15 May You, Me and RRSPs
We just finished tax season and I am currently consumed with the issue of RRSPs. I am consumed – and you should be interested – because I reviewed hundreds of returns over the past month. I have a wealth of knowledge over the impact of RRSPs on taxpayers in April.
This article highlights the retirement years of people based on RRSP contributions – this is your life.
As an aside, the idea for this article came about because of taxpayers who over contributed to their RRSPs. We should all have such challenges!
There are three types of people in the RRSP world:
- Those who ignore its existence entirely;
- Those who dabble; and,
- Those who keep it fully topped up and use all of their room each year.
Today I want to share with you what this looks like to an accountant (call her Pam) when she is reviewing the returns of three clients who havea recently retired. In our scenarios, we will assume the client is always 71 years of age.
In the first scenario, when Pam starts her review, she notes that taxpayer Penny (of penny wise, pound foolish) has four primary sources of income:
- CPP (Canada Pension Plan)
- OAS (Old Age Security)
- Pension income (if you are fortunate)
- Investment income from unsecured portfolios
Pam observes that their cash flows have dropped substantially over the last five years. The client is relieved to know that she can downsize her home, at some point, as her home equity has the benefit of the Vancouver real estate market. For many in this scenario, their income hovers around $20,000 per year. As they have no mortgage, they are okay but certainly this is not the retirement scenario they had hoped for. Those with long term pension plans are not as restricted of course, but such pension plans are not the norm, in my experience.
In the second scenario, Pam sees a different picture. Her client Yorick (alas, we know him well) has RRIF (registered retirement income fund) as a source of revenue, in addition to the primary sources listed above. This is the money that he contributed to his RRSP that is now coming back out to him over the remainder of his life. There is a minimum amount that must come out, based on age, but you can take more.
This client is pleased to see the RRIF income coming in and is often figuring out what it will pay for in the year to come. His lifestyle has greater freedom and he is enjoying the benefit of a lower tax rate on the RRIF income than he had experienced during his working years. This client is much less dependent on the value of his home.
Sometimes, though, Pam notices that Yorick is drawing down his RIFF at a great rate and he runs the risk of running out of funds before he is ready for his part in our play.
Pam has an entirely different conversation with the person in the third scenario. For if there is one discussion we hate most during the tax season it is the discussion of claw-back.
A claw-back is what happens when your income is high enough for the government to determine that you do not need OAS. When your income exceeds a threshold of approximately $72,000, the government starts to take some of it back from you (the details are for another discussion).
People hate claw-back with a passion usually reserved for a Calgarian watching the Oilers.
Please note the privileged position of this taxpayer, who we will call Kevin (this one speaks fluent French). In retirement, their income is over $72,000 versus the first person who is surviving on a lot less money. This person is concerned about:
- Minimizing tax
- Planning retirement activities
- Investing the RRIF income that is above their day to day needs
- Wishing he could draw less from his RRIF because he does not need the money
At Clearline, we want to help all of our clients live the third scenario. Let’s talk.