The famous “RRSP season” raises many questions. This is the opportunity to set the record straight by debunking some stubborn myths on the subject. Here is the question of one of our readers, Claude, who inspired this column.
“I’m going to be 60 in 2023 and I’ve been retired since January 2021. Most of the time it’s suggested that we start with RRSPs (registered retirement savings plans), so as to reduce my future taxable income , to have access to tax credits and tax benefits from Quebec and the federal government, which are influenced by our income. I have about $600,000 in RRSPs.
It seems to me that if I disburse before age 65, this will result in huge amounts of tax. Especially since everything is liquid, at Épargne Placement Québec, in GICs (guaranteed investment certificates) and in banks. Not to mention my other non-registered investments, which will also bring in taxable interest income of a few tens of thousands of dollars annually. Normally, RRSPs provide tax deferral at a time when our incomes are lower and in a lower tax bracket.
But here, I have the impression that having saved in a serious and very disciplined way will put me at a disadvantage. Is there something I misunderstood, did I make a mistake somewhere? »
Indeed, Claude seems to have been misinformed as to the order of disbursement of his assets. Here are some ideas for reflection adapted to his situation.
Defer tax for as long as possible
First of all, let’s remember that, if the RRSP account does not make it possible to eliminate the tax—which, moreover, harms its reputation with those who do not understand its advantages—it makes it possible to defer it.
For the majority of taxpayers, taxable income is higher during working life than in retirement. It is thus advantageous to reduce the taxes payable during this long period by enriching oneself thanks to the tax savings. While there are few hard and fast rules when it comes to personal finances, the fact remains that for many people the goal will be to disburse RRSPs as late as possible, and in set amounts, in order to optimize taxes according to the personal and tax situation.
RRSP withdrawals will be taxable, but the increased long-term net worth made possible by annual contributions more than justifies it. If the assets are significant, it is even possible, for certain taxpayers, to withdraw only the minimum annual mandatory withdrawals from age 72, when the RRSP is transformed into a RRIF (Registered Retirement Income Fund). And if you don’t need the money from these mandatory withdrawals, you should contribute annually to your TFSA (tax-free savings account), to keep a portion of the return tax-sheltered.
In certain situations, it is entirely relevant to calculate whether the income from withdrawals from the RRSP account may affect eligibility for the Guaranteed Income Supplement (GIS) from Old Age Security (OAS). They may be taxpayers who benefited from lower incomes when they were working and who accumulated few RRSPs, or, conversely, entrepreneurs who mainly accumulated their wealth in a holding company. In the latter case, the personal needs must still be extremely low for such a calculation to apply. Following the sale of a business, an RRSP withdrawal may also be effective in recovering the alternative minimum tax (AMT) more quickly.
This does not seem to be the case for our reader, who holds non-registered investments, which increase his taxable income. There is a good chance that the disbursement of these, in priority over his RRSP and his TFSA, will be more advantageous. He could, however, verify the relevance of converting a small part of his RRSP into a RRIF, in order to obtain the tax credit for pension income, which applies to the first two $2,000 of eligible pension income.
Disburse according to your needs
The best retirement disbursement plan must obviously optimize taxation, but it must first of all allow you to achieve your personal objectives. There are several crucial factors to analyze to arrive at a personalized disbursement strategy, such as your cost of living at retirement, your sources of additional income (e.g. retirement pension and/or net rental income, dividends from your holding company, sale of assets, etc.), your family situation and the composition of your
wallet.
Thus, in the case of a couple, it will be important to plan withdrawals from the RRSP so as to balance the tax bases as much as possible. Consideration should also be given to the best time to apply for a pension from the Régie des rentes du Québec (RRQ) or Old Age Security (OAS) benefits.
First, I therefore invite Claude to determine his desired cost of living in retirement, which should be based on serious reflection and provide for the integration of projects that are dear to him. Subsequently, various disbursement scenarios may be presented to him in order to spread the withdrawal from his RRSP over several years, thus allowing him to retain the advantages of compound interest and limit the taxation on withdrawals.
An underinvested portfolio in retirement?
Finally, even if it is not his main question, one element of the message deserves to be highlighted: why is his RRSP portfolio mainly liquid or invested in GICs? Unless his living needs are extremely important, the majority of his portfolio will not be disbursed in the short term… In other words, if you are retired, your portfolio should not be. At least not if you want to put the odds on your side in order to protect it against the risks of inflation, especially in the event of longevity.
A portfolio could be revised with the objective of generating greater current income, for example. However, a portion of the portfolio will also need to be invested for the long term. Once again, with personalized planning, it will be possible to establish this revenue requirement quite precisely.