Is it time to convert my RRSP?
For many years, the general rule of thumb was to let your RRSP grow as long as possible – in other words, don’t withdraw any money until you reach the age where you have to convert the plan to an annuity or RRIF (currently age 71). But today, new tax laws and new research suggest there can be benefits to starting your withdrawals at an earlier age.
First of all, if you don’t already receive employer pension income, the pension income tax credit applies to RRIF withdrawals made beginning at age 65. At the federal level, this credit essentially shelters up to $2,000 of pension income from tax per year.
An additional benefit is that RRIF income for recipients age 65 and older qualifies for income splitting with a spouse or partner. So, if you have a lower income spouse, you can potentially draw out some RRIF income at a fairly low tax rate. And there’s more. As long as your spouse or partner is not already claiming eligible pension income, this means that they too are entitled to the pension income tax credit. Now, as a couple, you’re sheltering up to $4,000 of pension income from tax each year.
Just be aware that, in order to take advantage of these tax benefits, payments must be received from a RRIF or annuity – cash withdrawals from an RRSP won’t qualify.
Beyond these immediate tax benefits, there are other reasons why early conversion to a RRIF can make sense. Consider the situation where, if funds are allowed to accumulate to age 71, the required RRIF withdrawals will push you into a higher tax bracket and perhaps even trigger the OAS clawback.
For example, say that Mary has $500,000 in her RRSP at age 65. If she converted her RRSP to a RRIF at that point, her required withdrawal would be $20,000 (4% x $500,000). However, if she leaves the RRSP alone until age 71, that $500,000 could grow to $670,000, assuming a 5% rate of return. At age 71, the required withdrawal moves up to 7.38%, meaning that Mary would have to withdraw $49,446 in that first year (7.38% x $670,000). You can see how such a dramatic increase in the minimum required withdrawal could have a negative impact on Mary’s tax situation.
The decision of when to convert your RRSP into a RRIF is a complex one and should be made with consideration of all sources of retirement income. Please contact us if you would like to discuss this issue further.
