Monday, June 23, 2014

RRIF Withdrawal Rates do not have to Rule Your Life

A very persistent myth is that retirees are forced to overspend their retirement nest eggs because forced RRIF withdrawals are so high. I get numerous comments to this effect on my articles, and other writers call on the government to reduce forced RRIF withdrawals. There is a simple remedy:

Don’t spend all the RRIF withdrawal that lands in your chequing account.

This story begins with the 4% rule of thumb that many people use for retirement income. The idea is that when you enter retirement, you calculate 4% of your starting savings amount as a withdrawal for the first year. Then you increase this withdrawal by inflation every year. So the 4% amount applies only to your level of savings on day one of your retirement.

There are a number of problems with the 4% rule as I explained in a post on a retirement income strategy. One serious problem is that the original research that led to the 4% rule assumes that you pay no investment fees. I showed that the safe withdrawal rate drops quickly as fees rise.

But whatever spending percentage you settle on as safe for your situation, it’s certainly going to be less than the forced RRIF withdrawal percentages. One thing to keep in mind is that the RRIF withdrawal percentages are based on your portfolio size in the year of the withdrawal. In contrast, the 4% rule is based on your starting portfolio value. However, even taking this into account, the forced RRIF withdrawal percentages will have you drawing down your RRIF faster than the 4% rule would in the vast majority of cases.

It’s at this point that so many people seem to throw their hands up and say the government forces people to draw down their savings too fast leaving them destitute in later life. This is nonsense. Just because money leaves your RRIF doesn’t mean you have to spend it. For example, you could put some of it in your TFSA to spend in a later year when your RRIF payments have shrunk.

It’s unfortunate that the default RRIF percentages are too high for a sustainable retirement income. No doubt many people just spend their RRIF withdrawals without much thought. So, it’s true that the current RRIF withdrawal rules will lead to many people overspending early in retirement. But that doesn’t have to be your fate. Thoughtful retirees can choose their own safe spending levels and save any excess RRIF withdrawals.

All the moaning about high forced RRIF withdrawals would be easier to take if the writers were to point out that people don’t have to spend all the money. It’s sensible enough to call for smaller minimum withdrawals to protect the unwary, but we should also try to educate retirees about how to protect themselves until the government acts.

16 comments:

  1. You are spot on there. When reading these articles I wondered the same. Just because you withdraw the money does not mean that it is gone.

    An easy solution is to use (part of) the withdrawal surplus to contribute to a TFSA. There are a couple of benefits.

    First, any distributions and capital gains from the funds would still enjoy tax-free treatment and could remain invested for as long as you don't need them. Second, you have full flexibility to access them if necessary, still tax-free. Third, there is no upper age limit. Fourth, a TFSA does not affect eligibility for federal income-tested benefits and credits like OAS or the GST credit.

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    1. @Holger: Great points. TFSAs can be very helpful to retirees who don't want to spend their entire RRIF withdrawals.

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  2. Better (from estate's perspective) to draw it out over a period of time, rather than have it deemed disposed (sold) on day of death at max marginal rate.

    I would like to read more about the "use case" of deemed disposed on day of death tax scenario.

    Is it something to worry about? (from estate's perspective. you'll be dead so who cares, but your estate may care)

    What are some potential solutions?

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    1. @Anonymous: This sounds like a good question for Mark Goodfield at The Blunt Bean Counter blog. I'm not a tax expert.

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  3. Hi Mike;
    I have commented onthe 4% withdrawal rate in the past. See https://www.woodgundy.cibc.com/wg/reference-library/topics/retirement-planning/rrsp-maturity-options/rrif-minimal-withdrawal.html
    for mandatory withdrawal rates
    As you mentioned, if you are so lucky as to get more money than you need then there are alternatives to spending it, like contributing to your and your spouse's TFSA's or even re-investing it in to a non-registered inestment account (paying dividends naturally), contributing to charities (a tax deduction), setting up RESP for the grand kids, etc.
    So where WILL your retirment funds come from? Obviously there is the CPP/QPP and OAS. You will have to figure out (or enquire) as to how much CCP/RRQ will pay. It depends on how long and how much you paid in to it as well as how many years you retire before reaching the sage age of 65. And then, do you have a company pension plan? If you do then you may not need to convert your RRSP's to a RRIF or annuity until you are 71 - lucky you if you are in this group.. Then your monies keep accumulating tax "free" until you are obliged to make a conversion at 71 years. However, sooner or later the governments are going to get those RRSP tax deductions back from you. Again, if you are pulling CPP/QPP & OAS and a company pension this could cause a claw back on the OAS some place around $85K of income. Don't cry however, a lot of people would like to have that problem. In fact the vast majority of retirerees will never get anything clawed back so do not plead Woo Is Me. No sympathy from me. But I digress. So you have CPP/QPP and OAS and maybe a company pension. You then really need to figure out just what you want to do in retirement. Big plans. vanilla plans or rocking chair plans? Each of these require different sums of dinaro ($). Do you hope to leave money to the kids, hopefully adults by now, and/or grand kids? Again a different scenario.
    You do not have to convert all of your RRSP(s) in to a RRIF or annuity until 71. SO at 65 you could say figure you need $65K gross (remember you WILL be taxed on this amount) to enjoy the lifestyle you are hoping for and figure out how much a RRIF will pay you to meet your objective when added to the other government, company pay outs you are receiving. See withdrawal rate chart link above.
    If you are so lucky as to have non-registered monies put away then you can choose to deplete them first or use them to top up any "extras" that happen to come along, like another cruise of a roof repair (not so much fun).
    All this to say that you really need to know how much you really need in retirement for what you "wish" to do and then how much and from where you will draw from the sources mentioned above.
    Personnally I have even budgeted to top up my TFSA every year. This is mainly because 1) it is really tax free 2) it can serve as an emergency fund and 3) I can always pull money out in one year for a "special" and re-contribute (hopefully) the next year without disturbing any of the remaining RRSP or RRIF accounts.
    My rant for today.
    Thanks for the article Mike

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    1. @Anonymous: I don't think it's an issue of whether you get more money than you need for your RRIF. If you really need to spend your entire RRIF withdrawal, you're likely in trouble, because the odds are high that those withdrawals will not keep pace with inflation.

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    2. Agreed. If you are spending it all then you will be subject to the law of diminishing returns as time goes by. In that case you had better try revising your plans to suit the revenue. You really need to sit down and at least try to figure out how much you need to live on and then how much you can afford for other things like hobbies, travel etc. The necessities of life come first. Champagne tastes on a beer revenue will not work in retirement.

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  4. "This is nonsense. Just because money leaves your RRIF doesn’t mean you have to spend it. For example, you could put some of it in your TFSA to spend in a later year when your RRIF payments have shrunk."

    I had to laugh when I read that...since I've thought of something similar.

    I think my plan is to convert some RRSP > RRIF in my 50s, spend some money and use any leftover funds not spent to max out the TFSA for tax-free income withdrawals.

    I wonder if all the moaning occurs because folks don't realize there are many options when it comes to using your RRIF, and you don't have to wait until your early 70s to have one, withdrawing 7+% per year.

    Mark

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    1. @Mark: I think most of the moaning comes from the fact that people are used to owning all the money in their accounts. You have to pay taxes on interest, but once you've built up funds in a non-registered account, it's all yours. However, this isn't the case with RRSP/RRIFs. People think of it as their money and don't like paying any taxes on it.

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    2. @MOA
      A whole lot depends on your time horizon for how you decide to utilize your funds. If you have another 15yrs or more of pumping up your TFSA & RRSP's the options for drawing down monies are more numerous. You can even possibly envision not maxing out the RRSP if the amount in there is sufficient to cause a claw back on your OAS. HAving said that, and as I mentioned before, there are one hell of a lot of people who will never even come close to that.
      The whole idea 0f this discussion (trust I am not putting words in your mouth Mike) is to inform people that there are many ways to plan for retirement. Just plugging money in to TFSA's and RRSP's without any ideas of the future uses for it, while not useless, could end up counter productive to what the future retireee seeks to achieve.

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    3. Thanks for the comments.

      I wonder how many folks still don't understand the premise of tax-deferred accounts (RRSPs and RRIFs). At least with my TFSA and non-reg. accounts, the money (and dividend income and distributions from ETFs) is all mine.

      I suspect if I'm close to the OAS clawback, this is a good thing. It means I saved enough money. This will be a good problem to have.

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  5. @Anonymous: It's hard to argue with the idea of examining options and making a sensible choice.

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  6. Have you seen Figure 2 in William B.P. Robson and Alexandre Laurin, "Outliving Our Savings: Registered Retirement Income Funds Rules Need a Big Update", June 2014 ?

    It is similar to your graph. In that paper, the retiree's portfolio contains government bonds of various maturities, and the authors compare results from 1992 and 2014. The expected real return was 5.7 percent in 1992 and only 0.25 percent in 2014.

    The authors warn against the temptation to invest tax-deferred savings in growth oriented assets, with the attendant risk of the required withdrawal occurring during a down market.

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    1. @Anonymous: I hadn't seen this paper -- thanks for the pointer. I'm not opposed to changing the RRIF withdrawal rules, but I found the paper to be overly alarmist. What is at stake is the timing of taxation. They don't mention until page 11 that retirees can save some of their RRIF withdrawals in a TFSA or non-registered account. The rest of the paper gives the impression that retirees are forced into poverty, which they are not.

      The warning against investing for growth in a RRIF is misleading. You can always make the withdrawal in kind and not sell. The issue is whether you are forced to sell stocks when they are down because you need money to live on. This problem exists whether your savings are tax-deferred or not.

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  7. What if you have dividend paying stocks in the RRSP and don't want to have to sell them when it comes to withdraw them? Would you have to swap cash for the investment and then withdraw the cash and pay tax on that? Or could you somehow take the security out, transfer it to a non-registered account and then pay tax on it without having to actually sell it?

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    1. @Anonymous: You can withdraw stocks from an RRSP or RRIF without swapping any cash. The value of the stocks at the time of the withdrawal is added to your income.

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