Leave To Grow Or Withdraw Some Dough � Factors To Consider When Pondering Early RRSP Withdrawals � Part 3

Colin Ritchie In this article, I’ll pick up where I left off at the end of my last article, fleshing out some of the things to keep in mind when deciding what to do with your Registered Retirement Savings Plans (RRSPs) and Registered Retirement Income Funds (RRIFs). For those of you coming late to the party who have not read the first two parts of this series, I suggest doing just that. Part 1 does some basic mathematical calculations showing how early RRSP withdrawals can mean big savings later in the right circumstances, while Part 2 starts explaining why. For those of you who have been with me since the beginning, the end is now in sight. Let’s cut to the chase.

Guaranteed Investment Supplement (GIS) and Other Benefit Planning.

People expecting to have very little taxable income during retirement may end up paying a lot more tax on the RRSP withdrawal by way of lost government benefits and government subsidies. If you expect to earn GIS benefits in future, each $2 in RRSP withdrawals can cost you about $1 in GIS benefits. Likewise, some provinces offer subsidies on drug costs during retirement based on income levels. Perhaps most importantly to some Canadians, the cost of public retirement facilities is based on income levels. Accordingly, reducing your tax hit prior to moving into an assisted-living facility may reduce your care costs later. These are just some potential examples.

Poor Health or Life Expectancy.

One of the biggest factors against withdrawing money early from your RRSP can be the lost profits you would have received on the money that you have to pay now in taxes that would have remained invested inside your RRSP if you do nothing. Although those lost profits will also eventually be taxed, some of them would still find their way into your back pocket. The less time between when you trigger taxes early compared to when you would have had to otherwise pay them anyway, the less time these extra profits would have had to grow inside your RRSP.

For example, if you withdraw $50,000 from your RRSP a year earlier than necessary at a 30% average tax rate rather than waiting and paying 50% on the same dollars the next year, although you’d only have $35,000 to work with initially, you’re probably still farther ahead of where you’d be if you let it ride for an extra year. Even assuming your investments grew at 20% and were taxed completely as interest at 50% in both cases, I’d much rather settle for getting $3,500 after taxes on the $35,000 I withdrew early (or $37,500 after taxes) than paying 50% tax on $60,000 in my RRSP a year later and keeping only $30,000 after the Canada Revenue Agency (CRA) gets its cut. Of course, the benefits of early withdrawal are far more pronounced if the non-registered money is invested more tax-efficiently. For example, if the $35,000 went into a Tax-Free Savings Account (TFSA) and still made 20%, the early withdrawer would earn $7,000 after tax that year while procrastinator would only make $5,000 after tax despite having $15,000 more before tax to sink into the market.

Ultimately, if you knew when you were going to pass on or that you wanted to use more than just the minimum amount you’d need to withdraw from your RRIFs in a few years, can get it out at a low tax rate, and can invest it tax-efficiently, it might make sense to bite the bullet.

Tax Deductible Investment Fees

If you pay investment fees inside your RRSP or RRIF, you can’t deduct them each year. Although you still pay them from inside your accounts and will get the same thing as a deduction eventually since you won’t have as much money to be taxed on, you need to wait until withdrawal to get this benefit. If instead, you have a non-registered portfolio and pay a percentage annual or monthly fee to your broker, you can deduct this fee each year. This works particularly well if you are earning dividends, capital gains or return of capital, which are taxed at lower rates than the deduction you receive from paying your fees. Thus, you get to deduct your fees now if in an open account rather than later and get to deduct them against investment income that likely won’t be taxed as heavily as it would if invested inside your RRSP.

Potential Estate Disparity When Using Beneficiary Designations.

If naming multiple beneficiaries on an RRSP or RRIF, the survivor gets the whole thing if the other(s) don’t outlive you. This can be a problem if you name your children jointly but would want grandkids to inherit in their parents’ place. To make things even worse, the surviving children would get the money tax-free most of the time and your estate would be the one paying the piper. That would mean that if your grandkids inherited their deceased parents’ share of the rest of the estate that they would get a smaller piece of that pie as well, as their share of the estate would be net of the tax bill on the RRSPs that went to their aunts and uncles. Obviously, you can update your beneficiary designations if necessary if you are still healthy, but if you are not, this cannot usually be done through a Power of Attorney. Thus, if you are sick for many years, you are banking on the fact that nothing happens to any of your children during that time.

An easy solution is leaving the RRSPs etc. to your estate and accepting that this means probate fees and exposure to will and estate issues. For larger registered plans, consider leaving them to a trust that can stipulate what happens to a deceased child’s share while still avoiding probate fees and estate challenge issues. Unfortunately, many people just rely on the simple beneficiary designations for their registered plans. Accordingly, I wanted to make sure my readers are aware of this problem.

Factors Discouraging Early Withdrawals

Most of the considerations mentioned in this and my first two articles in favour of pulling your RRSP money out early suggest keeping your RRSP intact should the necessary conditions not apply. For example, you might be better off taking some money out now if you are in a lower tax bracket, love dividends, have poor health and don’t expect to draw down your RRSP before death. Conversely, if you are in great health, may use all your RRSPs during your lifetime and love interest-based investments, you might be better off leaving things alone for now.

Here are a few other things to keep in mind that might suggest you keep your RRSPs intact for as long as possible:

RRSPs and RRIFs have creditor protection, which might be useful for those unlucky few facing bankruptcy or a nasty lawsuit;
The first $2,000 of RRIF money for those over 65 qualifies for the pension income credit. Accordingly, some of us with smaller RRSPs might be better off (depending on whether they are getting GIS or other income-based benefits) to take their RRIF money out $2,000 at a time. Assuming that it all comes out this way over time, it essentially means you can get your RRIF money out with little tax owing. As well, your money gets to compound for longer as you wait, which can mean more money to you over the long term;
RRSPs and RRIFs have beneficiary designations, which is an easy way of avoiding probate and potentially estate creditors. You can get this protection within TFSAs, segregated funds or other planning techniques if owned outside of your RRSP or RRIF, but it might also require a bit more effort and work on your part to put this in place;
If you have a financially dependent, disabled child or grandchild, you may be able to roll over up to $200,000 of your RRSP or RRIF to that person at your death, minus any other contributions made to their plans during their lifetime; and
It is easier for you to budget when inside your RRSP / RRIF. Some of us, such as those who are spenders or have a hard time saying no when children ask us for money, may benefit from keeping the cash in the RRSP / RRIF as long as possible if it helps with budgeting or makes it a bit harder to write that cheque for a child that is not truly in need.

Conclusion

Don’t get me wrong – I love RRSPs, particularly for clients in high tax brackets now who expect to be in lower tax brackets later. It’s just that I think about them in the same way that I think about investing – it’s all about having an exit strategy. If I can cash in registered money on the cheap, deploy it more tax-efficiently afterwards and also increase my financial flexibility, then, why wouldn’t I? Although it probably means looking at a smaller pool of investable assets in the short and also perhaps the medium term, it all comes down to how much is left after taxes and what I can do with the money rather than the size of my account before the tax man has received his due. Finally, life and circumstances are always changing and are rather complex. I like to be financially nimble and to be able to raise cash without worrying about triggering a huge RRSP withdrawal tax bill unless the costs of withdrawing more of my RRSP money now simply don’t make sense.

Accordingly, rather than relying on principles like it’s always good to defer RRSP withdrawals or to always take the money and run, it really depends on individual circumstances and usually requires revisiting your planning from time to time to see if yesterday’s advice still holds true today. Thus, I must, unfortunately, return to where I began two long articles ago. If asked whether it makes sense to withdraw RRSPs early, my answer still remains: it depends. Now, at least, I hope you know why.

Colin S. Ritchie, BA.H. LL.B., CFP, CLU, TEP and FMA is a Vancouver-based fee-for-service lawyer and financial planner who does not sell investment or insurance, just advice. To find out more, visit his website at www.colinsritchie.com.