Canadian Finance Blog » RRSP

Don’t Die With Too Much In Your RRSPs

Jim Yih — Tue, 13 Jul 2010 09:00:46 +0000

Have you ever heard people joke around about dying broke or spending your kids inheritance? It may not really be a joke but I can tell you for many people, it’s just not easy to do. The thought of spending your money may sound practical but it is actually very difficult to practice. Why? Because the biggest fear we have is running out of money and spending our money too quickly. We all strive to make our money last as long as possible. As much as we would love to spend our last dollar just before we die, we don’t simply because we never know when we are going to die. If you can give me your date of death, we can plan perfectly.

Spend your RRSPs before you die

If you think about it, the whole point of RRSPs is to enhance your retirement. Isn’t retirement about living the best years of your life? What’s it going to take to make retirement the best years of your life? I would assume it would mean spending some of the money you worked so hard to put away so you can enjoy the golden years.

The tax perspective

Although spending RRSPs for lifestyle makes sense, for many people, the thought behind RRSPs and RRIFs is to defer the income for as long as possible. Deferral is great but to a point. You can convert an RRSP to a RRIF as early as you want but if you have not converted them by the end of the year in which you turn 71, you will be forced to. But consider this . . . if you have not used the money by the time you turn 71, what makes you think you will need the money after 71?

In my experience most people that defer RRSP/RRIF income to age 71, take minimum income, which is the smallest income, possible. This often happens not only because they do not want to pay the tax on the income but also because they probably don’t really need the income either. Although deferring tax to the future can save you money while you are living, it may actually hurt you in the long run especially when you die.

When you die, all of your RRSP becomes taxable at once unless you have a spouse to transfer the RRSPs to. But eventually when the second spouse dies tax becomes inevitable. Dying with your RRSPs is the same as cashing out all your RRSPs at once and if you think about it, most people would not cash out their RRSP at once in fear of paying too much tax.

Critics of RRSPs

Most people understand the benefit of getting a tax deduction at the time of contribution. Most people also get the benefit of saving for retirement and our financial futures. And lastly, we also get the benefit of long-term tax deferral because any growth inside an RRSP is sheltered from tax until we take the money out.

Despite these well known benefits, there is increasing criticism about the RRSPs especially from the already retired group. Most of this criticism stems from the fact that you eventually have to pay the tax when you take the money out of the RRSPs. Many retirees argue that the original deduction was not free. It comes with a price later in life. If that’s the case, then we need to learn how to take advantage of the system in our own favour instead of the governments favour.

The proper use of RRSPs

So the secret to using the RRSP properly is to stream the money out over a long period of time instead of a short period of time because that spreads the repayment of tax out.

The best way to use RRSPs in your favour is to put the money into the RRSP when you are in a higher marginal tax rate and take the money out when you are in a lower marginal tax rate. In doing so, you will win every time. For more details on this check out my recent article on the the proper use of RRSPs.

Develop a withdrawal strategy

If this all makes sense to you then using RRSPs properly requires some planning around a strategy to get the money out of the RRSP. There are 2 great reasons to withdraw money from an RRSP:

1. When can I best use the money to enjoy my retirement? From a health and lifestyle perspective, it is easy to argue that you will enjoy your money the younger you are so sooner is better than later despite the fear of running out too quickly.

2. When is there a tax benefit to taking the money out? Would you be willing to pay tax at a 25% rate if you knew that in the future your tax rate would be 30%? I hope the answer is yes.

Canadians and Procrastination

Guest — Thu, 17 Jun 2010 09:00:40 +0000

Many of the challenges in life can be resolved by the process of time, some are created instead. While the do nothing philosophy can work on certain challenges, investing and saving are not one of them.

It has been my experience that Canadians end up doing themselves a financial disservice at times and can be aided and abetted in this by certain Government actions. Many times the actions are well meaning but can have unintended consequences.

Canada Pension Plan

Early in my career I observed the effect of Canada Pension plan. Surely we all realize the lack of real financial merit with CPP? You would have thought this was readily apparent, yet over the years I have seen client after client use CPP as a fairly central and important aspect of their retirement planning. In denying the reality, they were able to postpone saving in favour of greater current consumption and maintaining priorities that reduced retirement savings.

Registered Retirement Savings Plan

I also noted that Canadians will only tend to act when a deadline approaches. Use it or lose it will cause many of us to act. This could be seen in the long lines of people putting funds in RRSP’s to meet the Feb 28 deadline each year. During this last week of the “RRSP Season” we used to work regularly to midnight to make sure we got the funds in and the tax receipts issued. There were two motivations, one was the tax deduction and the other was that if you did not use the deduction, you lost it. There was no carry forward.

Seeing this problem, a benevolent Government changed the rules. You could carry forward unused deduction room for use in a later year. In my opinion this very action has resulted in further procrastination. We do not lose the deduction and can use it next year, “taking away the pressure or need to act now.” So, as a nation we took comfort in this and have reduced our usage of the RRSP deduction. Gone are the long last minute lineups and the “round 2 it” has taken over.

The kindness of Government has resulted in an unintended consequence, we are saving less. Not a good result. How much RRSP contribution room have you built up? Yet, we tend to applaud Government for their kindness and wisdom in this regard. A little like parents letting the kids have the car with no deadlines or rules.

Tax Free Savings Account

The TFSA (tax free savings account) rules have also been made flexible enough that general procrastination rules here as well. Have you setup your TFSA? I thought so!

Now I am not an advocate of tightening the rules. Personally I have fully utilized both programs and do not need the extra kick in the pants that a deadline would impose. However, I sense this is because I am a financial planner, accountant, and focused saver since I was schooled in the ways of my Scottish Grandmother by her admonitions about taking care of the pennies and the dollars will take care of themselves.

This does not, however, prevent me from lamenting about the general level of non-saving and lack of focus present in the general populace. Relying on future government largesse is the height of financial planning folly but I am at a loss as to how to help Canadians get motivated. Other than writing and speaking aloud in the faint hope that those that really need to read this will get motivated. Not holding my breath.

There are ways to get started almost painlessly, but getting started is the challenge.

Author Bio: Bruce McConnachie is a Portfolio Manager and Investment Advisor with the full-service firm Mackie Research Capital Corporation. With a background in accounting (CGA), financial planning (CFP) and finance and real estate (BCom), Bruce offers hands on guidance and management of portfolios for individual and corporate clients.

Converting An RRSP To A Registered Retirement Income Fund (RRIF)

Tom Drake — Thu, 08 Apr 2010 09:00:31 +0000

If you’ve been saving part of your income in your RRSP, by the time you retire you’ll likely have a comfortable nest egg. While there are tips to reduce your taxes when withdrawing your income, there is something else you’ll want to plan ahead for… the Registered Retirement Income Fund.

You must close out your RRSP by the end to the year of your 71st birthday. Thankfully there is an option to convert your investments into a Registered Retirement Income Fund (RRIF). An RRIF, like an RRSP, in not an investment in itself but simply a tax shelter plan that you can benefit from in your retirement.

Unlike an RRSP, you cannot make new contributions to an RRIF. There is also a minimum amount that must be withdrawn from your RRIF each year. This minimum is calculated as a percentage of your plan’s total value at the beginning of the year. The percentage is based on age, from as low as 4.76% at 69 years old to as much as 20% at age 90. Keep in mind that though the percentage increases each year, and depending on the return of your investments, the total value of your RRIF may have decreased as you draw down from the plan. These factors may even out the actual dollar value of your yearly minimum withdrawal.

While still taxable income, the mandatory minimum withdrawal does not incur any withholding tax at the time it is withdrawn. This will allow you to benefit from the entire amount until tax time, at which point you may owe less than most withholding tax brackets, depending on your tax situation. If you plan to withdraw more than the minimum, taxes will be withheld on that additional amount. Maybe you need less than the minimum amount? While you can’t avoid withdrawing it as income, you could move as much of the unneeded money as possible into your TFSA, up to your contribution limit. The TFSA may become a major part of retirement planning since there is no maximum age limit.

Though the Registered Retirement Income Fund has its restrictions, the RRIF will likely be an important part of your retirement.

New Year’s Resolutions For Your Personal Finances

Tom Drake — Mon, 04 Jan 2010 10:00:19 +0000

While we all hope to have our personal finances in order all year long, a new year can give us a fresh start to change some of the areas that need improvement. This first post of the year should give you some ideas of what you can do to make 2010 the best year yet, for you and your finances!

Did you start a TFSA in 2009? If not, the good news is that you now have up to $10,000 worth of room for investing in a TFSA since you gain another $5,000 each year.

If you’d like to pay off more of your mortgage, try switching to bi-weekly payments or simply increasing the amount you pay each time. Even better, do both if you can!

The start of a new year is a good time to remember to check your credit reports. Once you receive them, you can calculate your credit score and look to improve your credit rating.

When your home or auto insurance term ends, check online for lower premiums and save even more by increasing your deductible.

Have debt to pay down? Try to get your credit card interest rate reduced to make your payments more effective at reducing your principle.

Look for ways to save money. Doing this will free up money to add to your savings. Once you’ve saved in as many ways as you can, you could find more money to save by looking for other sources of income.

Do you get a raise each year? Consider taking that increase and saving it each pay period. Using TD’s e-Series Funds in your RRSP would be a simple way to boost your retirement savings.

Whatever improvements you choose to make, each small change could make a big difference between now and retirement!

Image by koka_sexton

What Is A Locked-In Retirement Account (LIRA)?

Tom Drake — Tue, 24 Nov 2009 10:00:31 +0000

If you are in a registered pension plan with your employer and leave that company, your pension will be transferred into a Locked-In Retirement Account (LIRA). Locked-In Retirement Accounts are sometimes referred to as the more appropriate name of Locked-In Retirement Savings Plans (LRSP).

Image by rpongsaj

LIRAs are similar to an RRSP, but as the name suggests, are locked-in until retirement. Also note that once the plan is converted to a Locked-In Retirement Account, you cannot make further contributions to it.

Once you reach retirement or turn 71 you are required to convert your LIRA to either a life annuity, Life Income Fund (LIF), Locked-In Retirement Income Fund (LRIF) or a Prescribed Registered Retirement Income Fund (PRRIF).

There are some exceptions that might allow you to access the money in your Locked-In Retirement Account before retirement. While the rules can vary from province to province, generally they include reduced life expectancy, unemployment or low income, balances below a certain amount, and those that will become a non-resident of Canada.

While a Locked-In Retirement Account has many restrictions, it could help to protect the pensions of those who change careers a few times throughout their life.

How To Use Spousal RRSPs To Split Retirement Income

Tom Drake — Wed, 23 Sep 2009 09:00:26 +0000

A spousal RRSP is an RRSP that you make contributions to but the plan is registered in your spouse’s name. You get to claim the tax deduction and the income will be withdrawn by your spouse at retirement.

If your and your spouse’s income are about the same, and you both have similar pensions and RRSP savings, then this wouldn’t be of any benefit to your retirement planning. However, if one spouse is in a higher tax bracket or expects a large pension at retirement, it would make sense for that spouse to contribute to a spousal RRSP. As a couple they would receive a larger tax deduction that year and the income at retirement would be more even, keeping both of them in a lower tax bracket for further tax savings and possibly avoiding an OAS clawback.

However, there are some things to keep in mind. The contributions you make to both your RRSP and your spouse’s RRSP must be within your maximum contribution limit, you don’t get to use their limit for your contributions to their plan. If a withdrawal is made within three tax years (two calendar years plus the year of withdrawal) then it would be taxed to the contributor, defeating the point of the plan but providing an option to access the money in an emergency.

Some may be thinking that this is no longer needed now that they can split their pensions. I would suggest that you still look into spousal RRSPs, one of the reasons being that if one spouse is in a higher tax bracket, this also means that investing through a spousal RRSP would give you that higher tax deduction in the current year. Equally important is how future politics could affect your retirement. While the current government brought in pension splitting, there’s no guarantee that future governments 10 to 30 years from now will still allow it. With spousal RRSPs, as soon as you contribute to it that investment immediately belongs to your spouse, making this a form of pension splitting that you can still rely on for your retirement years.

Contribute To RRSP or Pay Down Mortgage?

Tom Drake — Tue, 12 May 2009 11:00:51 +0000

This might be the most asked personal finance question in Canada, should you contribute to an RRSP or pay down your mortgage? Most people would lean towards putting money into an RRSP because of the tax credit and the possibility of a higher return.

When considering the tax benefits of the RRSP option, some people don’t realize the tax savings related to reducing their mortgage principle. Your mortgage payments are made with after-tax dollars. Because of this, you not only save the interest, but the taxes on that interest as well. The other argument for the RRSP was the potentially higher return, but with that return comes risk. Paying down your mortgage has a guaranteed return, equal to the interest and income tax saved.

With the current stock markets and mortgage rates, the arguments either way are magnified. For the pro-RRSP case, stocks are at lower prices, increasing the likelihood of a greater return. For the pro-mortgage side, rates are low, the more you pay on your mortgage principle now, the more interest you’ll save in the future when rates increase.

While you can never be completely sure which choice is best for you, you could do both as a form of diversification. You could contribute to your RRSP and then use the tax credit it provides to pay down your mortgage principle.