Managing RRIF Withdrawals: Part I

As we know, the amount invested in an RRSP directly reduces your taxable income so you get a tax deduction today. The money invested then grows on a tax-deferred basis until it is withdrawn. When you withdraw money from the plan, it is treated as regular income and taxed for that year.

The common theory is that your annual income will be lower and you will pay less tax in retirement. But, as some retirees are finding out, this is not always the case.

Here are two examples for Ontario residents. Both have RRSPs worth \$200,000 when they are converted to RRIFs.

Details are simplified and dollar amounts are constant for illustration purposes.

1. Company pension recipient

Pamela is a municipal city hall employee. She is earning \$60,000 annually when she decides to retire at 65. Her company pension will pay 70% of her salary.

• Pension payment – \$42,000
• Maximum CPP – \$12,780
• Maximum OAS – \$6,765

Total income \$61,545

This amount puts her in the current Ontario and Federal mean tax rate of 20.94%

At 71 she converts her RRSP to a RRIF and withdraws the minimum required amount of \$14,760 (7.38%) the following year.

Now her total taxable income is \$76,305, which puts her into the next mean tax rate of 23.25%. She will pay approximately \$1,700 more tax now than she originally deferred.

Pamela’s after tax income went from \$48,654 to \$58,563 after the RRIF withdrawal.

2. Low income retiree

Laura earns \$38,000 as an office administrator for a small management company. She has no company pension plan, so when she retires at 65 she will receive government benefits only. Her low income makes her eligible for GIS payments.

• Average CPP – \$7,327
• Maximum OAS – \$6,765
• GIS – \$9,173

Total income \$23,265

Laura is in the 3.15% mean tax level. GIS is not included in taxable income.

At age 72, Laura also withdraws the minimum amount from her RRIF – \$14,760 – which is added to her income. She is now at mean tax rate of 13.61% and pays an additional \$3,500 in tax. On top of that the GIS payment is reduced 50 cents for every \$1 she withdraws from her plan and she now receives only \$1,893.

Laura’s after tax income went from \$22,821 to \$26,818 after the RRIF withdrawal.

Conclusion

As you can see from these illustrations, RRSP withdrawals are not as simple as we were led to believe.

In Part II we will explore ways to minimize the tax bite and allow you to keep more of what you have saved.

1. Rich on February 13, 2015 at 7:29 am

One minor point in the first example you use. In all municipal pensions that I am aware of the 70% of pre retirement income is the TOTAL of the workplace pension plus CPP not 70% plus CPP.

• Boomer on February 13, 2015 at 10:09 am

@Rich: OK, my mistake. Let’s redo.

\$30,000 pension plus CPP & OAS = \$49545 = 18.47% mean tax rate = after tax amount of \$40,392

Add RRIF withdrawal = \$64,305 = 21.38% mean tax rate = after tax amount of \$50,555.

Different figures, but same result – more tax paid on RRIF withdrawal.

2. Lynne on February 13, 2015 at 8:04 am

Excellent topic…now if we could just spread the word to younger people. Most of the people I know are now scrambling to find cheap ways of getting this money out of RRSPs.

3. Ken on February 13, 2015 at 12:07 pm

I look forward to part II on how to reduce the amount paid on withdrawal.

However, I am not totally sold on the idea that RSP savings are less attractive than other forms of saving. For long term savers, the RSP has been growing on a tax deferred basis so the amount available is greater than savings upon which tax must be paid each year. In the example, we need to know how much of the \$200 thousand was due to contributions versus amount due to growth from interest, dividends and capital appreciation which would have attached tax when either earned for realize. Also remember that the tax deduction could also be used for further investment. That is, \$100 of RSP contribution may only be an investment of 70 to 90 depending on your tax bracket at the time.

However, more importantly to me, RSPs with the severe penalties for withdrawal save us from ourselves. With less accessibility, the money remains untouched rather than being used to fund the “Once in a lifetime” vacation that gets taken every few years.
I worked for a company with a benefit based pension plan and it was only after I began collecting it, did I realize how fortunate I was that I had to do the forced saving. When I figured out how much capital I would need to fund my monthly pension, I realize it would have been very difficult for me to have the discipline and savvy to properly save for retirement. An RSP does offer the advantage of making the funds less accessible and increase the chances it will be there when we need the additional income.

4. Sean Cooper, Financial Journalist on February 13, 2015 at 6:11 pm

The low income retiree is a perfect example for my mother. All she has are government benefits and a small defined contribution pension plan. She should have never contributed to an RRSP because of the GIS clawbacks. Unfortunately, the TFSA only came out in 2009. To minimize the clawback, I’m planning to cash out her RRSP in 2-3 years. I’ll withdraw the amount just below the next tax bracket. She may lose GIS a couple years, but at least she won’t lose it every year.

• Boomer on February 15, 2015 at 12:10 pm

Hi Sean: You are correct that a TFSA is a better long term savings vehicle for people in low income brackets. Unfortunately, it was introduced too late to make much of an impact on current retirees.

5. Harry on February 14, 2015 at 5:57 pm

Is the \$0.50/dollar GIS reduction a flat rate clawback and is this only for RRIF income?

• Boomer on February 15, 2015 at 11:23 am

@Harry: GIS is reduced by RRSP and RRIF withdrawals.

6. Bill on February 15, 2015 at 8:10 am

I don’t think I understand the statement: “She will pay approximately \$1,700 more tax now than she originally deferred.” Her net income went from \$48,654 to \$58,563 when her gross income increased by \$14,760. So this increase in gross income led to an increase of (\$58,563 – \$48,654) or \$9,909 in net income. Thus the difference between \$14,760 and \$9,909, or \$4851, must be the resulting increase in tax due to the RRIF withdrawal. Does the \$1700 refer to something other than the extra tax resulting from the minimum RRIF withdrawal?

7. Boomer on February 15, 2015 at 11:30 am

@Bill: The \$1700 is only an estimation, but I was referring to her original RRSP contributions and the refund (or tax deferment) she received at that time.

8. Bill on February 15, 2015 at 1:33 pm

Hmm. So you are assuming that she is paying \$1700 more in taxes for the RRIF withdrawal than she deferred with the past RRSP deposit? Is that correct? Of course that could be correct under certain assumptions. But would they not be rather unusual assumptions. When she deposits the \$14,760 (either in several or a single deposit), if her income was near her terminal salary of \$60,000, her marginal tax rate (using 2014 or 2015) would be 31.15% (at incomes between \$44,701 and \$72,064). Thus she would save (or defer) about \$4649.40 (on the total \$14,760, the min RRIF withdrawal). When she withdraws the \$14,760 from her RRIF this may push her into the next highest tax bracket (\$72,064 to \$81,847), but that only increases the marginal tax rate in Ontario to 32.98%. So the tax consequences would be an increase of \$4867.85 in taxes due in the year of the RRIF withdrawal. Thus she would only be paying \$218.45 more than she deferred. It seems to me that to get such a high number (\$1700), or even a positive number, you must be assuming a much higher marginal tax rate in retirement than when one is employed? This may be true for very low income earners, but would this not be the exception rather than the rule?

• Boomer on February 16, 2015 at 12:20 pm

@Bill: You’re assuming a working lifetime constant income and a last in-first out withdrawal. I’m assuming at least a 20 year work history which begins at the lowest end of the pay scale and annual contributions, and, yes it is an assumption.

9. Bill on February 16, 2015 at 12:36 pm

Then is this a special case? If not the TFSA would always dominate an RRSP contribution, when the choice is only one or the other. Many people refuse to contribute to RRSP’s because they fear exactly what this example shows: paying more tax (or at least as much) as was deferred, upon withdrawal. Of course prior to TFSAs this argument overlooked the true benefit of the RRSP: the ability to earn returns tax free. Many finance types also argued that marginal tax rates would likely be lower at retirement than during one’s working years (in most cases) and thus the fear that the deferrals would fall short of the taxes paid on withdrawal would also be incorrect (even ignoring discounting). If, they are wrong, and if the case you provide is more typical, that would suggest the TFSA would dominate the RRSP for Canadians who can only afford one or the other, at least from now on. Would it not?

• Boomer on February 16, 2015 at 6:46 pm

Yes, Bill, I agree that, going forward, contributing retirement savings to a TFSA as well as – or in place of – an RRSP may be of greater benefit to some in the long run.

We’re only talking about certain cases here – not everyone. An RRSP is still an excellent retirement saving vehicle. I’m just proposing that the old, standard bank line – that income earned when working is always at a higher tax bracket than at retirement, does not apply to everyone. RRSPs used to be the only tax advantaged option.

10. Nancy on March 1, 2015 at 2:44 pm

I am looking forward to Part II. Very few articles discuss how to withdraw from an RRSP/RRIF wisely. I have read about RRSP meltdowns so that all taxes are paid at once but this doesn’t optimize the total tax bill, only reduce the OAS clawback to one year instead of potentially many depending on the minimim RRIF withdrawal rate. Although a nice situation to have – with a defined benefit pension and both CPP and OAS payments it doesn’t take much income to put you over the threshhold for OAS clawback. I would like to see ways of withdrawing from a RRSP/RRIF and avoiding the clawback discussed.

11. John Lawson on March 10, 2015 at 6:37 pm

Why the focus on marginal tax rate in these examples ?— The RRIF withdrawal is not an elective thing like selling a cottage or a stock. The minimum portion is mandatory income. It is not different than pension or CPP. So why are you attributing the person’s MTR to the RRIF. It cause there TOTAL income to be what it was no more or less than any other income they had. The only meaningful tax calculation is TOTAL Tax / Total Income.

12. Bill on March 11, 2015 at 7:07 am

The tax savings from an RRSP contribution is a marginal calculation, so if you want to determine the overall impact of the deposit, and eventual withdrawal, it involves a marginal calculation. (I deposit \$1000 in 1995 and save \$x in tax; then in 2025 I withdraw \$1000 and pay \$y in taxes.)

13. John Lawson on March 11, 2015 at 8:23 am

I agree the deposit is a marginal event. It has to be. You reduce your top line income – no question. The RRIF withdraw is a different calculation. Many people like to “count” their RRIF last and therefore do a marginal calculation. But since the RRIF has a mandatory withdraw schedule — the mandatory minimum is ordinary income in the same way other pensions, CPP, etc. So it makes no sense to count that income last. People that get a company pension don’t look at the margin. So the withdraw is average tax. If you have CPP, small pension, and a RRIF and it adds up to 70K and you pay \$14K in tax — your tax rate is 20%. The margin is irrelevant because you have no choice in taking these incomes. The only marginal calc on a RRIF would be if you are analyzing to take more than the mandatory amount.
Cheers.

14. Bill on March 11, 2015 at 8:44 am

Or, if you wanted to determine whether the tax deferral from a current RRSP deposit would be overwhelmed by the tax payment resulting from a future withdrawal (required or otherwise), and thus decide whether it would make more sense to use a TFSA.

15. Bill on March 11, 2015 at 8:50 am

Just to expand a bit. If you never make a deposit to an RRSP you will never have a RRIF. So currently you can look at future RRIF withdrawals as marginal to your other income. Then use the marginal calculation as a planning tool to decide whether to contribute to an RRSP or how much to deposit.

16. John Lawson on March 11, 2015 at 9:22 am

You could if your goal is to have less after tax income in retirement. This has been modelled extensively by quants that are smarter than me using tools such as RRIF metic. But here is the net of it.
Person A puts 5K in a TFSA
Person B puts 5K in an RRSP and puts \$1650 in a TFSA from the tax reduction. ( 33% of the 5K – typical middle road tax bracket associated with 80K income )
70K income in retirement in Ontario pays 21% tax ( fact – not opinion ). Less than 5% of retirees have that income ( especially after pension splitting ). So the RRSP person has all accumulated gains + original 5K less 21% + the TFSA that represented 33% of the 5K each and every year + growth. Hard to see how the TFSA alone route comes out on top.

17. Bill on March 11, 2015 at 9:47 am

But the cases being considered here (I believe) are not average income Ontario tax payers but rather low income tax payers who, when they make withdrawals from a RRIF, are not only subject to tax, but also lose transfer payments. They could end up in very high ‘implicit’ marginal tax bracket. Now in the case of middle class Ontario tax payers who have lower marginal tax brackets at retirement (possibly due to income splitting) I agree that the RRSP will dominate. On the other hand, if ones marginal tax bracket while working and in retirement are approximately equal, then it’s a toss up (wrt to an RRSP or TFSA). But for some lower income Canadians it is likely that the TFSA will dominate. The ultimate calculations require a knowledge of marginal tax rates and that is why they are important.

18. John Lawson on March 11, 2015 at 11:00 am

Bill,

You are highlighting the challenge with the tax calculation. The slave like devotion to the word “marginal”. The most overused word by Cdn Financial media. The only purpose of marginal calculations is if you are going to do something that is discretionary like sell a family cottage or a stock and incur capital gains. Again — Even with a big RRIF in Ontario — 70K taxable pays 21% — 100K taxable pays 26%. These tax levels are much lower than the tax saved at contribution time.

I will grant you that low income people can lose more than they gain with an RRSP. No personal tax deferral program can compete with “FREE” – I get it. And Rich people will always be in the top bracket — working and retired. For the 90 % of other people – the facts do not support your assertion that their taxes are higher in retirement than when they worked in all but the very exceptional case. Average Family income is higher in working years than retired years ( StatsCan ) Then seniors get the age credit, the pension credit, and pension splitting. In 1985 if you made 26K in Ontario your MTR was 40%. Now in retirement you could make 300K before your tax payable is 40%. Not to mention — how does someone at that income level – get to a 300K income in retirement — the notion is ridiculous — but it highlights how rare higher tax is in retirement.
If you want to suggest that higher taxes in retirement are a common reality please cite some specific realistic examples. Years worked, Income, RRSP contribution, Amount of RRIF at age 70, other income, average tax after all the senior goodies — and lets compare.

19. Bill on March 11, 2015 at 11:31 am

I really don’t think we are disagreeing about much. I don’t think I made the assertion that marginal tax rates are generally higher in retirement. My belief, I presume like yours, is just the reverse. If you look at an earlier discussion I had with the author of this piece you can see that I made exactly the point that the cases highlighted in the article were, in my view, unusual. The author’s response was that she was taking issue with the standard bank line that marginal tax rates are always lower in retirement. So she decided to look at some cases where this wasn’t true. So my subsequent responses to you tended to highlight these less common cases.
By the way on a personal note, I am recently retired from a reasonably well paying job and given my ability to income split, my marginal tax rate will be much lower now. So I guess I fall into the average group.
On a bit of a side note, in my experience the concept of marginal tax is one of the most misunderstood terms by Canadian tax payers. I have no data to back this up, just a feeling from tax discussions with acquaintances.

20. John Lawson on March 11, 2015 at 7:44 pm

Congratulations on your retirement. Enjoy and good luck with it. Always good to debate/discuss these topics to learn new perspectives.

21. John Lawson on March 11, 2015 at 9:05 pm

Also — not sure about the OP’s qualifications — but I have issues with the math.
First off — the 2010 Marginal Tax Ontario for 60K income was 31% — not sure of her contribution – it was not detailed — but Pamela would have had a significant Pension adjustment — so it would be \$10,800 less her PA — perhaps 3K of contribution room. So she saved 31% in tax at contribution time. Later at age 70 — her tax rate on 76K of income is 23.25% — much less than 31% — so not sure why the author thinks she is yielding less?
Also the author is ignoring the Age amount, Pension Amount that would reduce tax payable in retirement that was not available at contribution time. The whole point is lost on me because it is incorrect.
Not that it matters for my point — but the whole example is somewhat fictional. Higher income in retirement are possible but very rare — and in this fixed income yield environment — even more rare. Public sector pensions that pay 70% replacement income are integrated with CPP and pay more before 65 and taper down when CPP is paid — so not sure there is even one municipal employee in Canada that retired with both 70% replacement and a 100% full CPP.

22. Alex on September 1, 2016 at 6:25 pm

Great article! Could you please help me to understand the following: in the Low income retiree example above, if every \$1 of income reduces GIS by 50 cents, should Laura receive GIS of \$9,173 – CPP \$7,327 x 50% = 5,510 only? Not full \$9,173?

• Marti on January 13, 2017 at 7:24 am

The 9173 is not correct, it should be 5388 with the CPP income stated.

23. Marti on January 13, 2017 at 7:22 am

The low income retiree (Lara) who receives CPP – \$7,327 will only get \$449/month or \$5388/year, NOT \$9173.

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