Decumulation

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  By Guest Blogger Sinan Terzioglu

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When it comes time to start withdrawing from an investment portfolio to fund retirement (as well as significant life events such as the purchase of a home) it often makes the most sense to begin with non-registered and tax-free savings accounts before withdrawing from registered savings plans like RRSPs. This defers the taxes that would result from RRSP withdrawals for as long as possible. A RRSP must be converted to a registered retirement income fund (RRIF) at the end of the year an account holder turns 71 and annual minimum withdrawals of approximately 5% must begin the following year, however, there are some circumstances when it makes sense to withdraw from RRSPs sooner so that you pay less tax over time.

Pension Income Tax Credit

Retirees 65 or older not requiring withdrawals from their RRSPs to fund retirement and without a defined benefit pension should consider converting some of their RRSP to a RRIF because the first $2,000 withdrawn annually from a RRIF is eligible for a pension income federal tax credit of 15%. Withdrawals from RRSPs are not eligible for the tax credit so to qualify you must open and withdraw from a RRIF. Since you do not have to convert an entire RRSP to a RRIF in order to qualify for the tax credit you can take advantage by transferring up to $2,000 per year to a RRIF starting at the age of 65 until your entire RRSP must be converted to a RRIF at the end of the year you turn 71. Old Age Security (OAS) and Canada Pension Plan (CPP) benefits are not eligible for the federal tax credit.

Higher Taxable Income & Capital Gains Expected

Retirees in their 50s and 60s expecting to have higher taxable income in the future because of defined benefit pensions and/or planned dispositions over time that will result in capital gains in non-registered accounts should consider early periodic withdrawals from RRSPs so that they are taxed at lower rates in the years their income is low. If an entire RRSP is converted to a RRIF the assets cannot be transferred back to a RRSP and you would be required to withdraw the annual minimum from that point forward so for maximum flexibility when planning period withdrawals from a RRSP, it would be best to not convert to a RRIF because RRSP withdrawals can be skipped in higher-income years.

Spousal RRSP

Contributing to a spousal RRSP is a retirement savings strategy married or common-law couples can use to even-out RRSP savings so that when it comes time to retire each spouse can withdraw a similar amount of money from their RRSPs and pay less total tax. The strategy is most beneficial for couples that are in different tax brackets because the higher income earning spouse can contribute to a spousal RRSP set up in the lower income spouses name and the contributions would count towards the higher income earning spouses deduction limit. After three years have passed the spousal RRSP account holder can withdraw funds and the withdrawal would be taxed at their lower tax rate but it’s important to be aware of attribution rules because they are in place to prevent the short-term use of spousal RRSPs for income-splitting purposes.

If withdrawals from a spousal RRSP are timed incorrectly they will be attributable to the contributing spouse and taxed at his/her higher rate. For example, if your spouse plans to retire in 2025 while you continue to work and you contribute $5,000 to his/her spousal RRSP in each of 2023, 2024 and 2025 and then your spouse withdraws $20,000 in 2025 than $15,000 would be attributed back to you and only $5,000 would be taxed in your spouse’s hands. In this example, in order to have no amount of the withdrawal attributed back to you your spouse would need to wait until January 1, 2028 to withdraw funds from his/her spousal RRSP.

First Home Savings Account (FHSA)

The FHSA will become available sometime in 2023 for any Canadian resident that is at least 18 years old and has not owned a principal residence in the previous four calendar years. Those that are eligible will be able to contribute up to $8,000 annually (tax deductible) up to a maximum of $40,000 over 5 years. Funds can grow tax free and remain in the account for up to 15 years at which point they can be withdrawn tax free to purchase a principal residence otherwise they will be taxed as income, however, taxes can be deferred by transferring the assets in the FHSA to a RRSP even if you do not have available RRSP contribution room. Another advantage of the FHSA is that up to $8,000 per year can be transferred on a tax-free basis from a RRSP to a FHSA and the funds can be withdrawn tax free so long as they are used to purchase a principal residence. For those that do not anticipate being able to contribute to a FHSA in the next few years and would like to purchase a principal residence sometime in the future opening a FHSA and transferring some RRSP assets to it is a great way to save for a down payment while paying no tax on that portion of funds.

Develop a Plan

When preparing for retirement and planning for major life events like purchasing a home it’s important to continually consider ways to best utilize your RRSP because it may help you not only pay less tax over time but also potentially allow you to maximize government benefits such as OAS which begins to get clawed back when income exceeds $81,761 in 2022. Early RRSP withdrawals may also make sense for those that will have defined benefit pensions especially if they have available TFSA contribution room because pension income is fully taxable and the income generated in a TFSA will help maximize after-tax income. While death and taxes are a certainty we at least have the ability to plan our RRSP withdrawals over time and pay less tax.

Sinan Terzioglu, CFA, CIM, is a financial advisor with Turner Investments, Private Client Group, Raymond James Ltd.  He served as vice-president of RBC Capital markets in New York City and VP with Credit Suisse in Toronto.