Retirement Income Withdrawal Strategies
Money In and Money Out
When I worked for the discount brokerage division of a major Canadian bank, I learned that the investment side of banking was referred to as “Money In.” That is, money came into the bank through investments in Guaranteed Investment Certificates (GICs) and mutual funds. The lending side of the bank was called “Money Out.” Mortgages and other kinds of loans would fall into this category.
Similar terms can be used in the investing world for individual investors, too. Investing is “Money Out” in the sense that it leaves our hands and goes into an investment vehicle, like GICs, mutual funds, bonds, stocks, Exchange-Traded Funds (ETFs), etc. “Money In” in relation to the investment world, is when we begin to withdraw from our investments in order to provide income for us when we are no longer earning an income from employment. The money we invested now comes back into our hands.
Debra, Our Client
Let’s suppose we have a client, Debra, who is about to retire. Debra earned an average income throughout her working career, which began straight out of high school and continued until reaching age 65, her current age. Debra never married and never had children. She has lived a relatively modest lifestyle, which has enabled her to save a substantial part of her income in her Registered Retirement Savings Plan (RRSP), her non-registered account, and eventually, in her Tax-Free Savings Account (TFSA). This is where the issue is for Debra because she’s not sure which to withdraw from first.
Strategy 1: Withdraw from all three accounts equally
Debra wondered if this would be the best choice because it felt like the simplest. Based on the balance at the end of the previous year, and assuming she lives to age 95, Debra wonders about the value of spreading the withdrawals from each of her accounts over the expected remaining 30 years of her life. Below are her yearly numbers, adjusted for 2% inflation, which result in an after-tax real return of $1,548,373 over her 30-year retirement.
Strategy 2: Steady withdrawals from RRIF; Withdraw from non-registered, then TFSA
In this strategy, Debra asked about keeping the RRIF withdrawals at the same pace, but then pairing that money with withdrawals from the non-registered account first until it was depleted, and only then drawing from the TFSA. With the same assumptions as above, the result is a slightly worse overall after-tax real income of $1,547,249.
Strategy 3: Rapidly withdraw from RRIF; Withdraw from non-registered, then TFSA
Operating on the idea that the RRIF is the most tax-inefficient when it is withdrawn, compared to the non-registered or TFSA accounts, Debra wondered if there was an advantage in spending it down first, so that, if she died prematurely, her estate would have less tax to pay. Debra is correct in that regard, but the impact of making her estate more efficient is that her own withdrawals become less tax efficient. This is the worst strategy for Debra as her cumulative after-tax real income is $1,538,425.
Strategy 4: Spend down non-registered account first; RRIF second; Steady withdrawals from TFSA
On the basis that money left inside an RRSP has a chance to grow tax-deferred, while a non-registered account is always subject to tax on dividends and interest as well as capital gains from any sales, Debra wondered whether it might be better to draw down the account that is not sheltered from tax first. After that, she would draw from her RRIF, all the while taking a small amount from her TFSA to supplement these other sources of income. Debra’s overall or cumulative after-tax real income using this method is $1,543,810.
Strategy 1, in which Debra withdraws from each account type at an even pace so that they are all exhausted by the time she reaches 95, happens to work out the best. This was a surprise to me since I have often heard recommendations that retirees draw from their RRSP/RRIFs first. Yet, the third strategy, which follows that path, yielded the worst overall return. Having said that, the differences among the strategies are not major. The annual difference between the best and the worst strategy is only $321, or $26.75 per month. I hope most retirees can manage that range of difference.
In Debra’s case, a single woman without children who may not have particularly strong concerns about providing an inheritance, there is not really a reason to spend down her RRIF first. However, if there is a desire to leave an inheritance, prioritizing withdrawals from the RRIF has some value in reducing the tax hit at death.
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.