Which is better? The RRSP Meltdown or RRIF Minimum withdrawals?
Let’s go over the pros and cons of each strategy because choosing the wrong option for your situation can cause you to pay hundreds of thousands more in taxes.
Let’s meet Kathy; she is 63 years old and retired. She currently receives $1,000 per month from CPP and plans to begin her OAS at 65.
In her own words, Kathy lives a relatively simple life. She can do all the things that she wants to do for $3,000 per month, which will be indexed to inflation moving forward.
She has been a good saver her whole life and has $900,000 in her RRSP and $120,000 in her TFSA.
Her current plan is pretty straightforward. She receives her CPP and withdraws funds from her RRSP every year. This will ensure she has enough cash on hand to spend $3,000 per month.
Once she turns 65, she will reduce how much she is withdrawing from her RRSP as she receives funds from OAS.
Once she turns 71, she will convert her RRSP to a RRIF and her plan is only to withdraw the mandated minimum amount every year. Based on the growth of her RRSP over the coming years, the mandated amount from her RRIF, will be more than she needs to meet her expense goals.
These extra funds she’s withdrawing will go into her TFSA and non-registered account.
If we look at Kathy’s net worth over time, she is in no danger of running out of money as her net worth continues to increase. We’ve also left her home out of these calculations as she has no intention of selling it.
Pros of RRIF Minimum Withdrawal Strategy
So, what are the pros of this strategy?
By utilizing this approach, Kathy is able to keep her tax bill extremely low. From now until she converts her RRSP into a RRIF, she is drawing funds out her RRSP in the lowest tax bracket.
She may want to consider drawing funds from her TFSA instead of her RRSP once she is 65 as she could qualify for the Guaranteed Income Supplement, but nonetheless her current strategy is very tax efficient.
Once she converts her RRSP to a RRIF, she also able to keep her tax bill low as she’s only drawing the minimum out.
Cons of RRIF Minimum
On the other hand, by only drawing the minimum, she still has quite a bit of funds remaining in her RRIF at the plan’s end.
The entire value of her RRIF will be added to her final tax return as income. This will lead to a 50% tax bill on a good chunk of her savings.
In this scenario, Kathy’s estate value after tax is just under $2.1M, again not including the value of her home.
On the other hand, Kathy can use an RRSP Meltdown strategy, where we draw funds out of the RRSP more aggressively to top up her TFSA and non-registered account starting today.
So, in this scenario, we are targeting a taxable income of $76k per year. By targeting this income level, her RRSP/RRIF is completely depleted by the time she is 89. Could we be more aggressive with our withdrawal strategy? Sure, but Kathy has longevity in her family and is healthy. We aren’t in a rush to pay more tax than we need to today.
Pros of RRSP Meltdown
By implementing this strategy, her estate will be taxed much more favorably as her TFSA is much larger, and she has funds in a non-registered account versus a RRIF.
In this scenario, Kathy’s final estate after tax is just under $2.3M. That is a difference of $200k compared to the minimum RRIF withdrawal strategy.
Now, does this mean that everyone should implement an RRSP Meltdown? Well, not necessarily,
When not to use the RRSP Meltdown
Having done these types of videos in the past, I receive a lot of emails from viewers about how they should meltdown their RRSPs.
In some cases, it simply doesn’t make sense.
Let’s say you are 70 years old with $200,000 in your RRIF. Let’s also assume you make 5% per year and only withdraw the minimum every year. You will have $124k left in the account at age 90.
Assuming you have $20k of income from CPP and OAS in your final tax year at age 90. Your total income would be $144k.
Looking at the Ontario and Federal tax rates, this would put you in a marginal tax bracket of 43.41%. At no point would you be even close to the 50% bracket.
Not only that, but these are the tax brackets today. Over the next 20 years, these income brackets will presumably increase as well due to inflation and chances are you’ll be in an even lower tax bracket.
So which strategy is better? Well it depends. Just because your neighbour is using a strategy doesn’t mean that strategy also makes sense for your circumstances.
