Tax Planning – It Doesn’t Stop at 65: The RRSP/RRIF Withdrawal Trap for Seniors

The minute you enter the workforce there is always someone out there, a friend, a loved one, a work colleague telling you that you have to plan for your retirement.  You don’t have a workplace pension to fall back on, so you contact your financial advisor and then your accountant and you do some tax planning so that you can maximize your funds available for retirement.

So, you work and work and work and contribute to your RRSP along the way in accordance with the plan your advisors have designed for you and finally that magic day comes – retirement and you say to yourself, now I can retire in peace and not have to worry about tax planning ever again. 

But you couldn’t be more wrong.  Tax planning is just as important after retirement as it is when you are in your working years.  Without proper tax planning in your retirement years all that hard work and diligent savings could disappear quite quickly.

You worked and saved your entire life and now you want to enjoy it, and you should.  But you need to be wary of the consequences when you tap into retirement savings accounts for such purposes.  Dipping into an RRSP/RRIF account has its downfalls from an income tax and cash flow perspective that you need to consider.

Tax Impact:

When you withdraw funds from your RRSP or excess funds from a RRIF account you are hit with an immediate withholding tax requirement.  Most people withdraw in less than $5,000 increments and are thus subject to only a 10% withholding tax on withdrawal.  But many don’t realize or forget the consequences come tax filing time in April where you could possibly be hit with a tax bill depending on your total income sources for the year.

Example #1

Mr. Smith receives Old Age Security of say $7,000 per year.  Mr. Smith also receives Canada Pension of $11,000 a year.  Assuming no other income, there is no tax liability for Mr. Smith at this point as his income is below his combined federal basic and age tax credits.

Mr. Smith decides to withdraw $5,000 from his RRSP during the year, paying the $500 withholding tax (10%) upon withdrawal and spends the rest believing he has no further taxes owing.

What Mr. Smith doesn’t realize is that this $5,000 withdrawal, which he believed was only going to cost him $500, will actually cost him a further $625 come tax filing time as the additional $5,000 of income puts Mr. Smith over the federal tax credits allowable to him and thus into a 20% tax bracket on the majority of the RRSP withdrawal. 

Mr. Smith then likely will be required to withdraw further funds from his RRSP/RRIF to fund this tax liability and the vicious cycle will continue and repeat itself over and over again.

Cash Flow Impact:

A second unintended impact of withdrawing funds from a RRSP or excess funds from a RRIF hits low income seniors right in the pocketbook.  Low income seniors are required to rely on many government programs out there for income/cash flow such as the Federal Guaranteed Income Supplement, the Federal GST credit, the Ontario Senior Homeowner’s Property Tax Grant and the Ontario Trillium Property tax and sales tax credits. What many people forget is that these credits are geared to income reported on your personal income tax returns and your future entitlements to these credits are affected by past income levels (which would include RRSP/RRIF withdrawals).

Example #2

Ms. Smith receives Old Age Security of say $7,000 per year.  Ms. Smith also receives Canada Pension of $7,500 a year and has no other sources of income, thus making her eligible to receive a non-taxable Guaranteed Income Supplement of $5,500 per year.

Ms. Smith decides to withdraw $5,000 from her RRSP during the year, paying the $500 withholding tax (10%) upon withdrawal.  She does this believing that because her total income is now only $19,500 she will not be greatly affected by this withdrawal and she will receive a refund on her tax return for most of the income tax withheld on the money withdrawn from her RRSP.

However, what Ms. Smith forgot to consider was how this withdrawal will impact the non-taxable amount she receives from the guaranteed income supplement.  Given her income has gone up by $5,000 in the year of withdrawal, the guaranteed income supplement she currently is receiving will be reduced by about $0.50 for every additional dollar of income she reports on her personal income tax return or about $2,500 per year in the year after her RRSP withdrawal.

Ms. Smith then likely will be required to withdraw further funds from her RRSP/RRIF to counteract this reduction in annual income and the vicious cycle will continue and repeat itself over and over again.


So, the question then is are Mr. and Ms. Smith doomed to live in this continuous loop or can something be done about it?  The answer is Something can be done about it!

With the assistance of your accountant, you can decide upon a proper upfront plan in your retirement years with respect to timing of RRSP/RRIF withdrawals.  With an upfront plan, seniors won’t have to continually worry about whether they will be surprised with a tax bill come April or will see a reduction in their future cash flow come July but will know the impact up front and can plan accordingly.

If you are faced with either of the above scenarios contact Jones & O’Connell LLP today to help develop a RRSP/RRIF withdrawal plan so you can keep more of the retirement money that you earned and deserve.

The information presented is only of a general nature, may omit many details and special rules, is current only as of its published date, and accordingly cannot be regarded as legal or tax advice. Please contact our office for more information on this subject and how it pertains to your specific tax or financial situation.

Posted: Wednesday, May 16th, 2018 | Categories: Commentary.

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