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Tips for Efficiently Managing RRIF Withdrawals and Avoiding Hefty Penalties

Registered Retirement Savings Plans (RRSPs) eventually have to be taxed as income once withdrawn. Often, after conversion into a Registered Retirement Income Fund (RRIF), a specific percentage must be withdrawn each year. Financial planners have various strategies to reduce taxes on RRIF withdrawals, especially when retired clients seek more income to meet rising costs due to inflation.

A recent example was a physician in his late 60s who was still working. In this situation, we would want him to incorporate his medical practice and retain his earnings within it, while drawing income to pay for living expenses from his RRSP, and later converted to a RRIF. In this case, the physician has reduced his RRSP balance, thereby reducing the income he would eventually take as RRIF withdrawals and building a hefty corporate investment account balance. This strategy gives him more control over how the money exits the corporation and reduces taxes paid on that income. Shifting money out of the RRSP has also reduced projected taxes due on the physician’s estate.

Planning around Old Age Security (OAS) clawbacks is critical when developing a retirement income plan. If clients need to withdraw more than planned from a RRIF at the end of the year, financial planners may advise they borrow from a line of credit to avoid initiating the OAS clawback and then repay the debt with a RRIF withdrawal in January.

Taking full advantage of someone’s marginal tax rate can be a way to reduce taxes on RRIF withdrawals over the long term. Instead of sticking to the minimum, advisors often suggest increasing withdrawals from a RRIF, so clients take out as much as they can at their current marginal rate. This approach is often more tax-efficient than deferring taxes as long as possible, only to pay the highest marginal rate as someone hits higher withdrawal minimums into their 90s or passes away with a large RRIF balance.

Planning for RRIF withdrawals starts when clients start contributing to their RRSPs. Throughout those wealth accumulation years, it’s critical to consider when and how much it makes sense to contribute with an eye toward future withdrawals. Financial planners also aim to smooth out a client’s income over time, which requires conversations about anticipated expenses and tax-triggering events. It’s a dynamic process, and advisors stay connected with clients to know when significant changes occur.

Despite the difficulty markets that appear during economic cycles, the greatest danger for long-term investors is not experiencing financial loss, but rather not having enough. That’s why maintaining a diversified portfolio is essential. While there is no guaranteed solution, there are three straightforward and effective investment strategies that can help.

1. Avoid Extremes

There is a growing number of investors who believe they should focus their portfolios on a few large technology stocks, especially due to their strong performance during the COVID-19 pandemic. This approach can lead to over-concentration, as the thrill of making a correct market prediction can be addictive. However, this method is not sustainable as no stock or sector consistently outperforms the market. At some point, something else will replace the performance of technology stocks, and it is impossible to predict what that will be.

Therefore, it is crucial to maintain diversification, even if it may not seem as rewarding in the short term. This approach ensures stability and reduces the risk of tragedy. For those who still want to take market risks, planners suggest setting up a separate, smaller “fun portfolio” in a self-directed account. This allows investors to experiment with market timing without putting all their assets at risk. By doing this, they can satisfy their urge for risk-taking while ensuring most of their assets are in well-diversified portfolios.

2. Be Wary of Cash

During uncertain times, some investors may be tempted to abandon their investment portfolios and turn to cash. Although the recent global pandemic and mounting geopolitical tensions are understandable reasons for caution, holding too much cash can have negative consequences.

A reliance on cash often creates a vicious cycle, where investors wait for market corrections and miss out on gains. Historically, those who became overly reliant on cash during market downturns in 2000, 2008, or in 2020, missed out on significant growth opportunities. While hindsight makes it seem easy to invest during these times, it’s never clear in the moment.

3. Be Prepared and Avoid Predictions

The art of investing involves more preparation than prediction. It is nearly impossible to predict the future accurately, which is why preparation is crucial. By conducting a “pre-mortem” analysis of their portfolios, investors, with the help of skilled planners, can anticipate potential challenges and develop a plan of action. For instance, if tech stocks were to suddenly drop 25%, investors would know whether to buy more shares or sell their positions, rather than allowing emotions to dictate their decisions. Preparing in advance leads to better outcomes over time.

Strategies and Solutions

The increasing number of seniors who opt to continue working during their retirement years face the challenge of finding ways to minimize their tax burden on multiple sources of income. This includes income from employment, the Canada Pension Plan, Old Age Security, pensions, registered investments, and non-registered investments. The challenge lies in striking a balance between these various sources of income for individuals in their late 60s and early 70s.

Delaying Government Benefits and Optimizing Tax Deductions

Many financial planners suggest that workers in their 60s delay taking their Canada Pension Plan (CPP) and Old Age Security (OAS) until they reach the mandatory age of 70. This not only reduces taxable income, but it provides a larger income later in life. Those who delay CPP to 70 from 65 can receive an extra 8.4% per year for five years, which amounts to up to 42% more. Delaying OAS for five years until the age of 70 results in an extra 7.2% per year, equating to up to 36% more.

Older workers should also consider contributing to their Registered Retirement Savings Plans (RRSPs) until they reach 71, if they have the contribution room, as it will help reduce their taxes, according to Mr. Natale. He reminds workers that they can claim RRSP deductions in future tax years and that even if they are over 71 and cannot contribute to their own RRSP, they can still contribute to their spouse’s RRSP as long as it is before the spouse turns 72 and they have RRSP contribution room.

Income Splitting

Couples who are either married or common-law can also take advantage of different income-splitting opportunities, including pension income splitting, spousal RRSPs, and spousal loans to help lower the overall family tax bill.

With pension income splitting, higher-income-earning spouses can transfer up to 50 per cent of their eligible pension income to their lower-income-earning spouses. That includes income from a registered company pension plan. Spouses can also split income from their registered retirement income fund (RRIF) with their partners, but they need to be 65 or older.

Meanwhile, a spousal RRSP enables couples with varying incomes to save for retirement and split income to reduce taxes. Finally, a spousal loan enables a higher-earning spouse to lend non-registered funds to the lower-earning one at the Canada Revenue Agency’s prescribed rate. The borrower spouse has to pay the interest by Jan. 30 of the following year, each year. The idea is to invest the money loaned and earn a higher return than the prescribed rate, and have the income taxed in the lower-income earner’s hand at a lower rate.

Older couples with a big age difference can also take advantage of rules that enable them to use the younger spouse’s age to determine the older spouse’s minimum RRIF withdrawals. If you don’t need the income, it might be best to take a smaller amount using the younger spouse’s age. Having those lower withdrawals means greater tax deferral, which can lead to less OAS clawback.

Strategies for Investing and Charitable Giving

Investors in their 60s can consider a variety of strategies to reduce taxes on their investment income, such as moving funds to different accounts or making charitable donations. Some planners suggest that investors may want to withdraw from their RRIFs early and transfer the funds to their tax-free savings account (TFSA). Another option is to sell certain assets and realize the capital gains before receiving other retirement income and benefits to avoid a higher tax bill in the future. There is also the possibility of the federal government increasing the tax rate on capital gains, which makes it worth considering for some investors.

In addition, there are tax incentives for those who donate non-registered investments directly to charity, as they do not have to pay taxes on the capital gain and receive a charitable receipt. Contributing to grandchildren’s registered education savings plans or registered disability savings plans may also be an option, as they receive government top-ups, thereby reducing investment income subject to taxes. These strategies can help reduce non-registered assets, as long as the individual is not concerned about outliving their funds.

Exploring Three Strategies for House-Rich, Cash-Poor Retirees to Access the Equity in Their Homes

The steady increase in property values across Canada over the years has offered retirees who own their homes a financial buffer for their retirement. With many individuals having a majority of their assets invested in their homes, retirees with limited savings may consider tapping into their property value through a home-equity line of credit, reverse mortgage, or by selling their home and downsizing or renting. In this article, we will examine the advantages and disadvantages of each of these options in detail.

Sell and Downsize, or Rent

Retiring individuals are increasingly choosing to sell their primary homes and downsize to a smaller house or condominium. The tax-free profit gained from the sale can then be invested to support their retirement goals and desires. Although it may be a challenge to let go of the emotional connection to their former home, it is an option worth considering. On the other hand, some retirees opt to sell their home and rent, which can be a more cost-effective solution. However, this decision also involves leaving behind a long-time residence and may lead to a feeling of being less rooted. Additionally, the uncertainty of losing the rental property to new owners or redevelopment can be stressful for seniors. If choosing to sell and rent, it is important to carefully navigate and manage these potential challenges.

Home Equity Line of Credit (HELOC)

A HELOC is a popular choice for retirees looking to tap into the value of their home to cover expenses. It offers flexibility and a relatively low interest rate. Financial experts suggest getting a maximum HELOC while still working and having a source of income, even if it’s not needed immediately.

A HELOC is a better option for funding retirement needs as it has a lower interest rate compared to a reverse mortgage and you only borrow what is needed. However, having immediate access to funds could be a challenge for those who lack self-discipline and may lead to overspending.

Reverse Mortgages

A reverse mortgage allows homeowners aged 55 or older to borrow against their primary residence without making payments against the loan until it comes due – usually when the owner moves, sells the home, or dies.

Reverse mortgages draw criticism because they typically carry higher interest rates than conventional mortgages or lines of credit, and there are penalties for early repayment, as well as requirements to keep the house in good shape. Still, it’s a good option for some retirees, including those who don’t qualify for a HELOC and it’s a great way to allow you to stay in your home to participate in long-term price appreciation.

A further advantage of the reverse mortgage is the ability to access the equity in a home without regular payments and you have no obligation to repay it, as long as you live in the house,” she says, but also cautions homeowners about the higher interest rate.

2023 Brings in New Federal and Provincial Laws in Canada

With the new year comes a wave of new federal and provincial laws that are expected to affect clients and financial planners alike. As the country navigates through the latest changes, it is important to be aware of the laws and how they will impact one’s financial life. Here is a breakdown of the most significant changes in 2023.

Federal Ban on Foreign Homebuyers

As of January 1st, 2023, a two-year federal ban on foreign homebuyers in Canada has come into effect. The ban is aimed at stabilizing the housing market and ensuring that Canadians have better access to purchasing homes. The new law imposes a $10,000 fine on anyone who is not a Canadian citizen or permanent resident and buys residential property. However, there are exemptions to the ban, including foreign buyers purchasing recreational properties, residential real estate outside of cities with a population of at least 100,000, and certain individuals like international students and refugee claimants. Despite the new law, real estate experts predict that it will have a minimal impact on Canada’s housing affordability issues.

Minimum Wage Increases

In 2023, some provinces will raise their minimum hourly wage, providing a boost to low-wage workers. The following are the changes by province:

Nova Scotia will increase its minimum wage by 70 cents to $14.30 on April 1st and by an additional 35 cents to $14.65 on October 1st.
Manitoba will raise its minimum wage by 65 cents to $14.15 on April 1st and by another $1 to $15 on October 1st.
Saskatchewan will raise its minimum wage to $14 from $13, effective October 1st.
Prince Edward Island raised its minimum wage by 80 cents to $14.50 on January 1st and will increase it by another 50 cents to $15 on October 1st.
Newfoundland and Labrador will increase its minimum wage by 80 cents to $14.50 on April 1st and by another 50 cents to $15 on October 1st.

New CRA Tax Rules

The Canadian Revenue Agency (CRA) has made several updates to its tax rules in 2023, affecting Canadians’ pocketbooks. Here are the key changes to look out for:

Tax Brackets Indexed for Inflation: All five federal income tax brackets have been adjusted by 6.3% to keep up with inflation.
Basic Personal Amount: The Basic Personal Amount (BPA) is the amount Canadians can earn before paying any federal income tax. The BPA has been increased for 2023 to $15,000 from $14,398 in 2022.
TFSA Contribution Limit: The annual contribution limit for tax-free savings accounts has risen to $6,500, up from $6,000 in 2022.
RRSP Contribution Limit: The CRA imposes an annual limit on how much Canadians can deposit into their RRSP account. The limit in 2023 remains 18% of the previous year’s income, with a maximum contribution of $30,780, up from $29,210 in 2022.
CPP and EI Payroll Deductions: Canadians can expect higher Canada Pension Plan (CPP) and Employment Insurance (EI) deductions on their paycheques in 2023. The CPP contribution rate for 2023 is rising to 5.95% and to 11.9% for self-employed Canadians. The estimated maximum contribution is $3,701, up from $3,499 in 2022. The federal EI contribution rate is 1.63%, up to a maximum of $1,002.45.

It is budget time in Ottawa and the federal government decided to leave two critical areas of Canadian tax policy unchanged:

Principal residence exemption still remains
Capital gains inclusion rate will stay at 50%

Below we outline some other key areas of the budget that financial planners will need to be aware of:

Anti-flipping Tax

Profit on sale of residential property held for less that 12 months would be taxed as business income

Canadians who sell a home or rental residential property that they have held for less than 12 months will be considered flipping and will see profits from a sale taxed as business income. The idea is to protect the current and important principal residence exemption for Canadians who use their houses as their homes. Under current rules, the CRA had to prove that your intention was to flip. The CRA no longer has to prove it anymore. Exemptions will apply due to certain life circumstances, such as death, disability, the birth of a child, a new job, or a divorce.

New Home Savings Account

A new measure for first-time home buyers

The Tax-Free First Home Savings Account (FHSA) would allow first time homebuyers to save up to $40,000. Similar to an RRSP, contributions would be tax-deductible and like a TFSA, withdrawals to buy a first home – including investment income – would be non-taxable. Individuals will still be able to withdraw from an RRSP to purchase a home, so they can now take advantage of both options to buy a home. The FHSA will have an $8,000 annual maximum contribution limit, and unused contribution room cannot be carried forward. There is no age limit. If after 15 years, the individual still doesn’t own a home, the funds can be transferred to a RRSP or a RRIF. To open an FHSA, the individual needs to be over the age of 18 and they have not owned a home in the current year or the previous four years.

Better Access to the Small Business Rate

Increasing the level of taxable capital at which business can still access the small business tax rate

The small business tax rate (federal) is 9% on the first $500,000 of taxable income, versus a general corporate tax rate of 15%. This rate is proportionately reduced once a business has taxable capital between $10 million and $15 million. The rate ends completely above $15 million. This has now been changed to $50 million. This will help capital-intensive businesses who are often not eligible for the small business rate. However, many are complaining that the passive income rules still prevent the savings of large reserves in a corporation for future expansion. The small business deduction limit starts to be reduced once investment income passes $50,000 and hits zero at $150,000.

New Minimum Tax on Top Earners

New measure targets the top 0.5% of earners

Tax filers with income above $400,000 – the top 0.5% of earners – make significant use of deductions and tax credits and find ways to have large amounts of their income taxed at lower rates. Canada already has an alternative minimum tax (AMT), but the new approach will be outlined at a later date to ensure that all wealthy Canadians pay their fair share of tax.

The Old Age Security (OAS) pension is a taxable monthly payment from the Canadian Government to eligible seniors over the age of 65.

Eligibility for OAS include the following:

You must be at least 65 years of age.
If living in Canada: You must be a Canadian citizen or legal resident and must have lived in Canada for at least 10 years since you turned 18.
If living outside Canada: You must have been a Canadian citizen or legal resident before you left Canada and must have resided in Canada for at least 20 years since you turned 18.

The current maximum monthly basic OAS payment as of the October to December 2021 quarter is $635.26. When your net income exceeds the income threshold set by the government, the OAS paid to you becomes subject to a clawback (or Recovery Tax as its officially referred to). The income threshold amount is updated every year. OAS clawback results in a reduction of OAS benefits by 15 cents for every $1 above the threshold amount and is essentially an additional 15% tax.

Ways to Minimize the OAS Clawback

Prioritize Your TFSAs
- Income from savings and/or investment in a Tax-Free Savings Account (TFSA) is tax free. Ensuring you maximize your TFSA accounts will allow you to draw income as required without impacting the OAS clawback
Analyze Your Sources of Income
- Income derived from non-registered accounts are treated differently for tax purposes. For example, interest income is fully taxable, while 50% of capital gains are taxable. If your investment income is taxable, then this could push you over the income threshold for OAS
Early RRSP Withdrawal
- If you know that you will have lower periods of income before age 65, consider withdrawing funds before you start your OAS payments. Funds withdrawn from your RRSP can be re-invested in a non-registered account or a TFSA
Defer OAS/CPP
- OAS payments can be deferred until age 70, which increases the monthly benefit amount by 36%. If you are planning to have higher income between the ages of 65 and 70, this will defer any clawbacks
Leverage Your Investing
- If you borrow to invest, the interest paid may be deductible and lower your overall taxable investment income
Realize Capital Gains Early
- If you are planning on making any large sales of property, consider doing this before age 65 ot 70
For Your RRIF, Utilize the Younger Spouse’s Age
- This strategy will lower your annual withdrawal requirements and lower your overall net income for OAS calculations
RRSP Contributions
- You can lower your taxable income by making contributions to your RRSP or your spouse’s RRSP if you are over 71, but they are younger. This will lower your taxable income
Income Splitting
- Splitting of pension and other income such as Registered Retirement Income Funds (RRIF), annuity payments, and CPP pension sharing between spouses can lower individual income for either spouse and help them limit or avoid OAS clawbacks.

Utilizing Life Insurance to make Charitable Donations

Many registered charities, including hospitals and universities, solicit donations of insurance policies from their supporters. The donors get federal and provincial charitable donations tax credit while the organization, which becomes the owner or beneficiary, receives the insured amount assuming, where applicable, premiums continue to be paid.

The federal charitable tax credit is 15% on the first $200 and 33% on any remaining amount. The 33% credit applies only if the individual’s income falls within the highest range of the marginal tax rate. Provincial charitable tax credit rates vary from province to province. These are non-refundable tax credits which reduce tax owed.

Assigning a new insurance policy to a charity

An individual can purchase a life insurance policy for the benefit of a registered charity. In order to obtain a charitable tax credit for the premiums he must assign the policy to the charity, making the charity the owner and beneficiary.

Example:

Heba has been donating $1,000 annually to the alumni fund of the college she attended and receives a tax credit receipt for that amount each year. The president of the college suggested that she consider buying a life insurance policy and assigning it to the college. She agreed and purchased a term-100 life policy with an annual premium of $1,000 and a face amount of $150,000 (Heba is 40 years old and a non-smoker). She assigns the policy to the college and continues to pay the premium for which the university issues a charitable donations tax credit receipt equal to the premium. Assuming Heba does not let the policy lapse, the insurance company will pay $150,000 to the college when she dies.

Assigning an existing policy to a charity

Individuals can donate an existing policy to a registered charity. In such cases the charity can issue a charitable donation tax credit receipt for the cash surrender value (CSV) and additional tax receipts for additional premiums paid. If, however, the cash surrender value (CSV) exceeds the policy’s adjusted cost base (ACB), the policy gain will be taxable as income in the year the policy was donated. In some cases, the fair market value will be used, and the insurer could issue a receipt equivalent to this amount.

Example:

Miguel has a permanent life insurance policy he no longer needs. The market value of the policy is $120,000. He calls the fund-raising office at his local hospital and speaks with the director who informs him that if he assigns the policy to the hospital, he will receive a tax credit receipt for the market value. Furthermore, if he continues to pay the premiums, he will receive tax credit receipts for these.

Naming a charity as beneficiary

A policyholder can name a charity as beneficiary of a policy. However, this may not be the most tax efficient option for the policyholder. First, the charity will not own the policy when this is done (or even know it is the beneficiary) so it cannot issue receipts for the cash surrender value (CSV), if any, or for the premiums paid. It will however issue a receipt to the estate when the policyholder dies, and the benefit is paid.

Example:

Anna reviewed her finances and decided that she no longer needed the benefit from an insurance policy she had purchased decades earlier. She called the issuer who sent her a change of beneficiary form which she completed, changing the beneficiary to a local clinic which is a registered charity. If she continues to pay the premiums to keep the policy in effect and does not change the beneficiary, when she dies the clinic will issue a charitable donation tax receipt to Anna’s estate for the amount of the benefit it receives. Because the charity did not own the policy it could not issue charitable donation tax credit receipts for any of the premiums she paid.

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Leveraging a Life Insurance Policy

Life insurance policies with a cash value component, such as universal life and permanent life policies, can be flexible financial planning tools – for both individuals and businesses. One way to access the cash value during the lifetime of the insured is by taking out a loan from a financial institution, using the policy as collateral. This is called “leveraging” a life insurance policy.

The primary advantage of this approach is that under current tax laws, the loan proceeds can be received tax free. In addition, loan interest may be deductible if the loan proceeds are used to generate income from business or property.

Whether leveraging is used in a personal or business context, the basic structure is the same. At the time of the loan application, the financial institution will issue a line of credit or a loan to the policy owner, taking the insurance policy as collateral through a collateral assignment.

The maximum amount that can be borrowed is based on a specified percentage of the CSV, usually 50 to 90 per cent depending on the investment options chosen by the policy owner. Interest may be paid annually or added to the loan balance, depending on the lender and the terms of the loan. When a financial institution calculates the loan amount, the calculation is designed to ensure that the loan balance never exceeds the maximum allowable percentage of the CSV before the estimated date of death

Upon the death of the insured, the financial institution has first claim on the proceeds of the policy. After the loan is fully repaid, the excess of the death proceeds, if any, will flow to the designated beneficiary, the policy owner, or the estate if there is no designated beneficiary.

Spousal RRSPs are often an overlooked account when in comes to investments or savings for retirement. This is mistake. Spousal RRSPs are one of the most powerful ways that Canadians can achieve income splitting. Let’s dive in.

What are Spousal RRSPs?

A spousal RRSP is similar to a regular RRSP, except that instead of the account being for the beneficiary of the contributor, it is for the benefit of the spouse. The contributor still receives the tax deduction for any contributions made to the account up to their personal CRA limit.

The primary benefits of spousal RRSPs is that a higher earning taxpayer can contribute to the RRSP of the lower income earning spouse or common law partner and claim the tax deduction. When amounts are later withdrawn, they will be taxed at marginal tax rate of lower income spouse.

Pension Splitting Rules

Back in 2007, the government introduced significant tax changes to income splitting rules that allowed retirees the option to allocate up to 50% of their pension income to their spouse on their tax return to help reduce overall taxes. For Canadians that have defined benefit pension plans, this splitting can start at any age once payments from the plan start. For all other pension income (e.g. including RRIF’s and spousal RRIF’s), income splitting can only occur at age 65 or older.

Prior to these new rules, the main way retirees could income split was through spousal RRSPs. Although these changes have cause spousal RRSPs to lose some of their importance, there are still benefits of utilizing them as part of your overall financial plan.

Why spousal RRSPs still make sense?

- - Income splitting before age 65 – if you retire early and need income, you could start withdrawals from the spousal RRSP because RRIF income cannot be split prior to age 65.
  - Leverage the Home Buyers or Lifelong Learning Plans in your spouse’s name to pay for education or the purchase of a home
  - Allows you to continue making RRSP contributions past age 71 if your spouse is under the age of 71. You can continue making contributions on their behalf if you have contribution room
  - They can be used for planned leaves (sabbatical or parental leaves) of absence or low income years. With proper planning you can withdraw from spousal RRSP to pay expenses during periods of low income and pay taxes at the rate of the lower earning spouse
  - For estate planning, you can make contributions after death. In the year of death, you cannot contribute to your own RRSP, but you can still contribute to a spousal RRSP if your spouse is under the age of 71.

Bottom Line

It is important to think ‘outside the box’ when it comes to setting up a spousal RRSP. Some key benefits to remember:

- - It creates an additional emergency fund or liquidity for your family
  - You can access spousal RRSP funds in a way that make sense from a tax perspective
  - It provides you with more flexibility
  - It allows for tax efficient retirement income to start earlier than age 65

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Mastering Your RRIF: Tips to Avoid Costly Withdrawal Penalties

The Importance of Staying Invested

Managing Income for Seniors

Strategies and Solutions

3 Strategies for Accessing Home Equity

2023 Brings in New Federal and Provincial Laws in Canada

Canadian Tax Policy Changes

Ways to Minimize the OAS Clawback

Ways to Minimize the OAS Clawback

Utilizing Life Insurance to make Charitable Donations

Leveraging a Life Insurance Policy

Why Spousal RRSPs Still Make Sense

What are Spousal RRSPs?

Pension Splitting Rules

Why spousal RRSPs still make sense?

Bottom Line

Investing Mistakes to Avoid

Mastering Your RRIF: Tips to Avoid Costly Withdrawal Penalties

The Importance of Staying Invested