I spent some time recently helping a low-income retired couple, the Wilsons, figure out what to do with their RRSPs now that they are on the verge of having to convert them into RRIFs. They know that because they collect the Guaranteed Income Supplement (GIS), the minimum RRIF withdrawals will reduce their GIS benefits. The question is whether there is anything they can do about this.
To protect their privacy, I’m not using the Wilsons’ real names and I won’t reveal their exact incomes or amount of savings. The fact that they collect GIS puts their income into a range, and I’ll reveal that their savings are shy of 6 figures.
I took a detailed look at how RRIF income affects the Wilsons’ finances, and one observation is that this is a complex undertaking. Low-income retirees don’t pay income tax, but they do receive a number of different types of benefits that are income-tested. This means that each dollar of RRIF income can reduce their benefits.
Not only is the GIS clawed back at either 50% or 75%, but GST/HST benefits can be reduced as well. The Wilsons live in Ontario and receive Ontario Trillium Benefits (OTB). Because they pay property taxes, they get the Ontario Senior Homeowners’ Property Tax Grant (OSHPTG). These benefits get reduced as income rises. There can be other types of income-tested benefits as well, but I’ve covered the 4 types that the Wilsons receive.
The default course for the Wilsons is to just take the minimum RRIF withdrawal amount each year. At their income level, the entire withdrawal amount causes their GIS to be clawed back at 50%. So, their net income (income tax return line 236) will rise only 50 cents for each dollar of RRIF income. Their OTB gets clawed back at 4% of this 50 cents, or another 2 cents. At the Wilsons’ income level, GST/HST benefits and the OSHPTG are not affected by minimum RRIF withdrawals. Accounting for all factors, the Wilsons only benefit by 48 cents for each dollar of RRIF income.
Another way to look at this is that only 48% of the Wilsons’ savings is really theirs if they follow the standard path. The remaining 52% will be lost due to reduced benefits. The question now is what can they do about this?
Surprisingly, the right answer may be to withdraw all of the RRSP/RRIF savings. I first looked at what would happen if the Wilsons were to withdraw the entire amount in 2013. This would trigger some income taxes and would completely eliminate their benefits for a year. The total tax bill plus benefits loss works out to 32% of their savings. This is a big blow for a couple who currently don’t pay any income taxes, but it is better than losing 52% with the standard RRIF minimum withdrawal path. Rescuing 20% of their savings is a big deal for the Wilsons.
Another scenario I looked at was to split the RRSP/RRIF withdrawals across 2013 and 2014. This reduced the total tax paid significantly, but creates 2 years of benefits reductions. In this scenario, the benefits don’t quite go to zero for 2 years, but they are almost zero. Totaling the income taxes and two years of benefit reductions works out to 33% of the Wilsons’ savings. So, this scenario is not quite as good as withdrawing the entire amount in 2013. Increasing the number of years of large RRSP/RRIF withdrawals just makes things worse.
As strange as it seems, the Wilsons’ best approach is to withdraw all their savings in 2013. A complication here is what they will do with the withdrawn money. The best answer is to put it in a TFSA. In the Wilsons’ case, once they pay their income taxes and hold back enough money to live on that makes up for the one year of lost benefits, the remaining savings just barely fit into their available TFSA room as of the beginning of 2014. They can even invest the remaining money in exactly the same investments that they had in the RRSP/RRIF.
So the Wilsons’ plan is to make a complete withdrawal near the end of 2013 (but not too close to the year-end that some kind of error would delay it until 2014). The brokerage will withhold 30% of the withdrawn amount for income taxes, but this will be more than the Wilsons will actually owe. Most of the remaining withdrawal will be made “in-kind” and placed in their TFSA. Part of this TFSA contribution will sit in a taxable account for a short time until the Wilsons have more TFSA room at the start of 2014. The Wilsons will take the small amount of the remaining withdrawal in cash. This cash combined with their 2013 tax refund will be used for living expenses to make up for the lost benefits from the middle of 2014 to the middle of 2015.
There are a couple of emotional issues with a complete withdrawal. One is that it just feels wrong to spend a working life building an RRSP and then just collapse it entirely in one shot. Another is that the TFSA account balance will be smaller than the RRSP/RRIF account balance. However, the entire TFSA account balance will belong to the Wilsons. Sticking with a RRIF means that 52% of the RRIF balance belongs to the government.
A caveat here is that I assumed the Wilsons will not earn any significant income in the future. If this is not the case, the entire analysis changes. Another possibility is that government rules for taxes and benefits may change in the future. But this seems like a reasonable chance for the Wilsons to take to save 20% of their money. This analysis was specific to the Wilson’s situation. Your mileage may vary.