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Best Ways to Invest
RRIF Withdrawals
Don’t fritter funds away.
By Olev Edur
“I know that once I roll my RRSP into a Registered
Retirement Income Fund, I have to start withdrawing
the money each year,” says Richard Archambault,
a retired widower living in Hull, Que. “But I
don’t really need the money to live on at this
point, so what am I supposed to do with it after I withdraw
it? I had kind of hoped to keep it for a rainy day.”
It’s a common question. How can you minimize
taxes and keep as much as possible of your RRIF nest
egg intact after it’s withdrawn from the plan?
In Richard’s case, his pensions and non-registered
savings have been adequate for his present needs. He
had hoped to use the RRIF money to move into a retirement
home maybe eight or 10 years down the road, and perhaps
to leave a little something to his kids. Now he’s
afraid it’s all going to be frittered away on
taxes and non-essentials.
Unfortunately, there is no way to avoid a tax bill
on those RRIF annual withdrawals, which must begin the
year after he opens the plan at age 69. The exact amount
of tax will depend on your marginal tax rate, which
in Richard’s case would be roughly one-third,
since his total income, including the withdrawals, would
be about $40,000 a year. So how can you ensure that
you get maximum mileage out of the remaining two-thirds?
Here are some suggestions on how to proceed:
1. Base withdrawals on spouse’s age. You have
to begin making annual withdrawals from your RRIF the
year after you open the plan, and the minimum amounts
you must withdraw are based on your age at the beginning
of each year. As can be seen from the accompanying table,
the percentage of the plan that must be withdrawn increases
gradually as you grow older, reaching 20 per cent by
age 94.
However, if you have a spouse who is younger, you are
allowed to calculate the minimum withdrawals based on
your spouse’s age instead of your own. This could
enable you to withdraw considerably less each year than
would be the case if you used your own age. For an example
of how this works, see sidebar on page 52.
2. Make RRIF withdrawals near year-end. Since the withdrawn
money will not be needed right away, it will have to
be invested somehow, and the earnings from those investments
will now be taxable. As long as the money remains inside
the RRIF, on the other hand, all earnings will not be
taxed. So it makes sense to defer the switch from non-taxable
to taxable earnings as long as possible.
While financial institutions will offer various types
of regular withdrawal plans – for example, bi-weekly,
monthly or quarterly – you need not opt for these.
Rather, you should simply take the money out as a single
lump sum as close to the year-end as possible. That
way, you maximize your non-taxable earnings for the
year, and minimize the taxable ones.
3. Invest the money right away. Decide how you’re
going to invest the money in advance, and then do so
as soon as you withdraw it, in order that it can begin
working for you right away.
The one exception to this rule would be in the case
of interest-bearing investments with terms of one year
or longer. Since the annual income from these investments
becomes taxable in the calendar year in which each successive
anniversary of the purchase falls, if you reinvest before
year-end, you’ll end up with a tax bill one year
sooner than if you wait until just after year-end.
Say, for example, that you were to invest some money
in GICs or Canada Savings Bonds on December 30, 2005.
The first anniversary would arise on December 30, 2006,
so the 2006 tax return you must complete by April 30,
2007 must include that first year’s interest income.
If, on the other hand, you were to wait until January
2, 2006 to buy the GICs or CSBs, the first anniversary
would be January 2, 2007. As a result, you would not
have to pay tax on the first year’s earnings until
you complete your 2007 tax returns. You would forego
a few days’ interest – probably just a few
pennies at today’s interest rates – but
you gain a full year’s tax deferral.
4. Consider equity-type investments. Your choice of
investments is going to be dictated by your preferences
and your tolerance for risk. If you prefer to avoid
the risks inherent in investing in the stock markets,
then you are going to have interest-bearing investments
both inside and outside your RRIF. One cardinal rule
of financial planning is that if you have both registered
and non-registered investments, you should give preference
to keeping your interest-bearing investments inside
the registered plan, and those earning dividends or
capital gains outside the plan.
The reason for this is that if they are earned inside
a registered plan, dividends and capital gains will
be treated as fully taxable income, just like interest
payments, when withdrawn from the plan. If they are
earned outside a registered plan, however, dividends
and capital gains are taxed at a much lower rate than
interest income.
If you do not need the money for a while – say
five years or longer – and do not have a complete
aversion to the stock markets, then the most tax-efficient
way to arrange your savings is to keep as much as possible
of your equity portfolio outside the RRIF.
There’s another advantage to structuring your
savings in this way: while both interest income and
dividends are subject to tax in the year in which they’re
earned, capital gains are not subject to tax until the
asset generating the gains is sold. As a result, if
you invest in equities outside the RRIF, you may not
need to pay the tax bill for many years.
5. Withdraw the minimum, except: As a general rule,
if you don’t need the money, you want to keep
your annual RRIF withdrawals to the absolute minimum.
There are, however, a few situations where you may want
to withdraw more than the minimum, despite the higher
tax liability.
Sometimes, the yields on investments increase as you
buy larger amounts. You might be able to earn, say,
3 per cent per annum on a particular type of GIC if
you bought $1,800 worth, but buying $2,000 worth might
entitle you to an extra half a percentage point. Too,
some mutual funds have minimum investment levels.
In this situation, it may well be worth withdrawing
that little bit of extra cash in order to get the higher
yield, or to get the mutual fund you want. You should,
however, weigh the tax costs carefully before proceeding.
Another situation where you might want to withdraw
more than the minimum amount is if it enables you to
maximize the use of the $1,000 pension credit that appears
on your annual tax return. Since Old Age Security and
Canada/Quebec Pension Plan benefits do not qualify for
this credit, if you have no other pension income and
your RRIF is relatively small, you may want to withdraw
$1,000 each year even if this is more than the minimum
amount.
The bottom line is that by using these strategies,
you can help ensure that your RRIF savings will last
as long as possible, and minimize the amounts you have
to send to Ottawa each year. And that will translate
into a happier and more secure retirement.
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