CPP or RRIF: Which to Withdraw from First
In my previous blog post, I introduced a fictitious client, Debra, who is about to retire. As you may recall, Debra is single, without children, and is about to turn 65. She is eligible for the maximum Canada Pension Plan (CPP), which is $14,445 per year at age 65, and the maximum Old Age Security (OAS), which is $7421 per year at 65. Her relatively modest lifestyle has enabled her to save a substantial part of her income, building up over $508,000 in her Registered Retirement Savings Plan (RRSP), $145,000 in her non-registered account, and more than $52,000 in her Tax-Free Savings Account (TFSA).
Debra has heard that she can delay taking her CPP until age 70, which will boost her annual payments by 42%, which in today’s dollars means a jump from $14,445 to $20,512. Alternatively, she is aware that she does not need to begin taking payments from her RRSP, until as late as age 72. In the year she turns 71, she will have to transfer her RRSP into a Registered Retirement Income Fund (RRIF) and then begin withdrawing at least an annual minimum amount as of the following year. Debra wonders which is the better strategy for her. Note that all figures are adjusted for 2% annual inflation.
Baseline Strategy: Withdraw from all accounts equally
Debra’s baseline strategy, which was presented in the last blog post, was to withdraw from all her sources of income equally beginning in the year she turns 65. As mentioned above, that means receiving $14,445 per year from CPP, and $7421 per year from OAS. From her personal savings, she would make annual withdrawals of $24,834 from her RRIF, $7,098 from her non-registered account, and $2,559 from her TFSA. This pace projects that her assets will last to the end of the year in which she reaches age 95.
From age 65 to 95, inclusive of all years, she receives an average annual income after taxes of $49,948, which totals $1,548,373 over 31 years.
What about delaying CPP to age 70 or delaying withdrawals from her RRIF until age 72?
Alternative 1: Delay receiving CPP until age 70
In this strategy, Debra is asking whether there is an advantage to delaying the start of her CPP payments to age 70, and whether she can manage withdrawals from her personal accounts to make up for that income gap in those first five years, from ages 65 to 69. In this scenario, Debra covers the delay in starting CPP by withdrawing more from her RRIF in those early years, while maintaining the same withdrawal pace from her non-registered and TFSA accounts as she does in the Baseline Strategy.
The outcome here is better than for the baseline strategy. Her after-tax annual income is improved by $966 per year to $50,914, which yields an improved total after-tax income in retirement of $1,578,340, $29,967 more than she would receive if she had chosen not to delay CPP.
Alternative 2: Delay taking RRIF payments until age 72
Delaying the beginning of withdrawals from age 65 to 72 allows the assets in Debra’s RRSP to grow tax-free for an additional 7 years. That could be beneficial because it means Debra will have a bigger pot of money in her RRIF from which to support herself in retirement. It also delays taxation on her RRIF, and who doesn’t want that? Of course, that means drawing more from other income sources to make up the difference between ages 65 and 71.
In this second alternative strategy, CPP and OAS payments are received steadily from age 65. Delaying RRIF payments means Debra must withdraw more from both her non-registered account and her TFSA in those first seven years. This completely exhausts her non-registered account by the time she starts withdrawing from her RRIF and she must also draw significantly more from her TFSA in those first years, resulting in very little tax-free (TFSA) income and no tax-advantaged (non-registered via capital gains and dividends) for her from age 72 onward. The result is an annual after-tax income of $49,660, yielding a total after-tax retirement income of $1,539,466 to the end of her life.
Comparing these three options, the baseline strategy and the two alternatives, the results work out as follows:
Alternative 1, delaying CPP to age 70, is the best option, followed by the baseline strategy of withdrawing from all accounts equally beginning at age 65. Delaying the start of the RRIF to age 72 is the worst of the three choices. Note that Alternative 2 also involves paying more taxes than the other two strategies, although interestingly, Alternative 1, which has the best after-tax outcome, still pays more in taxes than the Baseline Strategy.
Not every retirement income circumstance will be improved by delaying CPP until age 70. The prime example is someone who is retiring to a low income and is likely to benefit from the Guaranteed Income Supplement (GIS). However, for many retiring Canadians who have a reasonable expectation of living beyond their mid 80s, delaying the start of CPP is often the better choice. A guaranteed, inflation-protected increase in income of 0.7% for each month that you delay taking CPP past age 65 is hard to beat in the investment world. Yes, inheritances are a factor, but for someone with non-registered and/or TFSA accounts, those will probably better serve the purpose of passing on wealth to the next generation than a RRIF.
If you are considering retirement, give some thought as to how you are going to use your retirement income resources. The conventional practice is not always the best choice.
Tax calculations are based on the resources provided at taxtips.ca.
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.