Largely because I’m working full time and these are my contribution years, I haven’t put too much thought into making any withdrawals from our Registered Retirement Savings Plans (RRSPs). Enter my parents…
Now both of my parents are fully retired, I’m exploring RRSP withdrawal strategies to learn more what might make sense for them, and for us eventually. Today’s post will provide some insight into my thinking and provide a bias for cashing out the RRSP before my parents are forced to collapse the account.
Is there a best time to withdraw money from an RRSP account?
Yes, I believe so and my response will be provided below. First though, because RRSPs are designed as a tax-deferred growth account and investors receive a tax-credit associated with RRSP contributions, it would seem to make sense to keep money in this account for as long as possible. The rules of the RRSP are constructed to encourage investors to keep investments (e.g. individual stocks, Exchange Traded Funds (ETFs), mutual funds) inside the account until they are forced to collapse it or convert it; in the year investors turn age 71.
Does that really make sense?
Yes and no. I would say no if investors are fortunate enough to have solid pension plan(s) in retirement and are getting modest Canada Pension Plan (CPP) or Old Age Security (OAS) payments.
Why do I feel that way?
RRSPs are a tax-deferred account but you can also think of this as a long-term-government-loan-account. If you’ve been an astute investor over the years, you will have contributed most of your money to an RRSP in your highest income years with the intention of withdrawing money out of it in your lowest income years. This strategy would see you optimize the tax differential benefits provided by this account and defer taxes on the investments that grow within it. For this reason, I think RRSP contributions make little to no sense for low income earners and these individuals are better off maximizing their Tax Free Savings Account (TFSA) and/or paying down any debt.
Conventional thinking on its head
One common approach I hear financial experts write about is using up your non-registered money first and leaving RRSP withdrawals until the end. For some investors this makes no sense. If some investors wait to convert their hearty RRSP accounts into Registered Retirement Income Funds (RRIFs), based on RRIF minimum withdrawal requirements, they’ll pay more tax. In the first year RRSPs must be collapsed or converted, my parents would be forced to withdraw close to 7.5% from the RRIF. The RRIF withdrawals would only get higher from there. This approach is almost assured to push my parents into a higher tax bracket. I think as a senior that’s the last thing you want. As far as other RRSP conversion options go, I’m not convinced an annuity is a good idea based for them on their secure pension plans and there is no clear need for additional fixed income now. Maybe in their 70s, things will change.
Are there any next steps?
It’s going to take me more time to think through all the options for them but my parents are likely to start tapping into their RRSPs before age 71. The math seems to suggest small annual RRSP withdrawals (over the next few years) are an excellent way to wind down their RRSP account. After withholding taxes are paid, money that is left over should find a good home in a self-directed Tax Free Savings Account (TFSA) for them. Using the self-directed TFSA, investments my parents choose inside this account can grow tax-free and any withdrawals made from the TFSA will not be subject to government income-tested programs like their Old Age Security (OAS) payments.
What’s your take on cashing out RRSPs – hold ‘em until you’re forced to fold ‘em? Withdraw from them before age 71? I’d like to hear from you if you’re in a similar situation.