FP Answers: What’s the best way to maximize my RRIF money?

by Davies Otwell
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Contrary to popular opinion, drawing extra to minimize high after-death taxes might not make financial sense

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By Julie Cazzin with Allan Norman

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Q: I’ve always believed it’s best to draw down one’s registered retirement income fund (RRIF) or life income fund (LIF) to zero by about age 85 to 90 to minimize the end-of-life tax bill. But I recently wondered what the result would be if I just did the minimum withdrawal each year, let the funds grow tax free and paid the very high tax bill upon the passing of the last surviving spouse.

I was surprised. My numbers showed that the best approach is to just do the minimum withdrawals and pay the higher tax at life’s end. You’ll end up with more after-tax dollars that way. What do your numbers tell you about the two fundamentally different approaches to maximize one’s after-tax position on RRIF/LIFs? — Regards, John in Calgary

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FP Answers: John, a lot of people tell me they want to get their money out of their RRIF before they die. Often, they’ve either had a parent die and the estate paid a huge amount of tax, or they’ve been told they’ll lose 50 per cent of their RRIF to taxes when they die.

While it’s not quite 50 per cent, depending on your province, the maximum lost to tax will range from 40 per cent to 47 per cent. Still, working your whole life to save that much money, only to potentially lose almost half when you die is painful.

People focus on the final tax bill, and I understand why. We’re taxed throughout our lives: on our income, when we purchase goods and services, when we sell a second property, and so on. Tax, tax, tax — it’s everywhere. And then when we die, boom, another 40 per cent to 47 per cent is potentially gone. But is drawing more money than you need from your RRIF to support your lifestyle goals really the right thing to do?

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Drawing extra money from your RRIF, which is a tax shelter available to every working Canadian, means you have to put it somewhere if you’re not spending it. You can add it to a tax-free savings account (TFSA), which is another tax shelter, and in most cases is the usual thing to do if you don’t have non-registered investments available to top up your TFSA. You’re likely better off topping up your TFSA with non-registered money, which is not sheltered from tax, then to take it out of your RRIF.

But what if you have more than enough money to last your lifetime, your TFSA is maximized, you have non-registered investments, and you want to maximize the amount you leave to children? Then the question becomes: will paying a little extra tax today save me tax when I die, thus allowing me to leave more money to my kids?

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Let’s think about this. If you have $10,000 in a RRIF, it will compound tax sheltered until the day you die or draw it out, at which time it’s 100-per-cent taxable. Drawing $10,000 from your RRIF means being taxed at your marginal tax rate. A marginal tax rate of 30 per cent leaves you with $7,000 to invest in a non-registered account. Projecting ahead, $7,000 invested will grow to a smaller amount than $10,000 would.

In addition, you must pay tax on any ongoing earned interest, dividends or capital gains on non-registered investments, and that income may also push you into the next tax bracket or impact government benefits or credits, such as the Old Age Security (OAS) or age credit. Finally, you’ll be paying capital gains tax on the growth of your investments when you die. The taxable amount on capital gains is currently 50 per cent as opposed to 100 per cent on RRIFs.

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Taking those three items into account — a smaller investment, annual taxation and the capital gains tax at death — does it make sense to draw extra from a RRIF and invest it in a non-registered account?

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In most cases, the answer is no. The higher your marginal tax rate is, the less likely it makes sense to draw extra money from your RRIF and invest it in a non-registered account. And the more conservative your investment approach (if you invest for interest or dividend income, say), the less likely it is that drawing extra from your RRIF makes sense.

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Of course, every person’s situation is different, and we need to be careful with generalizations. John, congratulations for doing a preliminary run on the numbers yourself and not being led astray by focusing solely on RRIF taxation at death.

But do me a favour. If you have children, let them know you purposely left money in your RRIF so you could leave them more money. If you don’t, they’ll only see the tax bill and may wonder, why would dad, or his financial planner, do such a dumb thing and leave all that money in a RRIF? Seeing how thoughtful your approach was to your RRIF will leave them confident you got the most for your money — and your estate.

Allan Norman, M.Sc., CFP, CIM, RWM, provides fee-only certified financial planning services through Atlantis Financial Inc.  Allan is also registered as an investment adviser with Aligned Capital Partners Inc. He can be reached at www.atlantisfinancial.ca or alnorman@atlantisfinancial.ca. This commentary is provided as a general source of information and is not intended to be personalized investment advice.

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