Tax rules on RRIFs put retirees at risk
To help protect Canadians from outliving their savings, the federal government needs to revisit its rules governing how money eventually gets removed from RRSPs, according to a recent C.D. Howe Institute report.
Over the years, tax-sheltered RRSP money grows through capital gains, dividends, and interest, but none of that matters when filing your taxes; all withdrawals become regular income that’s taxed at your top rate.
You can defer this tax bite until you turn 71 (it was once 69), when you then have three choices: Cash in the plan and pay taxes in a lump sum; buy a life insurance annuity, which will pay you an annual taxable income for life; or establish a RRIF, which requires paying some tax each year, while still sheltering the remaining balance.
It’s the latter option — which obliges RRIF holders to withdraw annual amounts (dictated by an age-related formula) that rise higher and higher each year — that’s coming under increased scrutiny from pension experts.
In their report, Outliving Our Savings: Registered Retirement Income Funds Rules Need a Big Update(.pdf), authors Alexandre Laurin and William Robson urge the government to revamp the formula for those mandatory withdrawals, which hasn’t changed in 22 years.
Many seniors use this withdrawal formula as the foundation of their budget, assuming it’s a sustainable rate that will slowly liquidate their RRSP savings and provide them with a steady lifetime income.
Except that it isn’t, the C.D. Howe Institute maintains: “The reality is that Canadians are living in a very different environment than they did in the 1990s when these rules were written.”
“The good news is we’re living longer; the bad news is that we’re getting low returns on secure income-yielding investments.”
The result is that many RRIF holders are likely to run their tax-deferred assets down too rapidly, often to their detriment.
When the withdrawal rates were first established, a 71-year-old man would use up only 25 per cent of his RRIF savings upon reaching life expectancy, and a 71-year-old woman just 40 per cent.
The study finds a 71-year-old man can now expect to use up roughly 70 per cent of his RRIF upon reaching his life expectancy. For a 71-year-old woman, that number would be closer to 80 per cent.
This leaves little financial cushion for seniors who are long lived and that, more than anything, is what irks Calgary reader Joanne Doi, whose father died just before his 91st birthday and whose mother is still going strong at 92.
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