A recent paper by the C.D. Howe Institute’s William B.P. Robson and Alexandre Laurin (“Outliving Our Savings: Registered Retirement Income Funds Rules Need a Big Update”) suggests mandatory RRIF withdrawal rates are the main cause of premature portfolio depletion. Others have joined the chorus with the goal of convincing the government to lower withdrawals, allowing clients to defer taxes longer. Some even claim these steps will eventually give governments more tax revenue.
These arguments are mistaken: current mandatory withdrawal rates are not, in fact, why retirees are running out of money.
To demonstrate this, we use aftcasting, which relies on actual market history instead of Monte Carlo simulators or average return data. Aftcasting shows the outcome of all historical asset values of all portfolios on the same chart, and it gives a bird’s-eye view of all outcomes for a given scenario. It provides the success and failure statistics with exact historical accuracy because it includes actual historical equity performance, inflation and interest rates, as well as the historical sequencing/correlation of these data sets. For the equity benchmark, we use S&P/TSX historical data since 1919 (earliest available data). For fixed income, we use historical interest on the six-month GIC, plus a premium of 1% as the net yield. This approximates a bond ladder with an average maturity of five to seven years at current yields, with no defaults, capital gains or losses.
Rebalancing occurs annually if the target asset mix deviates by more than 3%. The withdrawal amount is indexed annually to CPI.
We have three hypothetical scenarios. Common to all are:
- $500,000 in the RRSP;
- 40% equity and 60% fixed income;
- Client is 65 years old, just retired and wants the money to last until age 100.
Each scenario is differentiated by unique details.
Scenario 1: Carlos has a lot of other income. He needs only $10,000/year from his RRSP/RRIF.
Scenario 2: Debbie needs $30,000 annually from her RRIF.
Scenario 3: Mark needs $40,000 annually from his RRIF.
Carlos needs $10,000/year, indexed to CPI, from his retirement savings. Until he’s 71, he withdraws this amount from his RRSP. At 71, he converts his RRSP into a RRIF. At age 72, the minimum mandatory withdrawal rate is 7.48% of the portfolio value at the end of the previous calendar year. Now, he is forced to withdraw a lot more than he needs. He pays the income tax and saves or spends the excess RRIF income.
If there were no mandatory minimum withdrawals from his RRIF, Chart 1 below illustrates what would have been the aftcast.
Each of the gray lines represents a specific starting year since 1919. The heavy blue line represents the median portfolio, where half of the gray lines are above it and the other half below. The green line is the lucky outcome—the top 10%. The red line is the unlucky outcome—the bottom 10%.
If the RRIF minimums did not exist, Carlos would accumulate about $4 million, if he’s lucky; about $1 million, if he’s unlucky; and about $3 million if he had the median outcome.
Chart 2 below shows the aftcast under current mandatory RRIF withdrawals. In this case, the RRIF portfolio didn’t deplete during his lifetime. There’s still some money left at age 100.
Bottom line is, if the 65-year old retiree needs less than the sustainable withdrawal rate (which is somewhere between 3% and 3.5% for a 35-year time horizon), indexed to inflation, then the current mandatory RRIF withdrawals do not cause the portfolio to run out of money. Even if he lives beyond age 100, he can save some of the surplus he had throughout retirement for the remaining few years. Removing RRIF minimums would essentially mean working taxpayers would be subsidizing Carlos so he could grow his RRIF to millions tax-free.
Debbie needs $30,000 each year, indexed to CPI, from her RRIF. This means a 6% initial withdrawal rate. The following chart is what we call an income carpet. The horizontal scale represents all starting years between 1919 and 2000. The vertical scale is the age. Each coloured box on the income carpet shows the level of income, received for a given age at a given starting year, as a percentage of total income required in inflation-adjusted dollars. Different colors indicate different ranges of percentages, as indicated in the legend to the right of the chart.
Green is good, red is bad. Blue means mandatory withdrawals are larger than what the retiree needs for that starting year and age. She can either spend the surplus or save it in an open investment account after paying taxes.
Chart 3 (below) shows Debbie’s income carpet as if there were no mandatory withdrawals. With no mandatory withdrawals, Debbie’s portfolio would be totally depleted 28.4% of the time. But since this is a RRIF portfolio, mandatory withdrawals apply. Chart 4 (below) shows the income carpet when those withdrawals are included.
Read: Don’t whiff on RRIFs
With mandatory withdrawals, Debbie’s portfolio would be completely depleted 30% of the time (the red rectangles). In other words, higher-than-sustainable income needs caused a failure rate of 28.4%; the mandatory RRIF withdrawal caused an additional 1.6% failure.
In absolute percentage terms, 95% of the failure was caused by the high withdrawal rate, which can stem from any number of factors, such as insufficient accumulation, rosy assumptions, larger-than-expected portfolio costs/losses, bad planning, or bad investments.
The remaining 5% can be attributed to mandatory RRIF withdrawals. But even if the government totally eliminated mandatory withdrawals, it wouldn’t solve the problem.
Mark needs $40,000/year, indexed to CPI, from his RRIF. This amounts to an 8% initial withdrawal rate. We do an analysis similar to what we did in Scenario 2, and here are the results: If there were no mandatory withdrawals, the portfolio would be depleted 48.2% of the time. With mandatory withdrawals, it would be exactly the same: 48.2%.
In absolute percentage terms, 100% of the failure was caused by a high withdrawal rate, meaning none of it can be blamed on RRIF withdrawal minimums.
Careful analysis shows that supposedly high mandatory RRIF withdrawals have little or no effect on those who need income from RRIFs or who are unlucky with their savings. Still, mandatory withdrawals help recover deferred income taxes from those who get lucky with their investments. Current RRIF minimums are fair, so don’t tinker with them.
by Jim Otar, CFP, M.Eng., a financial planner, market technician and founder of Retirementoptimizer.com Inc.