Do the RRIF Rules Need to be Changed?
“Industry organizations are calling on the federal government to raise the age at which RRSPs must be converted to RRIFs and to reduce the annual RRIF minimum withdrawal rates.”
“Industry groups call for changes to RRIF rules,” by Rudy Mezzetta, Advisor’s Edge, March 13, 2023
What is a RRIF?
I have written about RRIFs before. You might describe a Registered Retirement Income Fund (RRIF) as the mirror image of the Registered Retirement Savings Plan (RRSP). The RRSP is intended to encourage saving for retirement by giving contributors tax deductions and allowing the assets inside the RRSP to grow tax-free. These incentives encourage people to first, save because of the deduction, and second, keep the money in the RRSP because of the tax-deferred status of the investments.
Ultimately, however, the money must be withdrawn. You could just take it all out and pay tax on the lump sum. You could take the proceeds to buy an annuity which, in its simplest form, will pay the annuitant, you, a regular stream of income until you die, like a pension. By far the most common choice is to convert the RRSP into a RRIF. The year after the conversion, you are obligated to begin taking out a certain portion based on your age and the value of your RRIF at the end of the previous year. You can make this transition from RRSP to RRIF at an earlier age, but it must not take place later than the year your turn 71. Your first payments from the RRIF are due, therefore, not later than the year your turn 72. At that point, each dollar withdrawn is included in your taxable income.
These points, the age and the amount, are at the crux of the issue that is being studied by the Department of Finance. The recommendation is that seniors be allowed to contribute up to age 75, that any unused contribution room be indexed to inflation, and that up to $160,000, indexed to inflation, be excluded from the Annual Minimum Payment formula until age 85.
I am going to take a somewhat contrary view or at least question whether this is a good recommendation.
Why allow seniors to contribute to RRSPs until age 75?
There at a couple of arguments made to support this recommendation. First, the reality for many Canadians is that they have not been able to maximize their RRSP contributions. Indeed, according to Statistics Canada, only about 22% of tax filers contributed to RRSPs in 2020, the most recent year for which data is available. The median contribution amount: $3,600. With people carrying mortgages into retirement, savings opportunities have been limited for many. However, they may still have carried forward many years of contribution room.
Another Statistics Canada survey of data shows that the median after-tax income of households is $66,800. If your average combined federal and provincial tax rate works out to 20% or so, that’s about $84,000 before taxes. The average contribution of $3,600 to an RRSP could be because a significant part of the population contributes to a Registered Pension Plan through their employment, which causes a pension adjustment and reduces the amount of room you have to contribute to an RRSP. But, given that so few people contribute to RRSPs at all, the more likely reason, in my opinion, is that they don’t have, or don’t set aside, the money to contribute.
Who would benefit from this policy change?
The argument is that this would benefit seniors who have not taken advantage of their available contribution room. I wonder if that is right. Maybe this recommendation is more for the investment firms and the investment divisions of insurance companies. They could continue to charge product and advisory fees for several years longer. In the meantime, those with lower incomes would still be unlikely to contribute.
It probably also benefits working seniors who have never had any trouble contributing to their RRSPs and would like to accumulate more.
Is this about a desire to avoid taxes?
Canadians who have substantial RRSPs are often reluctant to convert them into RRIFs because they have to start taking minimum payments, which are taxable, and those payments can get quite large pretty quickly. Here is a table of the current RRIF minimum withdrawal rates by age at the beginning of the year.
For the next little exercise, I estimated the median income for an individual Canadian and assumed they were able to contribute 18% every year from the year they turned 18 until the year they turned 71. I further assumed a long-term average return of 4%. That may seem a bit low, but there were several stagnant years as well as major losses during the last half-century. I came up with a figure of $550,335 saved in an RRSP by the end of the year that this average Canadian turned 71. Assuming they took no more than the annual minimum payment, they would withdraw approximately $31,391 on average between ages 72 and 94. The amount withdrawn each year didn’t change that much because as the percentage required increased, the RRIF balance slowly decreased.
These are not astronomical numbers, but of course, some earn well above the median income and will have much larger amounts that they are obligated to withdraw.
These proposed rule changes may lead to more taxes being paid
One of the insights that financial planners have recognized is that delaying the transfer of an RRSP to a RRIF may be counterproductive.
Married couples or common-law partners
One of the benefits available to senior couples is that they can split their pensions with each other. After age 65, RRIF income is regarded as equivalent to pension income for splitting purposes. This can lead to equalization of income and an overall reduction in taxes paid. This is fine when both partners remain alive. However, when one spouse dies, the RRIF is thereafter taxed entirely in the survivor’s hands. A large RRIF, which in most respects, is a good thing, can lead to significant tax consequences, including the clawing back of some benefits that were otherwise previously available.
Impact on CPP and OAS
Many Canadians want to start receiving their Canada Pension Plan (CPP) payments as soon as possible out of fear that they will die before they get to enjoy the money that they’ve set aside for so many years. This ignores the probability that if you’ve made it to age 60, you are likely to live to age 90 or longer.
Starting CPP at 60 also lets retirees or near-retirees delay spending down their retirement savings in their retirement accounts. However, when you consider that RRSP/RRIF funds are often invested in risky products that are not guaranteed to grow or grow sufficiently, and match it against government-backed, inflation-adjusted payments from the Canada Pension Plan, it often makes sense to spend from the RRIF first, allowing retirees to delay the CPP start date, and possibly the Old Age Security (OAS) start date, too. The benefit of doing this is an increase in payments for each month delayed past 65.
This is not for everybody, but for the household with substantial RRSP assets and reasonable expectations of living a long life, it is an approach that can lead to more after-tax income and more stable income as well.
Tax Efficiency for Inheritance Purposes
Many seniors wish to leave an inheritance to their heirs. Not all do, and certainly, not all seniors can leave something for their heirs, but those with substantial RRSPs may wish to consider the tax impact of not spending down the RRIF. Consider a couple that each has RRIFs worth $500,000 at age 72. One spouse dies at age 80, and the surviving spouse dies at age 85. As a couple, they had a policy of never withdrawing more than the required annual minimum payment. If the surviving spouse continued on that policy, she (men tend to die before women) could easily have $700,000 in her RRIF. At death, the CRA deems the RRIF to have been completely withdrawn, meaning that most of that money will be taxed at the top marginal rate which, when federal and provincial/territorial rates are combined, can reach greater than 50%. It could be that some seniors don’t care about the tax efficiency of the money they leave for their heirs. Rather, their primary concern is to avoid running out of money, so it is understandable.
Some Suggestions for RRIFs Under the Current Rules
Spend part of it down while your tax rate is lower
As indicated above, one way to resolve the tax issue is to spend more of your RRIF earlier in retirement. Don’t wait until age 71 to transfer RRSP assets to a RRIF. At retirement, and without full-time employment income, most Canadians have a lower marginal tax rate. Note that you don’t have to move all of your RRSP into a RRIF. You must do so in the year you turn 71, but before that age, you can move a bit at a time, giving your more control over your RRIF spending. You can also take advantage of splitting the RRIF with a spouse and using the pension amount to get a tax credit.
Delay CPP and OAS
Using your RRSP in your earlier years means you can delay CPP and possibly OAS. Few people do both, but if you were to take one at 65, probably starting OAS would make more sense – unless your income is such that you could be subject to the OAS pension recovery tax (AKA “clawback”). Delaying CPP past 65 means a 0.7% boost per month or 8.4% per year, to a maximum of 42% if delayed to age 70. OAS increase by 0.6% per month, 7.2% per year, and a maximum of 36% if delayed to age 70. Note that by delaying OAS, the threshold for the pension recovery tax is also increased.
Take part of your RRIF and buy an annuity
If part of the reason for desiring a delay in the withdrawal requirement is to allow for a greater sense of security, then one available option is to take part of the RRIF and buy an annuity that will pay out to the end of one’s life. Regular monthly payments that are no longer subject to market risk can be a great relief from this concern. Note that the longer one waits, typically to age 71 or later, the better the monthly annuity income for the premium paid.
When you have to withdraw more than you need, put it in a TFSA
Retirees who find themselves with more money withdrawn from their RRIFs than they need can always use the surplus to contribute to a TFSA. While tax will still have to be paid, money put into the TFSA grows tax-free and has no impact on taxes when withdrawn. And even better for seniors, there is no age limit or earned income requirement constraining TFSA contributions. Finally, assets left to heirs in a TFSA have little to no tax consequences.
When you have to withdraw more than you need, give to your heirs now
Seniors who have more income than they need may wish to simply provide an advance on the inheritance. Instead of leaving a heavily taxed lump sum in the RRIF, by withdrawing regularly early on and giving part of it to the children and/or grandchildren now, the tax burden will be lighter and the joy of giving to loved ones will be increased.
When you have to withdraw more than you need, give to charity
Certainly, there is psychological or spiritual value in giving to a charitable organization, but the tax credit available for giving to registered charities should not be underestimated.
If you are not yet at retirement age, consider whether you should even be investing in an RRSP
The RRSP has been around much longer than the TFSA, so the former is almost the default choice. Everybody loves the tax deduction. However, for those Canadians who are at a lower income level, the tax deduction is not as significant, and the potential for a lower-income senior to wind up in the same tax bracket in retirement as during their working years means that the benefits are not as substantial. Consider the TFSA as an alternative. Sure, contributors do not get a tax deduction, but like the RRSP, assets in the TFSA grow tax-free, and when withdrawn no tax is due on any of the amounts. Even better, there are some benefits, like the Guaranteed Income Supplement (GIS), that are not impacted by withdrawals from a TFSA, whereas RRIF income’s impact is substantial.
This is the 189th blog post for Russ Writes, first published on 2023-03-20
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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.