What happens when you take money out of a Registered Retirement Savings Plan (RRSP)?
Not really a skill testing question, but one that most people don’t think about much. Most of us are more interested in what the government giveth in the spring in the form of a tax refund, then what it’s going to taketh decades from now.
But all good things come to an end and the tax avoided in an RRSP starts coming due a few years into retirement. There’s a growing consensus that the rules governing all this are no longer fair and actually hurt the people they are supposed to help.
When you turn 71 you must convert your RRSP into a Registered Retirement Income Fund (RRIF), a vehicle that allows Ottawa to get all those tax refunds back. You can cash out your RRSP and take it as a lump sum, keep the same investments, or convert your RRSP into an annuity that pays a monthly amount for life. All of the options involve paying tax.
If you choose the second or third option, there are strict requirements about how much you have to take out of your RRIF each year. The minimum annual withdrawal is 7.38 per cent in the first year, rising each year to 20 per cent a year at age 94 and beyond.
For example, if you have $100,000 in an RRSP converted to a RRIF, in the first year $7,380 comes out, leaving a balance of $92,620. In Year 2, the rate goes up a bit to 7.49 per cent, so $6,937 comes out, leaving a balance of $85,683. And so on. (The rates are available online by searching “RRIF tables.”)
As the federal government starts preparing its spring budget, one pitch it has received is to revisit RRIF limits. The rules are almost a quarter of a century old. We’re living longer and rates of returns on investments are much lower than they were. You want to have enough money to live on, but not outlive your savings.
“The problem is that we’re forcing people to take out too much soon,” says Clay Gillespie, managing director of Rogers Group Financial in Vancouver. “So, as you get older you end up taking a bigger portion of a smaller pie.”
Gillespie is on the board of Conference for Advanced Life Underwriting (CALU) and was in Ottawa recently making a proposal to the Commons Finance Committee.
With a federal election next fall and a budget surplus on hand, the expectation is that the Harper Conservatives will be handing out tax breaks. Changes to the RRIF rules would be easy because the government still gets the tax, it would just be delayed.
“The reception was quite positive,” Gillespie said.
The Life Underwriters group offers several ways to go and doesn’t have a preferred solution.
The easiest would be to delay the start date of the required withdrawals from 71 to say 73 and extend them to 95 or 100.
The required rate of withdrawal could also change. Or there could be a formula that smoothes out ups and downs in investment returns with an average withdrawal.
The C.D. Howe Institute argued in a paper this spring that the age limits should be increased and required withdrawals reduced.
“Governments impatient for revenue should not force Canadians to run their assets down prematurely,” authors Bill Robson and Alexandre Laurin wrote. “Reforming the rules for RRIFs and similar accounts would help retirees enjoy the post-retirement security they are striving to achieve.”
Gillespie says the timing is good for a change. Pension and retirement issues are in the news and the cost of the changes is minor. For Ottawa, it’s a question of when they get their money back, not if.
“There’s (political) mileage in this, so if they want to change, now is a good time,” Gillespie says.
It’s hard not to agree with that.