We all love the nice tax deduction that comes from contributing to a Registered Retirement Savings Plan (RRSP). But love turns to hate, or at least consternation, when Registered Retirement Income Fund (RRIF) time rolls around signaling withdrawal requirements and taxes.
While it’s good to remember that you’ve had decades of tax deferral, RRIFs do have some problems. Until the federal budget announcement of changes to RRIFs in April, the rules had been stagnant for 23 years, and reality for today’s seniors is different than it was in 1992. First of all, we’re living longer than we used to. A 71-year-old man today has a nearly three-year greater life expectancy than in 1992. For a woman, it’s four years. In addition to increased longevity, investment returns are far lower now; investments, particularly on the safer fixed income side of things, are returning 60 percent less than they did in 1992. Put these factors together and the result is a host of seniors who could outlive their retirement accounts.
The recent changes to RRIF withdrawal rules may be a step in the right direction to help to reduce the risk of seniors outliving their savings, but according to the C.D. Howe Institute report, “Drawing Down Our Savings: The Prospects for RRIF Holders Following the 2015 Federal Budget,” the changes may not be enough.
The updated rules around RRIF withdrawals include:
- RRSPs must be converted to a RRIF by December 31st of the year you turn 71.
- Mandatory minimum withdrawals begin at age 72.
- The first year withdrawal starts at 5.28 percent (this was previously 7.38 percent) and peaks at 20 percent when you are 95. The same holds true for life income funds and locked-in retirement income funds.
- RRSPs can be converted to a RRIF earlier and mandatory withdrawals begin at 4 percent.
- All or part of an RRSP can be converted to an annuity rather than rolled over into a RRIF.
According to the C.D. Howe Institute, a 71-year-old male in 1992 would only have depleted 25 percent of his RRIF capital by the time he reached the age of 90. Before the rule change, that same person would have run through nearly 70 percent of his funds based on current withdrawal rules and rates of return. With the new withdrawal rates in place under the 2015 federal budget, this figure shifts to a 56 percent depletion of capital. It’s an improvement, though it’s still a far cry from the nest egg that would have been in place in 1992.
Another concern is that seniors, especially those who are single with workplace pensions (notably defined benefit plans), could face Old Age Security clawbacks and a reduced old age tax exemption.
Aside from ensuring they don’t outlive their money, seniors need to address the issue of liquidity. After a stock market slide, it can easily take six or seven years for indices to recover. Without cash in a RRIF, seniors will be forced to crystalize losses by selling depressed investments, be they mutual funds, stocks or exchange-traded funds.
To avoid that kind of disaster, consider the following:
- Start preparing an RRSP for RRIF withdrawals a number of years before age 72. A good rule of thumb is to have at least three years of withdrawals in cash – such as laddered GICs – at the conversion date. If there isn’t sufficient cash in a RRIF, the brokerage or investment firm will simply sell securities to meet the withdrawal requirements. You want to be in control of this decision.
- If income from the portfolio isn’t sufficient to meet future withdrawals, and with current returns that’s likely to be the case, a regular program should be set up to sell equities if they are a significant portion of the RRIF. Selling gradually over time will smooth out stock market ups and downs.
- Fixed income investments should be laddered so that maturity dates work in conjunction with rates of withdrawals.
- Finally, if you are enticed by offers of tax-free withdrawals from an RRSP or RRIF, think again. The CRA refers to them as schemes and is stepping up enforcement against them. Thoroughly research any such pitches and if you don’t understand what is being proposed seek the advice of an independent investment professional.
You can’t avoid death or taxes but with a bit of planning, a RRIF can be structured to minimize investment losses and make withdrawals a painless process.