RRSP withdrawal strategies before age 71
Some time ago I wrote about generating retirement income. We’re doing some income planning now because we feel the process of planning (and re-planning) is important for our financial well-being. Otherwise these will be our retirement defaults years from now:
- Save more
- Work longer
- Spend less
Of course a combination of any three might be required. None of these seem ideal.
To date we’ve decided on a bucket approach to earning income in retirement.
We believe the following is a solid approach to start with (excluding any workplace pension plans and any government benefits):
- Bucket # 1 = cash savings. We intend to keep at least one years’ worth of basic living expenses in cash savings. That is likely somewhere around $50,000. Some of this money will be spent as income flows in from buckets #2 and #3, refilling bucket #1. The $50,000 in savings will also cover some emergencies if they happen without selling assets.
- Bucket #2 = dividend income. Our plan calls for holding up to 30 existing Canadian dividend paying stocks to help us generate income. I figure about $500,000 invested (lofty goal I know….) in such companies should yield at least $20,000 per year in tax efficient dividends (invested in a taxable account) and tax-free dividends (invested inside a TFSA). We also plan to stay invested in about 10 U.S. stocks for dividend income. Those stocks will sit inside our RRSPs – which brings me to bucket #3.
- Bucket #3 = distribution income + RRSP withdrawals. To reduce our “home country bias” we intend to keep our RRSPs full of U.S. stocks and U.S.-listed Exchange Traded Funds (ETFs) that own hundreds if not thousands of stocks from around the world. This means we’ll continue to index most of our RRSP assets for market-like returns. To gain some much needed diversification I will continue to buy and own a couple of low-cost U.S.-listed ETFs for our portfolio.
Over the last few years I feel I’m getting a better handle on how our dividend income from Canadian stocks will help fund part of our retirement expenses. If things stay on a decent trajectory (over the next 10 years), then at the end of that time period income from our Canadian dividend paying stocks should pay for the following as long as we live:
- All home property taxes
- All home utilities
- Any home maintenance and improvements, to a reasonable amount
- All food and households supplies up to $1,000 per month.
That’s pretty good I think from our Canadian portfolio only…
One thing I remain fuzzy on is when we should take money from our RRSPs. Shall we wait until age 71? Do RRSP withdrawal strategies before age 71 make any sense? If so how might this decision fit into our overall plan?
RRSP withdrawal strategies
Conventional financial wisdom has typically informed investors to keep RRSPs intact until age 71, when you’re forced to convert your RRSP into meaningful income. Some financial advisors believe paying tax on your RRSP savings, years before you have to, is a flawed strategy. Doing so you give up years of tax-sheltered compounding power. However tax implications are not always the best reasons for any financial decision – although they can be important ones.
I’m personally not a fan of keeping our RRSP intact until age 71. I’ll come back to that in a bit.
Let’s recall, you have a few choices when killing off your RRSP:
- You can cash it all out
An option but not likely a good one unless you have a small RRSP. This is because of the tax hit associated with this move; a good chunk of your money could go to the government in one swing.
- You can start a RRIF (Registered Retirement Income Fund)
For what it’s worth, this is going to be my option unless someone can convince me otherwise. I can hold the same investments inside my RRIF as my RRSP; those assets can deliver my RRIF minimum withdrawal requirements, and for estate planning purposes I can designate a beneficiary as a successor annuitant. This means my spouse will be able to take over from me and she’ll continue to receive my RRIF payments after I am gone. Additionally, and lots of people don’t think about this, you can start a RRIF long before age 71. You don’t need to be 71. You can also only use a portion of your RRSP to start a RRIF. It’s not an all or nothing deal.
- You can buy an annuity
This is essentially a one-way contract with an insurance company. An annuity provides predetermined payments for the rest of your life. An option, yes, but not for us.
Do RRSP withdrawals before age 71 even make sense?
I believe so.
The future considerations for us in doing so are the following: 1) to smooth out taxes, 2) to use income when we want it most, and 3) to defer inflation-protected pension payments.
Smoothing out taxes
RRSP income can create clawbacks on income-tested programs, such as Old Age Security (OAS). RRSP withdrawals are fully taxable. So, if we combine income from our pensions, government benefits and investment income, we could in the future end up paying more taxes then necessary the longer we defer RRSP assets. Taking out money from our RRSPs, slowly, over time, can help smooth out taxes over time.
Using income when we want it the most
I could be wrong about the future but we’re probably in the best physical and mental shapes of our lives, now. I suspect it will be a different story in our 70s. My wife and I have decided that using the RRSP money, sooner, in our 50s and 60s is better. We believe retirement or semi-retirement will be more than just smoothing out taxes. Using RRSP money before we have to is very much a lifestyle choice. We prefer not to defer our lifestyle any longer than we have to. Life is short. Enjoy it!
Deferring inflation-protected income
We’re lucky and we know it. We have workplace pensions. Most people don’t. The downside (if there is one with pensions) is you’ll need to defer them to gain any meaningful income. Taking our workplace pensions at age 55 comes with major early withdrawal penalties. Even taking our pensions at age 60 comes with reduced payments. At age 65, there are no penalties involved. Same goes for Canada Pension Plan (CPP) and Old Age Security (OAS) – the longer you wait to take these benefits the more income you’ll earn.
Government benefit examples – deferral to age 70.
CPP benefits increase by 0.7% per month up to age 70. This means delaying CPP from age 65 to age 70 will yield another 42% in benefits. This could mean close to $1,000 per month for most individuals who have contributed to the plan throughout their career.
OAS benefits increase by 0.6% per month up to age 70. This means delays to OAS income from age 65 to age 70 will yield another 36% in income. That income could be close to another $1,000 per month for many Canadians.
Between those two government benefits, this is not trivial income.
Now, deferral of pensions and government benefits have big risks. First of all you need income to supplement what you are deferring. Second, you need some assurance of longevity (otherwise, why bother deferring money if you die young?). Third and just as importantly, you need to consider how investing losses with your personal assets may kill your deferral plans. All plans seem great when markets are good. Plans also need to protect you when markets are bad (and stay bad). Deferring our inflation-protected fixed income sounds like a good idea but we’ll need to ensure our personal assets are more than enough to bridge the gap.
The good news is personal finance is personal. You can learn about other strategies people are writing about or taking to tailor your financial plan. Hopefully this blogpost has helped you consider some things…you can let me know in a comment of course. (I read everything on this site.)
Given the ability to smooth out taxes over time, use the money we’ve saved when we’ll most enjoy it, and to defer workplace and government pension benefits to optimize their benefits – we’re intending to withdraw money from our RRSPs for income before age 71. That’s the plan but plans are always subject to change.
For those planning for retirement, near retirement or in retirement – what factors did you consider for RRSP withdrawals before age 71?