[Summer 2024 GPS] Tax Planning For RRIFs

RRSPs are an important piece of most Canadian's' financial plans. When you contribute to an RRSP, you get to deduct the contribution from your income, thereby lowering your income and taxes as a result. The goal of RRSP is to contribute when you are in a relatively high tax bracket and make withdrawals when you're in a lower tax bracket. This will happen naturally in most cases because, generally, investors contribute to RRSPs while working and start making withdrawals once they've retired.

In the year you turn 71, you must convert an RRSP to a RRIF, which is like an RRSP with a hole drilled in the bottom. The year following the conversion of RRSP to RRIF, you are required to withdraw a minimum annual payment (MAP) from the account (thus the hole analogy). The minimum annual payment is calculated by multiplying the value of the RRIF on December 31 of the previous year with a percentage based on your age at the beginning of the year. As a RRIF account owner, you can take withdrawals above the MAP, but not below. The explanation above seems simple enough, but there are a few key decisions to make when converting an RRSP to a RRIF. In this article, 'we will provide some key frameworks and outline strategies to help you make better decisions when converting your RRSP to a RRIF.

You have no choice but to convert your RRSP to a RRIF in the year you turn 71, but the first key decision is whether you should use your or your spouse's age as the basis for making withdrawals. The lower the age you use, the lower the required MAP. For investors who ' do not need the income for cash flow and who already have a high taxable income, i.e. retirees with a sizeable pension, more income is not necessarily welcomed, as it could push their tax bracket higher and reduce access to other government benefits like old age security. In a situation like this, it can make sense to use the younger spouse's age as the basis for calculating the MAP. For a 71-year-old RRIF annuitant, the factor for calculating the MAP is 5.28%, where as the factor for a 65-year-old is 4%. While this may not seem like a big difference, it translates to $6,400 less on a RRIF with a market value of $500,000. If we take an example of a retiree with $80 K of taxable income excluding RRIFs, the ability to take $6,400 less from the RRIF translates to ~$2,000 in tax savings for an Ontario resident and a savings of ~$960 of Old Age Security that otherwise would have been clawed back [i]. Yes, the tax will have to be paid eventually, but if you compound annual tax savings of $2,800 at a conservative return of 4%, over 20 years, you end up with ~$86 K, a significant savings.

Once you have decided whose age to use as the basis for the MAP calculation, the next decision is when to receive your payments. You can of course choose to take payments monthly, which many investors do to mirror their monthly bill schedule, but if you do not need the income for cash flow, we generally recommend opting for annual payments. If you decide to take your MAP annually, you will typically choose to take it at the beginning or end of the year. For investors who have maximized their TFSA, we generally recommend taking the payment at the end of the year because often, investments pay distributions throughout the year, and given a choice, you would typically want a distribution to occur within a tax-sheltered environment of the RRIF. Whereas if you do not have a TFSA or it is not maximized, it can make sense to take your MAP early, and move it to a TFSA where it is tax-sheltered and can continue to grow tax-free. Particularly for married couples, it makes a lot of sense to maximize TFSAs to the extent that you can because if you name your spouse as successor holder, they can essentially merge your TFSA into their own even if they have already maximized their TFSA.

In addition to the above strategies, it can make sense to adjust the asset allocation of portfolios such that interest bearing investments, which tend to be less-tax efficient and more conservative are held in RRIF accounts as opposed to open accounts or TFSAs, but we'll save that for a future blog post!

 

 

 

 

[i]Assumes the taxpayer is single and has no other deductions.