking advantage of deferral opportunities over time often makes sense.

Having too much in basket A means you may have very little flexibility if an emergency arises and you need cash (new roof, vehicle). If A / (A + B) is greater than 75 per cent (a bulge) then we would recommend you speak with an adviser to determine in you should convert your RRSP to a RRIF early.

Above, we noted Michael has $560,000 in basket A. He also has $120,000 in basket B. With these numbers, Michael has a bulge percentage of 82 per cent.

With many clients we recommend pulling RRIF income out to the point that net income is just below the Old Age Security repayment amount, also commonly referred to as a “claw-back.”

For 2020, the OAS repayment is triggered when net income (line 236 of your income tax return) is $79,054. For many individual clients (that have a bulge) who are in retirement, we will nearly always withdraw extra out of the RRIF to get up to this $79,054 annually. For most of the couples we assist, the combined net income goal is $158,108 ($79,054 x 2).

A financial plan prepared while you’re still working largely results in savings strategies to reach your retirement and other goals. In retirement, a financial plan is prepared to create withdrawal strategies that are tax efficient and smoothed out during your lifetime. They can also be prepared in conjunction with estate planning.

Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director, wealth management, with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138. greenardgroup.com