Melting Down Your RRSP

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The RRSP was designed to help you save for retirement by:

  • Deferring tax on your contributions
  • Allowing your contributions to grow tax-free within the RRSP

However, any withdraws are taxed like ordinary income.  Additionally, RRSPs must be converted to RRIFs or an annuity by the end of the year you turn 71.

If you’ve been a diligent contributor and done well with your RRSP investments, you may have a sizeable six figure or seven figure nest egg in you RRSP as you near retirement.  Then at age 71, you can either buy an annuity (not generally recommended given today’s low interest rates) or convert it into a RRIF.  With a RRIF however, you are required to withdraw a minimum amount each year according to a government prescribed rate, based on your age.  Currently, the minimum withdrawal at age 71 is 5.28% of your total RRIF value and that percentage rises as you get older.

What You Need To Know

If you have a RRIF worth $500,000, your minimum withdrawal at age 71 will be 5.28% x $500,000 = $26,400 for the year.  If you also collect CPP and OAS at their maximum amounts, you will have received $13,370 and $7,025 respectively in 2017.  These 3 income sources alone will total $46,795, pushing you above the lowest Federal tax bracket that ends at $45,916 for 2017.  Therefore, any additional income from pension plans, non-registered investment accounts, rental income, etc. will be taxed in the higher tax brackets.

At age 65, you gain 2 tax advantages – the Age Amount that provides $7,225 in non-refundable credit for 2017, and the Pension Income credit, providing $2,000 of tax-free pension income.  The Age Amount however, is income-tested and it reduces by 15% of the amount your net income exceeds $36,430 for 2017.  The other worry is your OAS clawback, because it starts when your net income exceeds $74,788 in 2017.

This then, is the issue with leaving a large RRSP alone until you’re forced to convert it into a RRIF by age 71.  At that stage, you are subject to government minimum withdrawal rates that may:

  • Push you into a higher tax bracket
  • Cause a partial or total loss of your Age Amount tax credit
  • Cause a partial or total clawback of your OAS income

And since the minimum withdrawal rate gets larger as you get older, this issue may worsen as you age.

Bottom Line

If you’ve accumulated a sizeable RRSP, you should look into strategies for “melting down” your RRSP well before you reach age 71.  If you stop working in your early 60’s or earlier, consider withdrawing some RRSP, instead of your TFSA or non-registered accounts, to top up your income at a lower tax bracket.  The whole premise of the RRSP is to defer taxes until a time that you may withdraw the funds at a lower tax rate.  You may find that your RRSP’s lower tax rate is before you start collecting CPP and OAS.

For more information or to discuss further, please feel welcome to contact us.

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Disclaimer

This information is designed to educate and inform you of financial strategies and products currently available. As each individual’s circumstances differ, it is important to review the suitability of these concepts for your particular needs with a Qualified Financial Advisor.