Thursday, September 25, 2014

Changing RRIF Withdrawal Rates

In a recent report Rethinking RRIF Withdrawals, York University Professor Moshe Milevsky makes a strong case for reducing the forced RRIF withdrawal percentages. But what should individual retirees do in the face of a government that won’t reduce the size of these forced withdrawals?

People are living longer and guaranteed returns after inflation are lower than they were years ago when the RRIF withdrawal percentages were set. By leaving the withdrawal percentages too high, the government is encouraging people to overspend in retirement and risk being left with too little to live on in their old age.

Milevsky looked at the other side of this debate as well:
“Of course, defenders of the status quo (and certainly those interested in maximizing tax revenue) might argue that [Required Minimum Distributions] are “red herrings” since retirees are not required to consume the withdrawn funds (but merely to withdraw them from the tax-protected shelter of the registered account).”
It’s true that this argument does not give a good reason to leave withdrawal rates as they are. Too many people do spend their entire RRIF withdrawals not understanding the risks they take. This is a good enough reason to reduce the mandatory percentages.

However, what should individual retirees do if the government won’t act? The answer is that they should determine for themselves their safe spending rate and save any RRIF withdrawals that are above this safe spending level. The fact that retirees can protect themselves in this way does not mean the government shouldn’t act. It just means that in a situation that isn’t ideal, retirees are left to protect themselves by spending less than their entire mandatory RRIF withdrawals.

It’s possible for both sides to be wrong in a debate. The government can be wrong for not reducing forced RRIF withdrawals, and retirees who know better but just throw up their hands and spend their entire withdrawals can be wrong as well. It’s the retirees who don’t understand the risks they are taking who concern me the most.

12 comments:

  1. I suppose if a retirees could automate things and every year do a:

    * Take out the amount Government wants me to take out
    * Deposit X% in Day to Day Savings account
    * Deposit 100-X % in to TFSA account, and let money grow there?

    The problem is you have lost the Tax on the RRIF removal and such, but maybe if someone could create such a system might save a few folks from the money "burning a hole in their pocket"?

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    1. @ Big Cajun Man: You were going to pay the taxes anyway. The real loss is OAS clawbacks for higher earners and future taxes if you don't have enough TFSA room and have to put some money in a taxable account. I wouldn't be surprised if some advisors do automate a process for their clients in the way you describe.

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  2. Hi Mike;
    Your last line says it all "retirees who don't understand"
    It is (supposedly) up to us to educate ourselves. Long gone are the days when we went off to school to "get" educated. We, hopefully, know by now that one plus one equals three (oops! guessed I missed grade one - LOL). So, by putting money in RRSP's we are deferring taxes - not eliminating them. The main concerns that I have seen expressed so far would appear to be with the OAS clawback once the threshold, $71K - NET this year, is reached.
    There are many withdrawal scenarios that can be envisioned to mitigate reaching this threshold. For sure, if you are lucky enough to have stashed away that much, there is a point where you will not be able to avoid the clawback because of the minimun RRIF withdrawal percentages starting at 71 yrs of wisdom - you got through grade one.
    I would presume that if you have a sizeable RRSP that could possibly activate the clawback once withdrawals have commenced you probably would also have a significant amount of non-registered funds as well. Once you have made the decision to retire it would be fairly simple to convert some of your RRSP's, you do not have to convert the full RRSP but can do it in stages, in to a RRIF so as to draw down the RRSP savings without triggering the OAS clawback while utilizing your non-registered funds to complete the funds you require for your lifestyle. Remember, only the dividends or interest received from non-registered funds is taxable and if it is dividends then they are taxed at a lessor rate. You are trying to maintain your "NET" revenue below the clawback threshold.
    So it is a balancing act between your RRSP (RIF) accounts and your taxable savings to try to achieve the balnce needed to stay below the threshold.
    Now if you have something like $2 million in your RRSP you might be advised to invest in Kleenex for all the tears you will shed once the clawbacks kick in. Then you can maek money on th ecapital agins of your shares, which are taxed at a lower rate. For some reason I will not shed any tears for you because I will not reach that level. But I may come close to having to scheme my withdrawals to avoid the clawbacks.
    FYI
    http://www.servicecanada.gc.ca/eng/services/pensions/oas/pension/recovery-tax.shtml#recovery_tax
    https://www.woodgundy.cibc.com/wg/reference-library/topics/retirement-planning/rrsp-maturity-options/rrif-minimal-withdrawal.html

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    1. @Anonymous: It's certainly true that those who are destined to get hit by the OAS clawback may be able to reduce their taxes through strategies that include partially draining RRSPs before turning 65. I've been looking at this for myself, but haven't found what I think is the optimal strategy yet.

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    2. Hi Mike;
      The "optimal" strategy is to think about it before you max out your RRSP's. In some cases, high earning individuals, it may be more tax efficient to put your money in non-registered accounts than in RRSP's. But again, if you are so lucky as to have that $2 million RRSP, I will not be shedding any tears for you.
      Having said all that it again behoves the individual to take their investments in hand and figure out how to invest in the most tax efficient way. TFSA's are a no brainer. Max them out every year. RRSP's? Your present age and retirement date are BIG factors in how to invest. A lot is guestimates on the return of your investments over several years. Obviously a high principal value at the end of your contributions will reflect on your withdrawals. I am jsut at the point of having to scheme my withdrawals so as to avoid the clawback.
      This is a VERY simplified scenario but an individual with $1 million in their RRSP will have to withdraw approx. $71K at 71. If the stock market crashes by, hopefully not, 50% then they only have to withdraw $35K. If their dividends have still held up, they may actaully be ahead of the game with the crash.

      Again, many scenarios not all of which will come true. Excuse me Mike, I am going looking for my crystal ball.

      RIchard

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    3. @Richard: I'm certainly not looking for any sympathy :-)

      In running various scenarios, it's become apparent to me that there is a huge income-splitting advantage to be married during retirement. Another thing I've found is that retiring well before 65 offers huge opportunities to drain RRSPs mostly tax-free and save a lot of tax over the long run. Apparently, the government set up the tax system to encourage me to be married and quit work young :-)

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  3. Interesting ideas throughout, though as a mid-40s guy I haven't really looked into this. The withdrawal rates are clearly unsustainable, though in a way they encourage people not to be overly penny-pinching in retirement, perhaps stimulating the economy.

    I would be concerned about less-informed or demented seniors over-spending though.

    Do you suppose these rules are so focused on high-withdrawals because when they were drafted defined-benefit pensions were more common? You also cited increased longevity which almost certainly plays a key role.

    Thank you for continuing to keep up this entertaining and enlightening blog, Michael.

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    1. @Gene: Thanks for the kind words. Increased longevity is one factor. Another is that the risk-free rate used to be higher. No doubt there were other considerations.

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  4. My Dad is 84 and he is always screaming about this issue. I am planning , to melt down and spend my RRSP and go into those mandatory years without paying that tax. That's the plan anyway, I've heard enough regrets, to not take action for myself. I will tweet out this link, Thanks Michael

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    1. @Peter: A complete RRSP withdrawal is not the best option for most people (but is right for some). I urge you to do some calculations for your specific situation before making a final decision.

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  5. When we get very very close to retirement and/or are in retirement we might develop a drawdown strategy. In the meantime, I expect the rules to keep changing (such as OAS moving to age 67.) I wouldn't even be surprised if they start applying an "asset cap" to qualifying for OAS or for applying a unique tax rate to RRSP withdrawals. They keep saying that there will be too many retired people vs working age people. If so, I'm expecting to see big changes for the worse.

    I'd still rather have too much money saved and worry about taxes than too little and worry about eviction, though.

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    1. @Bet Crooks: Some draw-down strategies only work well if they start well before starting to draw OAS. I agree that rules will keep changing, but I think tinkering with starting ages and reducing benefits in other small ways is more likely than anything that smells like an asset tax. If I believed the government was planning to take my savings to give to people who didn't bother to save, I'd be plotting my escape to the U.S. Giving up half my income is a price I'm willing to pay to live in a society where people don't go hungry, but digging into the other half would be too much to take.

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