By Tom Feigs, CFP®, CET
What do you think when you hear the term RSP? If you are like many people, you probably think: contributions. Certainly the banking industry focus is on RSP sales, because that’s where they make their money. But the point of all this saving is to provide for your future. How you withdraw money from your RSP will have a big impact on your retirement.
In this article we’ll look at how you can create a strategy to ensure you make the best choices for your situation.
Don’t Do Anything Without a Plan
Before you can make decisions regarding RSP withdrawals, you need to create as clear a picture as possible of your retirement income and expenses. You can do this on your own, but it can be daunting. You may want to consider working with a professional.
If you have registered and non-registered accounts, you may have seen conflicting information about where it is best to withdraw from first. It used to be accepted wisdom to defer RSP/RIF withdrawals as long as possible, but now balanced withdrawals from various accounts is often recommended. With a better understanding of your needs, creating a withdrawal game plan becomes more achievable.
But before we get to an ‘exit strategy’ for your RSP funds, let’s have a closer look at the basics.
The government requires you to decide about your RSP no later than December 31 of the year you turn 71. There are currently four options to choose from:
Cash out the RSP – This is rarely the best option as the entire amount is taxable the year you withdraw it.
Life Annuity – With this option your RSP is rolled into a life annuity with an insurance company and they pay you a fixed “pension” for the rest of your life. After your death there are no beneficiaries of the pension. There are many annuity options, such as reduction factors and indexing, that you would want to discuss with your insurance agent if you choose this path.
Term Annuity to age 90 – This option runs on the same principles as the life annuity except that the payments stop when you reach 90. The benefit is that you can name a beneficiary to receive the remaining payments should you die before reaching age 90.
RIF – a RIF is a Retirement Income Fund—it’s the most common choice for converting an RSP. Of all the choices, it is the one with the most flexibility for your funds. It allows you to decide how frequently you take funds and how much you take. Withdrawals must begin at age 72 (or when the younger of you or your spouse turns 72). There are minimum withdrawal requirements based on a percentage formula, but there is no maximum limit unless you have a locked in RIF.
You could also choose a joint approach by converting part of your RSP to a RIF and part into an annuity. That option gives you the flexibility to invest, while still maintaining some guaranteed income. What’s important to remember is that while you must convert your RSP by age 71, you can begin drawing on your RSP well before then. In fact, depending on your circumstances, that may be a sound idea.
Let’s look at what has been the more common approach towards RSP withdrawal, and a new, more balanced option that is gaining favour for its potential tax savings.
The Common Approach
For a long time it was common advice to defer taking money from your RSP for as long as possible. But that approach reflects a time when it was likely that your retirement income would be significantly less than your working income, which would mean that RSP or RIF withdrawals would be made at a lower tax rate.
Today retirement often looks very different. Multiple savings vehicles, pensions, government benefits, and many seniors continuing to work in some capacity, have increased the possibility of being in a higher tax bracket after retirement. Or it may be that the withdrawal minimums you’re required to take after age 72—push your income to the next tax bracket. Your first required RIF annual withdrawal is 5.28%, which can be a significant amount of money depending on your assets.
The best approach for you, will likely come down to minimizing taxes, which is why it’s crucial to understand your entire financial picture. Many advisors now suggest withdrawing funds earlier than the mandatory age.
A More Balanced Approach
Starting to manage your retirement income before the government requires that you do, puts you in the driver’s seat. Waiting to withdraw your money until you need it—may be more costly than prudent.
If you anticipate being in a relatively high tax bracket in your later years, it may make sense to withdraw money from your RSP before you are required. The money can still be put aside for the future in a Tax Free Savings Account (TFSA) if you have contribution room, or in a non-registered investment, if the funds are not required in the short term.
What About TFSAs?
TFSAs have tax-shielding benefits without the withdrawal minimums of a RIF, which make them a great ongoing savings vehicle even in retirement. When deciding where to draw funds, it usually makes sense to look to your non-registered investments before a TFSA, as the growth is taxable—growth in a TFSA is by definition tax free. If you won’t be hit with too much of a capital gains tax, it can also be advantageous to sell a non-registered investment and contribute the funds to your TFSA if you have the room.
It Comes Down to Your Circumstances
As you can see, there is a lot to consider when deciding how to parse out your retirement income. And while there are some general principles, understanding your personal situation is what’s most important. Working with a retirement specialist can help you evaluate what strategy will serve you best. You work hard for your retirement savings; you deserve to maximize the results.
We hope this article has been helpful and provided some practical advice on how you can improve your financial well-being. If you need additional support, please contact one of our Money Coaches today.