An industry colleague and I were talking the other day about registered retirement income funds (I know, we aren’t the most exciting people) and he suggested the government should just remove RRIF minimum withdrawals entirely. The comment was like a lightning bolt to me. It is such a straightforward thought and, in my mind, makes a lot of sense.
What fascinates me is that seniors would love to see this change, because it would likely lower their tax bill in the short term. Our firm will quite often tell people to draw more down than the minimum, and we like to take a lifetime approach to taxes. Either way, let’s look at this idea from both the government and individual’s perspectives to see if it is something that could really work.
In 2015, the federal budget lowered the amount that had to be withdrawn from a RRIF each year starting after you turn 71. This was a pretty major change, lowering the minimum withdrawal at age 71 to 5.28 per cent from 7.38 per cent. The change was viewed as a big win by seniors’ advocacy groups, and likely resulted in a meaningful decline in taxable income for many seniors — at least in the short term.
In 2019, the federal budget announced a new advanced life deferred annuity under certain registered plans, which is an annuity that can be purchased from within an RRSP or RRIF, and where the payments can be deferred until age 85. Again, the goal was to help seniors find another way to defer, somewhat, drawing out their RRIF assets each year.
My view is that the government should stop tiptoeing around and just eliminate the minimum withdrawal altogether.
Overall, I believe the federal and provincial governments would collect more in tax dollars if they allowed seniors to draw out as little or as much as they wanted each year from their RRIFs. The reason is that if someone leaves as much money as possible in their RRIF, it still ultimately gets taxed when the person dies (or when the surviving spouse dies). If there is a sizeable amount in the account upon death, the entire amount is taxed as income in the final tax return, likely at a higher tax rate.
Let’s say someone has an average taxable income of $60,000 a year in retirement including their RRIF withdrawal. Their average tax rate in Ontario would be 18.4 per cent. If they had $250,000 in a RRIF when they die and another $40,000 of income in the final year, they will have an average tax bill on that large amount of 40.5 per cent, which will include a portion of the income taxed at 53.5 per cent.
Using a different example, and using a marginal tax perspective, let’s say someone drew out $15,000 a year at a 29.65-per-cent marginal tax rate for 18 years. The total withdrawal would be $270,000 and the taxes would be $80,055. If, instead, they drew out nothing for 18 years but upon death they had $540,000 of RRIF assets (due to growth and tax sheltering), they are taxed at an average rate of 46.53 per cent (assuming no other income) and about 60 per cent of the amount would be taxed at 53.5 per cent. Using the average rate, the tax bill would be $251,262.
Looking at this from the government’s side, it benefits from a potentially much higher amount of tax collection and gets a big political win from seniors who would appreciate the freedom and flexibility on their RRIF assets. But it would be hurt by collecting a lower tax amount in the short term, until the larger tax bills start to come in over time, and it would pay out a little more Old Age Security (OAS) to those who currently might be clawed back because their income is too high.
Of interest, only about five per cent of seniors are clawed back today and only two per cent lose the entire amount, according to a report from the former Human Resources Development Canada. Some of the five per cent of people would still be clawed back even without RRIF income because their overall income is too high. This shouldn’t be much of an issue for government since it could easily adjust the income numbers for clawbacks in order to not pay out more OAS under a “Freedom of RRIF Withdrawal” scenario.
On the other side, a typical Canadian senior would benefit from the flexibility to manage RRIF withdrawals as they see fit and in a way that may minimize their year-to-year tax bills, the ability to have more tax-sheltered earnings and their funds can grow faster without the near-term tax bills, the possibility of collecting more OAS and feeling more in control over their own money.
They would be hurt by a likely higher lifetime tax bill if they delay too much in drawing out their RRIF until death, and possibly spending less on themselves while they can, in order to lower tax bills.
It is not often that a new rule can be implemented that would be cheered by the electorate and likely lead to higher taxes in the long run. Eliminating RRIF withdrawals minimums could be one of those rare cases.
Reproduced from the National Post newspaper article 28th August 2019.