Saving for retirement is one thing. Figuring out how to draw down those savings without triggering unnecessary taxes is another. Many retirees are surprised to learn that the order in which you withdraw funds from your accounts can have a major impact on how much tax you pay and how long your money lasts.
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Their Situation
Jane was 60 years old and had just retired. Like many retirees, she needed to create her own retirement paycheck. Before deciding where to pull income from, she looked at her fixed income sources.
She had a workplace pension paying her $14,400 per year. She had also started CPP at age 60 and was receiving $9,000 per year. When she turns 65, she will begin collecting Old Age Security, which will pay her $8,300 per year.
Altogether, once her OAS starts at 65, Jane will receive just under $32,000 per year in guaranteed income.
Jane’s retirement lifestyle goal was to spend $65,000 per year. The difference between her guaranteed income and her total lifestyle needs would have to come from her retirement savings.
Her Retirement Accounts
Jane had saved $1 million across three different account types.
She had $700,000 in an RRSP. While RRSPs are great for saving, withdrawals are fully taxable once retirement begins.
She had $200,000 in a non-registered account. These accounts are taxed more favorably than RRSPs. Contributions can be withdrawn tax-free, and only interest, dividends, and capital gains are taxed along the way.
Lastly, she had $100,000 in a TFSA. This account allows for tax-free growth and withdrawals, making it the most tax-efficient option.
She also owned a home worth $600,000, though she preferred not to access her home equity during retirement.
Three Strategies to Compare
To help Jane make the most of her savings, we compared three different withdrawal strategies. Each would generate the same annual income, but the long-term outcomes were very different.
1. Hybrid Strategy
In this strategy, Jane starts by withdrawing from her non-registered account. Once that is used up, she moves to her RRSP. The TFSA is saved for the final years of retirement.
This strategy would leave her with $479,000 after tax by age 87.
2. Registered Drawdown Strategy
Here, Jane begins by withdrawing from her RRSP, followed by her non-registered account. The TFSA is again used last.
This strategy would leave her with $472,000 after tax by age 87.
3. Registered Deferral Strategy
In this approach, Jane defers RRSP withdrawals as long as possible. She begins with her TFSA, then uses the non-registered account, leaving the RRSP for last.
This strategy would leave her with $356,000 after tax by age 87.
Which Strategy Made the Most Sense
At first glance, the hybrid strategy left Jane with the highest estate value. However, the difference between the hybrid and registered drawdown strategies was only $7,000.
If Jane were to pass away before age 87, the registered drawdown strategy would actually have been the more effective plan.
What If Jane Wanted to Spend More
Jane didn’t like the idea of leaving such a large balance behind. After reviewing the numbers, she asked what would happen if she increased her spending to $68,000 per year instead of $65,000.
With this higher spending target, the best strategy changed. In this case, the registered drawdown strategy became the most effective, leaving Jane with $85,000 more than the registered deferral strategy by age 87.
Final Thoughts
The order in which you withdraw funds from your retirement accounts can make a big difference. It affects not only your annual tax bill but also how long your savings last and how much you may leave behind.
In Jane’s case, the difference between the best and worst withdrawal strategies was more than $100,000 after tax. Taking a few minutes to plan ahead saved her thousands.
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