Personal Finance

A balanced approach to withdrawals from registered and non-registered accounts can ease the tax impact.
By David Aston | 23/05/17

While building a nest egg is usually what we focus on in planning financially for retirement, mastering the art of drawing it down deserves more attention than it usually gets.

About the Author
David Aston, CFA, is a freelance personal finance and investment journalist who has also written for MoneySense, the Globe and Mail and Canadian Business. He has an M.A. in economics and is a Chartered Professional Accountant. He is a past Portfolio Management Association of Canada journalism award winner and was named 2014 Journalist of the Year by the Toronto CFA Society.

One classic withdrawal issue is which accounts do you tap first in retirement: RRSPs or non-registered? The conventional view is that you should draw from non-registered first and defer touching your RRSPs for as long as possible. However, financial planners who have looked closely at the issue find it is generally better to take a balanced approach to withdrawals to ease the tax impact. "Smooth out the RRSP withdrawals so you bring that income from registered assets into taxation at the lowest rates," advises Daryl Diamond, a financial planner with Diamond Retirement Planning Ltd., based in Winnipeg.

The conventional viewpoint correctly understands that deferring RRSP withdrawals allows you to compound your returns tax-free within the RRSP for longer. However, that factor must be balanced against the progressive nature of the tax and benefit system which taxes higher incomes at much higher rates. If you take bigger, concentrated RRSP/RRIF withdrawals later in retirement, that can cause income spikes that result in much higher taxes and perhaps Old Age Security clawbacks.

Of course, making RRSP withdrawals early in retirement generally results in paying more immediate tax, so you have to take a long-term view. "People tend to be reluctant to intentionally pay tax today," says Jason Heath, a fee-for-service financial planner with Objective Financial Partners Inc., based in Markham, Ontario. "But the way I look at it is I'd rather pay the least amount of income tax over my entire retirement rather than just the least amount of income tax this year."

This issue tends to be particularly important for affluent retirees with sizeable sums in both non-registered accounts and RRSPs. Start by understanding future tax liabilities from RRSPs that you may want to smooth. Consider the requirement to convert your RRSPs to a registered retirement income fund (RRIF) and begin mandated minimum withdrawals by the year you turn 72. Then for couples, the death of a spouse generally results in RRSPs/RRIFs being combined in the hands of the surviving spouse, which effectively doubles minimum mandated withdrawals. Finally, at the death of the second spouse, a large remaining RRIF will result in a hefty tax bill to the estate at high marginal rates.

But balanced RRSP withdrawals can be important for retirees at all income levels. Consider a strategy that Diamond calls "topping up to bracket." The idea is to pay attention to key taxable-income thresholds above which taxes jump to a higher marginal rate. Then try to smooth out income to stay just under the next highest bracket.

Here are four noteworthy federal 2017 taxable-income thresholds (bump-ups in provincial tax rates also apply at different income thresholds and vary by province):

  • $20,860, the combined total of three common tax credits for seniors. This amount is composed of basic personal amount for all taxpayers ($11,635), age amount for those 65 and over ($7,225), plus the pension amount applicable to certain pension income ($2,000). If these credits all apply, no federal tax is payable up to this taxable-income level. The federal marginal tax rate for amounts above this tax-free threshold is 15%. Similar provincial tax credits apply but generally shield lesser amounts at lower tax rates;

  • $36,430, the start of the federal age-credit clawback. The increase in the effective marginal tax rate for taxable-income above this threshold is 2.25%. (Clawbacks of government benefits are based on taxable income with adjustments to exclude certain deductions which apply in special situations. Technically, they are based on the line on your tax return called "net income," with or without adjustments.) Lesser clawbacks of provincial age credits also apply at income thresholds that vary by province;

  • $45,916, which is the start of the second federal tax bracket for all taxpayers. Above this threshold, the increase in the marginal tax rate is 5.5%.

  • $74,789, which is the threshold for Old Age Security clawbacks. Taxable income above this threshold is subject to an increase of about 10% in the marginal rate. This tax increase, which varies by province, is net of reduced federal and provincial taxes on the reduced OAS benefit.

Optimizing withdrawals depends on specifics, but here's one example (based on a scenario provided by Diamond). Assume a retired couple, both age 70, who live in Ontario with $30,000 each in annual taxable income composed of CPP, OAS and an employer pension, which they find is entirely sufficient for their spending needs. In addition, both have sizeable RRSPs.

In that case, it makes sense to take out at least an additional $6,000 each from an RRSP -- even though it's not needed for current spending -- and then reinvest the withdrawn amount ($4,800 after tax) in a TFSA. This allows some additional money to be taken from RRSPs at a relatively attractive tax rate. When taxable income is $36,000, the combined federal and provincial marginal tax rate in Ontario in 2017 for each dollar of additional taxable income is the same 20% rate payable when taxable income is only $30,000.

The benefits of withdrawing registered money become clearer when individuals are forced to convert their RRSPs to RRIFs and begin minimum withdrawals at age 72. When taxable incomes rise from $36,000 to above $46,000 in Ontario, the combined federal and provincial marginal tax rate for seniors increases from 20% to 32.6% in several steps. So big RRSP balances eventually lead to hefty forced RRIF withdrawals at much higher marginal tax rates.

The mandated RRIF withdrawal rate is 5.28% for the year you turn 72 and rises as you get older. So if you have a $400,000 RRSP, your minimum withdrawal from the RRIF that year would be $21,120. If other taxable income is $30,000, that would bring total taxable income to $51,120.

In addition, as Heath notes, if you don't have an employer pension, it pays to convert some RRSP money to a RRIF when you turn 65 to get the pension-income tax credit. The federal version of the tax credit is worth $300 a year if you have at least $2,000 in annual income from a RRIF (generally after age 65) or an employer pension (at any age). You also get a smaller provincial tax credit in most provinces.

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