Is Withdrawing The Minimum Amount From My RRIF Every Year A Mistake?
This was recently a question posed to us by our client, Sandra.
Payments from a Registered Retirement Income Fund (“RRIF”) are fully taxable as income in the year in which they are received by the owner. Much to the surprise of many Canadians, death is not an exception to this: the entire balance of a RRIF on death is included as income on the deceased’s final tax return, assuming there is no eligible rollover. Rollover eligibility applies to:
- a spouse or common-law partner
- a financially dependent child or grandchild under 18 years of age, or
- financially dependent mentally or physically infirm child or grandchild of any age
Sandra has none of the above individuals to roll her RRIF over to, so her estate (& beneficiaries) could be facing a significant tax burden when she passes. Fortunately for Sandra, she is in a good financial position where she can afford to just receive the minimum amount from her RRIF every year. However, this does create a potential tax & estate planning problem for Sandra.
Here is an illustration of the above: Sandra’s RRIF currently has a balance of $250,000. If she were to pass away tomorrow, that $250,000 RRIF would be treated as income, putting her in the top marginal tax rate in BC – this results in a tax bill of ~ $90,000 on the RRIF income alone! The executor of her estate would be responsible for ensuring this tax bill gets paid to CRA prior to distributing any assets to Sandra’s beneficiaries.
One alternative strategy for Sandra would be to increase her RRIF minimums gradually, year over year. The reasoning behind this strategy is to spread the tax owing over time, as opposed to a substantial chunk of tax on death. See below:
| SCENARIO 1: RRIF MINIMUM WITHDRAWALS | |
| CURRENT VALUE: | $250,000 |
| # OF YEARS WITHDRAWING: | 10 |
| INCOME TAXES PAID ON RRIF MINIMUMS: | $28,000 |
| RRIF INCOME TAXES ON DEATH: | $59,000 |
| TOTAL RRIF INCOME TAX: | $87,000 |
| SCENARIO 2: RRIF MINIMUM WITHDRAWALS | |
| CURRENT VALUE: | $250,000 |
| # OF YEARS WITHDRAWING: | 10 |
| INCOME TAXES PAID ON RRIF MINIMUMS: | $55,000 |
| RRIF INCOME TAXES ON DEATH: | $5,000 |
| TOTAL RRIF INCOME TAX: | $60,000 |
*Assumptions made: 5% annual rate of return on the RRIF investments
The above is a very simplistic look at the difference between withdrawing extra amounts from a RRIF to spread out the tax liability, as opposed to keeping withdrawals at the minimum until death. In the above example, Sandra would seemingly reinvest the excess RRIF payments in a non-registered account (her TFSA is maxed), so the tax on investment income would negate some of the RRIF income tax advantage seen in Scenario 2 above. These are complex calculations and projections which we will run for Sandra to show her the full picture.
Aside from the components mentioned above, there are many other factors that should go into the RRIF withdrawal decision, such as:
- Life expectancy
- Current marginal tax rate
- Sources of income
- Net worth
- Investment risk tolerance
- Discretionary spending
- Longevity risk concerns
- Estate planning wishes
Furthermore, Sandra’s withdrawal schedule is something we will review periodically, ensuring the amounts align with all the other components mentioned above, as well as her overall financial plan.
For a detailed review of your retirement income situation or for any other questions pertaining to this, please contact Jeff Graham at (604) 363-7549 or jeff@firstoakfinancial.ca.
DISCLAIMER: this commentary is provided for general informational purposes only and does not constitute financial, insurance, investment, tax, legal or accounting advice.