Jason Heath: These strategies can help reduce tax, increase retirement income and maximize your estate
During RRSP season, the attention is focused on long-term retirement savings accumulation for young and middle-aged savers. It is not surprising given these are the best clients for banks and investment firms to target — people who will be accumulating investments for many years to come.
Retirement savers in their 60s who are approaching or who have already begun decumulating their savings tend to be ignored this time of year. But there are strategies that people in that age group who still have Registered Retirement Savings Plans should be considering.
Treat CPP like an RRSP
Many people take the wrong approach with their Canada Pension Plan (CPP) retirement pension. For some, CPP is an arbitrary decision. Service Canada mails them an application form prior to their 65th birthday, and they complete the paperwork, sign on the dotted line, and start their pension.
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For others, CPP is an act of spite because they have toiled away in the salt mines for their whole lives, bitterly paying tax along the way. In their minds, after all these years, it is about time the government gives something back to them.
Arbitrary or spiteful CPP decisions ignore the true value of the CPP. To quantify that value, consider that if someone is entitled to the maximum CPP at age 65 in 2019, they would need to have $277,075 in an RRSP earning 4 per cent per year to provide the same income to their life expectancy of age 90. This assumes the CPP rises each year at 2 per cent inflation, and that they earn a flat rate of return each year for their RRSP. Age 90 is the life expectancy for a 65-year old Canadian.
So, CPP may be your $277,075 RRSP account, and when you think of it in those terms, the timing of your CPP “RRSP” withdrawal decision may change. Whether you withdraw from other sources, or start your CPP, you are reducing the future income that you can earn from that source.
For each month you defer the start of your CPP retirement pension after age 65, up to age 70, it increases by 0.7 per cent. That means an increase of 8.4 per cent per year for your payments and given CPP is also adjusted for inflation — call it another 2 per cent annually — that is a 10.4 per cent annual increase to defer after 65.
That does not mean your $277,075 CPP “RRSP” has increased in value by 10.4 per cent if you defer for a year, just that your subsequent payments would increase by that amount. In order to quantify it, an RRSP would need to earn an even higher 4.57 per cent annually from age 65 to age 90 instead of just 4 per cent to provide the same retirement income as a CPP pension deferred to age 70. For a conservative investor, or someone who figures they may well live to 100 and earn an even higher “return” on deferring, CPP deferral can be better than a lot of RRSP investment options.
For an investor with a higher risk tolerance who expects to earn a 6 per cent annual return on their investments, receiving the maximum CPP at age 65 is like having a $226,808 RRSP (assuming 2 per cent inflation and an age 90 life expectancy). Deferring CPP to age 70 for that high-risk investor would be like earning 6.14 per cent return instead of 6 per cent for life, so not much different.
CPP deferral may therefore be less compelling for an investor with a high risk tolerance or a short life expectancy. These examples are over-simplified and ignore factors like a CPP survivor benefit for a spouse, but hopefully reinforce the point that CPP is more like an RRSP than many people realize.
It is not uncommon for a taxpayer’s income to decline in retirement. This is one of the main benefits of an RRSP. That is, to contribute in a high-income year and to withdraw in a lower income year.
In your 60s, if you are still working, your time horizon to take advantage of RRSP tax deductions at a high tax rate may be disappearing.
It is not uncommon for people to have a non-registered company savings plan, a stock savings plan, or other investments they have accumulated outside an RRSP as they approach retirement. This could even include a Tax Free Savings Account.
In the final years before retirement, contributing to an RRSP from other sources like these could be a last chance to use up existing RRSP room, even if you then need to take an RRSP withdrawal the very first year of retirement (likely at a lower tax bracket).
Nobody likes paying tax, and RRSP savers benefit from saving tax as a result of their contributions. Upon retirement, it can seem counterintuitive to then take RRSP withdrawals when you do not need them and intentionally pay tax. Some retirees would rather defer their RRSP withdrawals until 72, or believe they must wait that long, relying instead on non-registered or TFSA savings or their CPP pension to supplement their cash flow in the interim.
Early RRSP withdrawals frequently result in less lifetime tax, higher potential retirement spending, and a larger estate, both in theory and in practice.
In theory, retirement planners can run retirement simulations to compare drawing down from an RRSP early versus deferring to the mandatory withdrawal age of 72. Retirement models often project better scenarios throughout retirement and upon the retiree couple conveniently dying at the same time in eachother’s arms like Romeo and Juliet at age 95.
In practice, things do not always happen as planned. If one spouse requires expensive long-term care, there may be unanticipated expenses that lead to required large RRSP withdrawals over a few years at high tax rates if retirement savings are hoarded in an RRSP.
If one spouse dies young, the survivor will have all pension, investment, and RRSP income taxed in subsequent years on their sole tax return, instead of split over two tax returns for two spouses at a lower tax rate.
If both spouses die young, or have large RRSPs upon the second of their two deaths, as much as 54 per cent of an RRSP can disappear to tax depending on other income sources and the province or territory of residence.
Taking early RRSP withdrawals does not mean you need to spend the withdrawals. They may help preserve non-registered investments or ensure a TFSA can be maximized for as many years as possible.
If an RRSP is converted to a RRIF, the withdrawals can also be split with an eligible spouse after age 65 to reduce family tax payable and can qualify for the $2,000 pension income amount tax credit.
Senior RRSP Season
60-somethings may not get as much attention as younger RRSP savers, but the RRSP deadline should also be a reminder for older Canadians to consider their RRSP options.
Maximizing RRSP contributions, optimizing RRSP withdrawals, and making the right choice with a CPP “RRSP” can help reduce tax, increase retirement income and maximize your estate.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.
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