When it comes to money and personal finance, this time of year gets people thinking about tax and RRSPs (Registered Retirement Savings Plan). When you buy your RRSPs, we often get focused on the tax deduction and forget the benefits of future tax deferral.
I just finished reading an article on Moneyville about how Registered Retirement Income Funds (RRIFs) work.
The article had a lot of good basic information, but I started shaking my head at one statement from David Birbeck, Retirement Product Strategist of RBC, near the end of the article.
“We advise clients to take out RRIF money last.”
RRSPs and RRIFs defer tax
The whole point behind Mr. Birbeck’s statement is RRSPs and RRIFs defer tax. Deferring tax is a common and meaningful strategy. In fact, it is one of the three D’s of tax planning. Deferring of tax simply means instead of paying the tax now, you can pay it in the future — allowing you to use the government’s money for your own benefit.
Aren’t you supposed to spend your RRSPs in retirement?
Deferring RRSP and RRIF income is smart, especially in your working years. If you take money out of your RRSPs when you are working, you will probably pay more tax because you will be in a higher tax bracket.
When you retire, just remember the whole point of putting money into the RRSPs in the first place. You save money to enhance your retirement to make retirement the best years of your life. Despite this common goal, far too many people hit retirement and are reluctant to spend their RRSPs and RRIFs because of over generalized advice around the benefits of tax deferral.
When should you take money out of your RRSPs/RRIFs?
My advice has always been for retirees to come up with a withdrawal strategy for their RRSPs and RRIFs in retirement. Often this withdrawal strategy is to help retirees create more income so they can spend it. But for some, they don’t need or want to spend the money, or they get so focused on tax deferral that they do not withdraw any money. Even if you do not need the money, it might make sense to develop a withdrawal strategy for other tax reasons.
Reasons why deferral of RRSP and RRIF income may not make sense
1. RRSP income can create clawbacks on income-tested programs. RRSP withdrawals are fully taxable and can cause higher incomes, which can lead to Old Age Security (OAS) clawback, and less Guaranteed Income Supplement (GIS). If you know your higher taxable income can create ‘clawbacks’, it can be advantageous to take money out of the RRSPs before you qualify for these programs.
2. Higher incomes in retirement. If you knew you would pay 32% tax on any RRSP withdrawals in the future, would you be willing to take that money out now at only 25% even if you did not need the money? In most cases, people retire with less income than while they were working. However, I’ve run across many examples where people might actually have more income in retirement. This can be more common with people who have defined benefit pensions and others who plan to work in retirement.
3. Deferral of lifestyle. Retirement is not just about money and tax. People who defer their RRSPs to age 71 are also deferring their lifestyle. Think about this . . . if you have not used your RRSPs by the time you turn 71, what makes you think you will need your money after 71? I see so many people deferring RRSPs to age 71 only to find they can’t spend it later. They then take minimum income because they have to but don’t even spend that money. And then they die with too much RRSPs.
4. Taxation of RRSPs at death. I’ve written extensively about why you do not want to die with too much RRSPs. The tax consequence can be too significant. You might wind up paying even more tax when you die than if you developed a withdrawal strategy while you were living.
Planning is personal
My guess is that RBC does not advise all clients as a general policy to take money out of RRSPs and RRIFs last. If they do, that’s very wrong. This statement is too general and can be misleading and misguiding. Planning is personal.
All the theory in the world is useless unless you can apply it to yourself. Just because it made sense for someone to defer RRSP income into the future, does not mean you should, too. Good planning will make all the difference, so take this information and apply it to you.