Latest from Michelle Connolly

If your clients are receiving RRIF, or if they turned 71 in 2015, you should consider:

• how much RRIF income they should generate;
• whether they should they repay excess 2015 RRIF payments received prior to the reduction in RRIF minimum amounts; and
• whether they should take the minimum RRIF amount annually, or perhaps average their RRIF payments over 30 years.

Let’s examine potential solutions.

## Recent events

In 2015, two things happened to make advisors ponder what RRIF income strategy is best for clients.

1. Lower RRIF withdrawal minimums

On April 21, Canada’s Department of Finance introduced new RRIF minimum amounts to align with Canadians’ longer lifespans and to address potential lower returns. For annuitants who received their 2015 annual RRIF minimum payments prior to the reduction, they can re-contribute the difference by February 29, 2016. More information is available on the CRA website.

2. Changes in personal tax rates

In early December, Minister of Finance Bill Morneau announced new federal personal tax rates, effective as of January 1, 2016.

When the top federal personal tax rate of 33% is added to respective provincial tax rates, the combined personal tax rates for each province for \$1 of RRIF income earned in excess of \$200,000 are:

Province Tax Rate
BC 47.70%
AB 48.00%
SK 48.00%
MB 50.40%
ON 53.53%
QB 53.31%
NB 58.75%
NS 54.00%
PEI 51.37%
NL 48.30%
YT 48.00%
NT 47.05%
NU 44.5%

## 2015 reduced RRIF minimum – to repay or not?

When considering the potential 2015 RRIF minimum repayment, would most clients benefit from the reduced RRIF minimum rates? Yes, if the client does not need the extra RRIF funds to cover lifestyle spending. All other things being equal, clients reporting taxable income in 2015 between \$45,282 and \$90,563 should repay and withdraw those funds again in 2016. Why? They will pay 1.5% less tax on RRIF income in 2016 than in 2015.

Read: New RRIF rules have GMWB implications

## Impact of 2016 top federal rate of 33%

Given the new 33% federal tax rate on taxable income in excess of \$200,000 and increased provincial personal tax rates implemented over the last three years, there is a chance that upon the death of a RRIF annuitant (or the survivor of a couple), RRIF assets will trigger a substantial terminal personal tax liability. So should clients withdraw the new RRIF annual minimum, minimizing income tax while they are alive, or should they average the FMV of the RRIF over their projected lifetime to try to avoid a potential terminal tax rate of 50%, or higher that will be triggered when collapsing the RRIF upon death?

For instance, if a widower passes away in Nova Scotia with a RRIF of \$300,000, all or a portion of his RRIF will attract a combined personal tax rate of 54%.

## Case Study

Let’s consider the following RRIF scenario:

• Widower, age 65, has a RRIF with FMV of \$800,000.
• The RRIF is generating realized returns of 4% and unrealized returns of 2%.
• He requires \$30,000 in after-tax RRIF income annually.
• His life expectancy is 30 years, to age 95.
• His annual TFSA contribution is included in his above after-tax income requirements, so any after-tax RRIF income excess would be invested in a non-registered account.
• For comparison purposes, average tax rates while alive are 25% or 40%, and the terminal tax rate is 50%.

Should this widower take the RRIF minimum annually? Or, should he take \$55,800 per year, which would liquidate the RRIF over 30 years given the aforementioned returns?

Here are some numbers to consider:

At the end of 15 years RRIF minimum withdrawn @ 25% average tax rate while alive; 50% tax rate at death Withdraw \$55,800/year @ 25% average tax rate while alive; 50% tax rate at death RRIF minimum withdrawn @ 40% average tax rate while alive; 50% tax rate at death Withdraw \$55,800/year @ 40% average tax rate while alive; 50% tax rate at death
After-tax RRIF income – cumulative \$515,000 \$627,000 \$412,000 \$502,000
After-tax income of non-registered account – cumulative \$11,000 \$51,000 \$1,000 \$12,000
Total after-tax income \$526,000 \$678,000 \$413,000 \$514,000
Death – after-tax proceeds of RRIF and non-registered accounts \$529,000 \$543,000 \$447,000 \$361,000
Total after-tax RRIF receipts \$1,055,000 \$1,221,000 \$860,000 \$875,000
At the end of 30 years RRIF minimum withdrawn @ 25% average tax rate while alive; 50% tax rate at death Withdraw \$55,800/year @ 25% average tax rate while alive; 50% tax rate at death RRIF minimum withdrawn @ 40% average tax rate while alive; 50% tax rate at death Withdraw \$55,800/year @ 40% average tax rate while alive; 50% tax rate at death
After-tax RRIF income – cumulative \$1,385,000 \$1,297,000 \$1,108,000 \$1,038,000
After-tax income of non-registered account – cumulative \$181,000 \$295,000 \$48,000 \$66,000
Total after-tax income \$1,566,000 \$1,592,000 \$1,156,000 \$1,103,000
Death – after-tax proceeds of RRIF and non-registered accounts \$911,000 \$809,000 \$477,000 \$211,000
Total after-tax RRIF receipts \$2,477,000 \$2,401,000 \$1,633,000 \$1,315,000

Points to consider:

• The RRIF minimum will not cover lifestyle needs of \$30,000/year for the first four years when the widower’s personal tax rate is 25%, and for 10 years when 40%.
• In terms of collective after-tax income received from the RRIF and non-registered accounts, the RRIF duration and the widower’s average tax rate while alive had an impact.
• 25% average tax rate while alive: Taking \$55,800 per year generated greater after-tax income than taking the RRIF minimum throughout the 30 years. The differential between \$55,800 and taking the annual RRIF minimum increased annually up until year 18, when the maximum cumulative difference was \$156,427. However, subsequent to year 18, the differential diminished each year likely due to cumulative increased personal tax liabilities associated with the average tax withdrawal and realized returns earned in the non-registered account versus in the RRIF.
• 40% average tax rate while alive: Taking \$55,800 resulted in greater cumulative after-tax income up until year 15; subsequent to year 15 but prior to year 29, the differential diminished each year. Then, in year 29, the cumulative after-tax income was in fact greater if the widower had taken the RRIF minimum each year.
• In terms of after-tax liquidation values at death from both the RRIF and non-registered accounts, again time had an impact, particularly when the widower’s average tax rate while alive was comparable to his terminal rate. The tax savings from only taking the RRIF minimum and earning income in the RRIF tightened any differentials. In three of the four situations presented above, greater after-tax proceeds were received when the RRIF minimum was taken.

## Conclusion

While Finance’s 2015 announcement regarding reduced RRIF minimums generated much fanfare, taking the new RRIF minimum payments may not be in your clients’ best interests, particularly when their average tax rates are less than 40% while alive and they’ve accumulated significant RRIF assets. For some Canadians, taking the reduced RRIF minimums will attract a lower tax rate while alive; however, there is a real potential that upon death, the liquidation of RRIF assets will trigger a more substantial tax liability – meaning they will receive less after-tax income overall and lower liquidation values from their RRIF accounts.

Read: Keep the claws off OAS

When discussing with your clients whether they should take the new RRIF minimum, an average amount, or perhaps an even greater amount, factors to consider include:

• estimating the duration of the RRIF;
• personal tax rates of the annuitant(s) while drawing RRIF income;
• their estimated terminal personal tax rate;
• the anticipated rates of return for the RRIF and non-registered accounts; and,
• after-tax income required to support retirement lifestyle needs.

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Michelle Connolly, CPA, CA, CFP, TEP, is vice-president, Tax, Retirement and Estate Planning at CI Investments. MConnolly@ci.com