—John
Hi John. You are right to raise this because registered retirement income fund (RRIF) withdrawals can cause several unexpected consequences. Higher RRIF income can increase your tax bill, trigger Old Age Security (OAS) recovery tax, reduce income-tested tax credits such as the age amount, and affect certain provincial benefits. It can also lead to CRA instalment payments if not enough tax is paid during the year.
Having to make instalment payments is an inconvenience and/or a surprise for people who have received a paycheque throughout their careers. The reduced value in credits may be modest, but it still reduces after-tax income. The bigger financial hits come from clawbacks, and for those that qualify, reduced provincial benefits.
The problem with the RRIF withdrawals is that the total withdrawn is taxed as ordinary income, like a paycheque. That taxable income is then stacked on top of your other income, which in your case, John, is CPP/QPP, OAS, and your salary. If you are saving or investing in a non-registered account, the interest, dividends, and capital gain earned that year is also added to the mix.
The stacking of all those taxable incomes reduces the benefits and credits that are income-tested. The key is how to minimize tax.
Start with instalments
With some forward thinking you may be able to reduce some of the negative consequences but John, you are in a tough spot. You are working past the age of 71 and you are required to draw the minimum from your RRIF starting at age 72.
Instalment payments are the easiest to deal with. Most people are not aware that financial institutions are not required to withhold tax on the minimum RRIF payment. That does not mean the payment is tax-free; it means you may need to set aside the tax yourself or ask the institution to withhold an amount voluntarily.
So, what does that mean for you? Assume that you have a $1-million RRIF. At age 72 your minimum withdrawal is 5.4% or $54,000. As an illustration, someone in Ontario with $100,000 of other income who must withdraw $54,000 from a RRIF could face roughly $25,000 of additional tax, depending on deductions, credits, and whether OAS recovery tax applies. The challenge or surprise for some people is that they are not aware of this tax until they complete their yearly taxes and they haven’t saved enough to pay the tax.
CRA may require quarterly instalments when your net tax owing is more than $3,000 and the same was true in one of the prior two years. The notice can come as a surprise if your employer previously withheld most of your tax from each paycheque.
If you don’t want to make instalment payments, the easiest solution is to ask your financial institution to withhold tax on the minimum payment. You can set any rate you want but try to coordinate it with your other income so that at the end of the year you are close to not owing tax or receiving a refund. Also, this is not fixed in stone; you can change the amount of tax you want withheld at any time.
How to cut your tax bill
John, I may have some partial solutions for if you are in a common-law relationship or married such as pension splitting, spousal RRSP contributions, and basing minimum RRIF withdrawals on a younger partner.
Pension splitting allows your partner to pay tax on $27,000 of your $54,000 RRIF income, which makes sense if they are in a lower tax bracket. Splitting pension income will also allow you to keep more of your OAS.
You can no longer contribute to your own registered retirement savings plan (RRSP) after December 31 of the year you turn 71. However, if you will still be earning RRSP contribution room and if your spouse or common-law partner is 71 or younger, you may be able to contribute to a spousal RRSP in their name.
In addition, you can base your minimum RRIF withdrawals on a younger partner. For example, the minimum withdrawal at age 67 is 4.35% or $43,500, which is $10,500 less taxable income than what you are required to withdraw.
These are good planning options for couples but not much use if you are single.
Look at the long-term picture
John, I want to be careful here. I have written about the negative tax consequences of RRIF withdrawals. I find there are a lot of people who only focus on the tax and conclude that RRSPs and RRIFs are a bad thing.
