RRSP meltdown

Opinion

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This article was published 31/05/2014 (4146 days ago), so information in it may no longer be current.

Suzanne is a financially footloose and fancy-free retiree.

Her teacher’s pension, OAS and CPP provide her with about $50,000 in cash flow annually, so she rarely has to dip into $126,000 in savings.

Despite owing about $67,000 on her condo, she has a modest cash-flow surplus each month, which she rolls into savings.

But here’s her problem: About $75,000 of her money sits in a RRSP, and Suzanne, 71, will have to make mandatory withdrawals from it when the account converts to a RRIF (registered retirement income fund) before the start of next year.

“I don’t know what to do with the money that comes out because I don’t really need it for day-to-day living.”

Suzanne says it galls her she will have to withdraw a minimum of about $5,600 annually, paying taxes on money she doesn’t need to live.

While she has been looking for ideas to reduce the taxes, she has yet to find a good solution, so she’s hoping an expert can provide a solution.

Certified financial planner Darren Quiring says Suzanne isn’t going to like his answer.

“I’m sorry to say this, but there is no way around paying the taxes,” says the adviser with Edward Jones in Winnipeg.

While Suzanne can find ways to reduce her taxes, she will ultimately have to give money away to get tax savings in return. For example, she could give money to charity. That will result in 15 per cent tax savings on the first $200 donated annually and a 29 per cent return on donations over that amount.

She can also donate to political parties for greater effect, but the maximum tax savings she could receive donating to a federal or provincial party is $650.

Other options exist, but they are dubious.

“I’d never advise this, but there are some questionable charity donations where you give $1,000 and they give you a tax receipt for something like a $10,000 donation,” he says. “But she doesn’t want to be lured into these donation traps as some of my clients have done — without our advice — and now they’re being audited by CRA.”

Many people who wrongly choose this route initially find CRA accepts the donations and they receive a substantial refund, but CRA usually flags their files and audits them at a later date, a process that can lead to a hefty tax bill, including interest charges and penalties.

A legitimate alternative for Suzanne would be to invest the RRIF withdrawals in a non-registered account to purchase flow-through shares that provide tax deductions and credits. In Manitoba, flow-through share investors in eligible Manitoba-based resource-development firms can deduct their investments against income. In addition, the investment can be eligible for up to 45 per cent in non-refundable tax credits.

But Quiring says this strategy likely isn’t a good fit for Suzanne because she would be investing in companies that are very risky. Many do not turn out to be profitable, and investors can lose their money.

These aforementioned tax-saving strategies aside, Suzanne can still be proactive in addressing the tax quandary with her registered money.

“If she was my client, I would motivate her to start taking withdrawals now and every year going forward, an amount that would maximize her annual TFSA contribution.”

Suzanne will still pay taxes on the withdrawals, likely in the 39.4 per cent bracket, but she would be transferring her net wealth into her TFSA, investing it for a tax-free future. This strategy will reduce the amount of her fully taxable savings sooner instead of later, decreasing the tax liability to her estate.

“In time, she will eliminate her registered money replacing it with TFSA money, so if she lives to 85 or 90, she could use her savings without tax concerns,” he says.

If Suzanne is paying 39.4 per cent in taxes on her RRIF withdrawals, she will likely need to withdraw about $9,000 annually to have enough net cash available to maximize her annual TFSA contribution.

That’s more than the first mandatory minimum RRIF withdrawal she would have to make, which is 7.48 per cent of $75,000, or about $5,600.

But this strategy will reduce the tax liability to her estate more quickly than if she follows the minimum RRIF-withdrawal guidelines.

As for how to invest the money after contributing it to her TFSA, that’s another conversation entirely.

“The cookie-cutter advice would be to have 70 per cent of it in fixed income — bonds — and 30 per cent in the stock market, based on her age, but I’d be reluctant to offer that kind of recommendation.”

Because Suzanne doesn’t need the money, she really could invest as she pleases. She could invest in the stock market for the long haul, ultra-conservatively in savings for short-term needs, or somewhere in between.

And in the future, when interest rates rise and her mortgage costs increase, she could use the money to pay down her principal faster and to help absorb the higher interest charges.

Quiring says at the very least, Suzanne is in very good shape for a financially worry-free retirement — even if she will have to pay more taxes than she would like.

“Unfortunately, she will not get the answer she seeks, so she’s likely best off to just grin and bear it.”

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