For those who are 65 or older, RRIF withdrawals are considered eligible pension income, whereas RRSP withdrawals are not.Sean Kilpatrick/The Canadian Press
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For Canadian retirees who are 65 years or older, withdrawals from registered retirement savings plans (RRSPs) may be required to fund their lifestyle or as part of a lifelong tax-averaging plan designed to pay taxes at lower rates today and avoid higher tax rates in the future or upon death.
Yet, these investors should consider whether they’re better off withdrawing from a registered retirement income fund (RRIF). People who are married should prefer RRIF withdrawals, as should single people who aren’t receiving a monthly payment from a defined-benefit pension plan.
It’s common for people to wait to convert their RRSP into a RRIF until the year they turn 71, when they’re required to do so. However, there’s no minimum age for converting all, or a portion, of an RRSP to a RRIF.
It’s important to understand that investors who have money inside a RRIF are required to make a minimum annual taxable withdrawal. The amount of this forced withdrawal uses a formula: a percentage based on the person’s age at the beginning of the year multiplied by the market value of the RRIF account as of Jan. 1. The percentage gets higher as the account holder gets older.
For those who are 65 or older, RRIF withdrawals are considered eligible pension income, whereas RRSP withdrawals are not. As such, there are four main advantages to withdrawing from a RRIF instead of an RRSP:
1. Up to 50 per cent of the amount withdrawn from a RRIF can be split with a spouse by making a joint election in a tax return on Form T1032. Income splitting can be useful even if the investor is in the same marginal tax bracket because lowering one spouse’s income can open the door to an increased claim amount for income-tested benefits and tax credits such as medical expenses, the age amount credit and Old Age Security clawback.
2. Having eligible pension income on a tax return allows each taxpayer to claim the $2,000 pension income amount tax credit. That tax credit will save the taxpayer $300 in federal taxes and $51 to $162 in provincial taxes, depending on where they live.
3. RRSP withdrawals are subject to withholding taxes: 10 per cent on withdrawals up to $5,000; 20 per cent on amounts between $5,000 and $15,000; and 30 per cent on withdrawals of more than $15,000. If someone’s average tax rate when they file their tax return is only 20 per cent, then it can be painful to have to pay 30 per cent on larger RRSP withdrawals.
To highlight this, consider for a moment that if someone needs $35,000, they would need to withdraw $50,000 from their RRSP due to the 30 per cent withholding tax. They would then be taxed on the full $50,000 when they file their tax return.
If they had converted all or a portion of their RRSP into a RRIF instead, then the minimum amount required to be withdrawn from the RRIF wouldn’t have any taxes withheld at the time of withdrawal. While the taxes will still need to be paid when they file their annual taxes, they would be able to limit the magnitude of their withdrawal and reduce their taxable income for the year, which keeps more money in their pockets for longer.
4. Many financial institutions don’t charge fees for RRIF withdrawals, but most charge a fee (ranging from $25 to $50) per RRSP withdrawal.
That all sounds great, but what’s the downside?
A fair pushback to this strategy comes from those who don’t want a forced minimum withdrawal before it’s required. This is a reasonable concern, as many people want the flexibility to choose how much income to bring onto their tax return each year. For example, those with a large capital gain might not want additional RRSP or RRIF income that year, but might be okay with RRSP or RRIF income the next year.
Fortunately, there’s a solution that still allows an investor to reap three of the four benefits mentioned above while avoiding a forced minimum withdrawal each year.
When an investor turns 65, they could open a RRIF account but leave it unfunded (or funded nominally, if preferred). If the account has a zero balance on Jan. 1, there will be no required minimum payment. If the investor decides they want or need to make an RRSP withdrawal partway through the year, they could first transfer the money from their RRSP into their RRIF (typically at no fee, but that depends on the financial institution), and then withdraw the money from the RRIF immediately and transfer it to their bank account.
When filtered through the RRIF, it becomes eligible for income splitting and the pension credit, and will often avoid withdrawal fees. The only benefit that will not be attainable is the planning flexibility around withholding tax rates because any amount withdrawn from a RRIF that exceeds the mandatory minimum amount is subject to the same withholding tax rules as regular RRSP withdrawals. That’s a small price for keeping someone’s options as flexible and tax-efficient as possible.
Aaron Hector, CFP, R.F.P., TEP, is a private wealth advisor at CWB Wealth in Calgary
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Editor’s note: This article has been updated to clarify who should prefer RRIF withdrawals – that is, people who are married; and single people who aren’t receiving a monthly payment from a defined-benefit pension plan.