RRSPs are a great tool to save for retirement, but they can become a huge tax nightmare if misused during the withdrawal phase of life. If you do nothing, a large portion of your RRSP will more than likely to donated to the CRA. Here are 3 reasons why you should meltdown your RRSP.
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The Hidden Tax Risk in Your RRSP
Imagine that you and your spouse each have $800,000 saved in your RRSPs. If one of you passes away, the surviving spouse receives the deceased’s RRSP tax-free. That sounds like good news, but now there is $1.6 million in a single account.
When the surviving spouse eventually passes, that entire amount becomes taxable income on their final return.
In Ontario, income over $246,000 is taxed at a marginal rate of 53.53 percent. Even when averaged across lower brackets, the effective rate on a large RRSP could still approach 50 percent. The result is a potential tax bill of more than $750,000 on $1.6 million.
This issue is not unique to Ontario. Most provinces show similar outcomes once income crosses higher thresholds.
Reason One: Take Advantage of Lower Tax Brackets
Let’s say you and your spouse are both retired with annual incomes of $60,000. That level of income is typically enough to cover most retirement lifestyles while keeping you in a moderate tax bracket and below the Old Age Security clawback threshold.
Now suppose each of you withdraws an additional $30,000 from your RRSPs. Even with the withdrawal, you remain in the same bracket and pay a tax rate of less than 30 percent.
If you do not need the extra cash for daily spending, the funds can be directed into your TFSAs or a joint non-registered account.
By doing this, you remove $60,000 from your RRSPs at a lower tax cost today, rather than risking a 50 percent tax rate later.
Reason Two: Reduce Mandatory Withdrawals Later
Once you turn 72, you are required to convert your RRSP into a RRIF and begin making minimum withdrawals each year.
If your RRSP grows to $1 million by age 72, the minimum RRIF withdrawal would be 5.28 percent, or approximately $52,800 per person. If you already receive $60,000 in income, your total taxable income jumps above $110,000.
This is enough to trigger Old Age Security clawbacks.
If you had started drawing from your RRSP earlier in retirement, your RRIF balance would be smaller and the required withdrawals would be lower. That could help you avoid losing part of your OAS benefits.
Reason Three: Ease the Burden on the Surviving Spouse
Now consider what happens if one spouse passes away.
The surviving spouse may inherit a $2 million RRIF and still have their own income, which could now include survivor benefits from CPP or a pension. Let’s say their total income increases to $80,000 before RRIF withdrawals.
With a $2 million RRIF, they would be required to withdraw over $105,000. That means the survivor now reports a taxable income of roughly $185,000, as a single individual.
This creates a much steeper tax burden.
Had both spouses drawn down their RRSPs earlier while filing jointly and remaining in lower brackets, the surviving spouse would have less to withdraw and pay less in taxes.
Final Thoughts
An RRSP meltdown strategy is not about spending more. It is about withdrawing funds in a planned, tax-efficient way while you are still in a relatively low bracket.
This strategy can help you reduce the impact of required withdrawals, avoid OAS clawbacks, and minimize the tax bill on your estate.
If you are retired or approaching retirement and not sure how to approach RRSP withdrawals, it may be time to put a strategy in place.
