Monday, August 26, 2019

Reader Question: Should I Draw Down My RRIF?

Long-time reader, AT, asked the following question (edited to remove personal details):

I’m a single 67-year old living in Alberta. A CGA friend suggests I start drawing extra lump sums from my RRIF to reduce the amount of tax my estate will pay when I die. I'd like a second opinion before I start the withdrawals.

Here are the relevant financial details:
  • RRIF/LIF total assets of about $800,000 with total regular monthly withdrawals of $3780 (before tax)
  • Total of CPP and OAS is $1641 per month (before tax)
  • Part-time work brings in $10,000 to $15,000 annually (assume $12,500 in this analysis)
  • Only $8000 in TFSAs (lots of remaining room)

To start with, I’m not a CGA, and I may be missing pertinent details about AT’s situation. So, the following is for information purposes only. It’s not advice.

AT’s total income works out to $77,552. Coincidentally, this is just slightly below the 2019 OAS clawback threshold of $77,580. So, any extra RRIF withdrawal larger than $28 would trigger a 15% clawback of AT’s OAS payments. This clawback would apply to about the first $50,900 of RRIF withdrawals after which all of the OAS would be gone.

AT’s income puts him in the 30.5% marginal tax bracket in Alberta. Adding the 15% OAS clawback brings this up to 40.925% (note that there is no tax on the clawed back amount as pointed out by reader Farly). The top marginal tax rate in Alberta is 48% on income over $314,928. So, the most AT can save on the first part of his withdrawals would be 7.075%, assuming he ends up in the top marginal rate upon death.

This 7.075% savings is based on the assumption that the assets AT takes out of his RRIF get taxed and the after-tax amount goes into his TFSA to be invested the same way his RRIF assets are invested. Any money that goes into a non-registered account would cause even more taxes; a transfer to a TFSA is the best-case scenario.

Calculating the amount AT could save gets complicated by the fact that withdrawing more puts him into higher marginal tax brackets, but then the OAS clawback goes away. The following chart shows how much AT saves vs. the size of the extra RRIF withdrawal.


At first, AT is saving at 7.075%, but then the Alberta marginal tax rate jumps to 36% and he saves less. Things turn around after the OAS clawback runs out.

The total savings look worthwhile for large withdrawals, but remember that these tax savings are conditional on moving the after-tax proceeds to a TFSA. Assuming AT has about $56,000 worth of TFSA room available, withdrawing an extra $96,700 from the RRIF would give $56,000 after tax to fill the TFSA. The tax savings for this size of extra RRIF withdrawal are only about $5700. But AT couldn’t do this again next year because he wouldn’t have TFSA room available.

What about investing the after-tax RRIF withdrawal in a non-registered account? This would generate annual dividend taxes and capital gains taxes at death. I haven’t run the numbers, but I think these taxes would more than swallow up the savings shown in the chart above.

So, the most AT can save is $5700 at the cost of using up all his TFSA room. Depending on his spending level into the future, it’s possible he’d want to use some of that TFSA room. Overall, there seems to be minimal benefit to making any extra RRIF withdrawals.

One thing that could change this situation is if AT stops working. This would give him some room to make a modest RRIF withdrawal without triggering the OAS clawback.

I’d be pleased to get feedback from AT’s CGA friend. It’s certainly possible there are more moving parts here than I’m aware of. If not, then I don’t see much point in AT making any extra RRIF withdrawals.

4 comments:

  1. The OAS claw back would add a bit less than 15% to the marginal tax rate, since there is no tax on the amount clawed back. In case above the marginal tax rate would be 40.9325 % (.305 + [.15 * .695]).

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    1. @Farly: Good catch! I'll update the post using the correct after-tax clawback amount. The funny thing is that I recently created my own simplified tax calculator. I went back and checked; I did the calculation properly in the calculator, but didn't apply the OAS clawback properly in the first version of this post.

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  2. I see this all the time and it makes me sad. He should NOT have started his CPP and OAS so early. He could have been drawing down his RRSPs all throughout his 60s and getting that money out at a lower tax rate. Now, he's got the tax 'base' of CPP and OAS and will pay for it in higher taxes forever.

    Unfortunately, commission-based advisors want to keep their commissions going as long as possible, so they tell their clients CPP at 60, RRIF at 71.

    So much lost money...

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    1. @Unknown: I haven't looked at AT's situation from this point of view, but I'm very satisfied for my situation that drawing down my RRSPs before age 70 and taking CPP and OAS at 70 is the best way to go.

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