Retirement expert argues that pushing out RRIF withdrawals can force retirees into paying marginal tax rates as high as 58%
Offsetting RRIF withdrawals is a typical mantra of advisors’ practice. Clients spent their careers building assets in their RRSPs and once they turn 70, they don’t want to see their principal drawn down on a schedule set by parliament. Not to mention, they don’t want to have to sell assets in a down market to make a necessary withdrawal. But, one retirement specialist argues that offsetting RRIF withdrawals and keeping money in those registered accounts all the way through retirement can actually result in much higher tax bills down the road.
Doug Dahmer, CEO of Retirement Navigator, explained that many of his clients are now dealing with huge tax bills as their parents pass on and leave largely untouched RRIF accounts. He argues that investors and advisors focus so much on tax-free compounding during the accumulation years, that by the time drawdowns come along they don’t want to touch those registered accounts.
“We have this little thing called the old age security clawback, which means too many people in retirement pay more money in taxes than they saved by contributing to their RRSPs,” Dahmer says. “That’s because they waited until the last possible moment and lived in the lap of luxury on low taxes in their early retirement years. But all they’ve done is push their tax problems into the future. So when you have those higher drawdown amounts coming in, let’s assume that you have a 43% marginal tax bracket, and then the clawback comes in for another 15%.
“That’s a 58% marginal tax bracket.”
Dahmer argues that as clients grow more focused on affording their lifestyles for longer, their advisors need to expand their focus beyond the RRIF. He believes that by withdrawing from RRIFs earlier, even before a retiree’s registered accounts automatically convert at the age of 70, the tax burden can be spread out over time, such that when RRIF withdrawals are being made later in life, the marginal tax rate isn’t so high.
Key to that strategy is a mapping of when expenses will rise and fall during retirement. Dahmer believes in a ‘peaks and valleys’ approach to map out when a retiree might need to make a major purchase like a new car, and when they might be able to live a little leaner. During those peak times he argues for taking more money from tax efficient sources of income, and when a retiree needs less cash they can withdraw from places like a RRIF that will come with a higher tax bill. In doing so, they can steadily draw down their RRIF without triggering a higher marginal tax rate.
Dahmer also argues for using RRIFs before clients turn 70, because RRIF withdrawals can help push out a retiree’s CPP start date. If a retiree waits until they turn 70 to start their CPP benefits, they’ll get an additional 8.4%, in addition to an inflation adjustment. If clients expect to live past 85, waiting until they’re 70 makes a great deal more sense in Dahmer’s view.
While the tax case is clear, Dahmer notes that the hardest work an advisor can do is resetting their clients’ attitude towards their registered accounts. Saving is addictive, and a well advised client should have good savings habits. But retirement is what they were saving for, and the time when those savings will begin to get drawn down. Watching an account shrink, even at sustainable rates, is a hard thing for a client to do.
Dahmer’s approach is to talk his clients through what will be drawn down, from where, and what the tax implications will be. He aims to give them a fulsome picture, so they don’t fixate on one number in their account. He prepares them for small course corrections but argues that advisors need to commit themselves to resetting client expectations around those accounts.
“I had a meeting with a couple who stopped and said to me ‘we’re taking THAT much out on an annual basis? This is going to take some getting used to,’” Dahmer says. “They were used to putting in let’s say $20,000 per year into their RRSPS, and now they’re taking $80,000 a year out of their investments. That’s a $100,000 swing, and maybe we need to hire some psychiatrists to help them with that mental shift.”
