Reaping the greatest benefits when you’re ready to retire
How to prevent high taxes from eating away at savings as you withdraw your money
You’ve spent decades diligently stocking away money into your RRSPs to plan for your retirement; the last thing you want to do is lose large sums of that money to taxation when it comes time to withdraw your funds.
If you want to make sure you are withdrawing your money in the most tax-efficient way possible, it pays to plan ahead and speak with a financial planner at least five years before you plan on retiring. You should develop a multi-year plan that maps out how much money you’ll need and when you’ll need it.
“Say to yourself: ‘In x years from now, I want x dollars unregistered,’ ” says Paul Shelestowsky, CFP, a senior wealth adviser with Meridian. Then work backwards to develop the best way to get the money out of your RRSPs. The ideal scenario is to al- ways put money into an RRSP when you are in a high tax bracket, and take it out when you are in a low tax bracket. If your taxable income dips down one year for any reason, you should take money out of your RRSPs and move it to a nonregistered savings account, ideally a taxfree savings account (TFSA).
“I’m trying to change the thought process of RRSPs last to RRSPs first,” Shelestowsky says. In most cases, it makes sense to start withdrawing your RRSP funds before you actually need the money. “Many people plan to touch their RRSP funds as a last resort, and that is a mistake,” Shelestowsky says. Since your RRSPs are taxed as income, you don’t want to be left needing to take out large yearly sums when you are in your 70s. As soon as your salary starts to decline, you should begin to take out small amounts of money each year, and move it to easily accessible, low-risk savings accounts so that you can access it tax-free when you need the money.
“The most tax efficient way to get money out of your RRSP is when you have no taxable income and you are withdrawing around $10,000 annually,” says Victor Lee, CFA, CPA and member of the CFA Society Toronto. “The RRSP withdrawal would be completely tax-free in this situation.” However, in most situations, it is probably impossible to plan for such a perfect scenario. Best-case scenarios will vary from person to person depending on their current and future expected earnings. The general principle is to reduce your taxable income as much as possible when you need to withdraw.
“Self-employed individuals have a lot more flexibility to plan for this than employees,” Lee says. He also adds that you should keep in mind that taxable income is not the same as income. “For example, income from a tax-free savings account (TFSA) is not counted as taxable income,” says Lee.
If you are close to retirement age and you have a reduced taxable income period, you should take advantage of that and withdraw from your RRSP before your taxable income goes back up when you start getting CPP. For many people, it makes sense to take out $20,000 a year for five years prior to, or early in, their retirement. For example, if you take out $20,000 a year, and are in a 9-percent tax bracket, you’ll owe just under $2,000 in taxes. Your net withdrawal from your RRSP will be $18,000. However, if you take $100,000 all at once, you will owe approximately $25,000. You’ll lose 25 per cent of your money!
The worst thing anyone can do is wait until they turn 71 to start withdrawing their RRSPs. Withdrawals from your RRSP become mandatory when you turn 71 and all funds in an RRSP must be transferred to a regis- tered retirement income fund (RRIF) at this age. Withdrawals from a RRIF are mandatory, resulting in a loss of control of taxable income level by the taxpayer.
“$40,000 is usually where we cap out the recommended yearly withdrawal of funds,” says Shelestowsky. When you are doing your withdrawal plan, ensure that you won’t have to take out more than $40,000 in any given year. And remember that your withdrawal amount shouldn’t be the same from year-to-year. It should always be based on your taxable income so that you can take advantage of years with no to low income and minimize withdrawals in periods with higher income.
Having too much money in your RRSP if you pass away will also cause huge estate-taxation problems, as the whole amount will be taxable in the same year. Plan early and withdraw early, so that you can net the best overall return on investment.