The end game for millions of Canadians who diligently save for retirement by contributing to registered retirement savings plans (RRSPs) is to be able to accumulate, on a pre-tax basis, a sufficiently large enough nest egg that will last through retirement. The tool most RRSP savers ultimately use to provide such an income stream from that plan is a registered retirement income fund (RRIF).
But RRIF rules haven’t kept up with recent demographic and economic trends, something that is the subject of a new report by the C.D. Howe Institute think-tank, as well as an ongoing study by the federal Department of Finance. But before delving into what’s wrong with the RRIF — and how to fix it — let’s review some RRIF basics.
As I’ve often said, RRSPs are the No. 1 way to save for retirement. But under current rules, you must collapse your RRSP by the end of the year in which you turn 71. You have three choices: cash it in, buy a registered annuity or convert it to a RRIF.
Cashing in your RRSP rarely makes sense because you will have to include the entire fair market value of the plan in your income, all in one year. It could, however, be an option if the amount in your RRSP is relatively small and your tax rate is zero (or close to zero) in the year of collapse. You could also contribute the withdrawn RRSP funds into your tax-free savings account (TFSA) for future tax-free growth, assuming you have the TFSA contribution room.
The second option is to buy a registered annuity from a life insurance company, which can provide a steady, guaranteed flow of retirement income. This is rarely done as Canadians are reluctant to annuitize their retirement savings, either because they want the flexibility to access more cash than the annuity income would provide, or because they worry that if they die too soon, the annuity funds are gone, leaving no inheritance for their beneficiaries.
The third, and by far the most popular, option is to convert your RRSP to a RRIF. With a RRIF, you can keep the same investments you had in your RRSP, and continue to enjoy the tax deferral on the funds, with the exception that you must withdraw at least a required minimum amount annually, starting in the year after you set it up.
It’s this forced annual minimum withdrawal that has caused concern for some retirees since it effectively forces them to pay tax on their retirement assets before they need to spend them. Given the increases in longevity, combined with low real rates of return on non-risky assets that often form the bulwark of a septuagenarian’s portfolio, perhaps it’s time for the required minimum amounts to, once again, be revisited.
The required minimum amount is based on a percentage factor, often referred to as the “RRIF factor,” multiplied by the fair market value of your RRIF assets on Jan. 1 each year. For example, if you converted your RRSP to a RRIF last year (2022) when you turned 71, and the balance of your RRIF was $100,000 on Jan. 1, 2023, then you must withdraw 5.28 per cent or $5,280 this year. The RRIF factor increases each year until age 95, when the percentage is capped at 20 per cent annually thereafter.
A new C.D. Howe Institute report, Live Long and Prosper? Mandatory RRIF Drawdowns Raise the Risk of Outliving Tax-Deferred Saving, calls for a “revamping” of the RRIF withdrawal rules. Co-authors William Robson and Alexandre Laurin said longer lives and lower returns increase the likelihood that current mandatory minimum withdrawals “will leave seniors with negligible income from their tax-deferred saving in their later years.”
They believe that “government impatience” to collect tax revenue on RRIF withdrawals should not force fund holders to prematurely deplete their nest eggs. Instead, we should ensure that minimum withdrawals and the ages at which we are no longer allowed to save in an RRSP — and, consequently, begin drawing down on those retirement savings — should be adjusted to reflect updated demographic and economic realities.
The authors go so far as to suggest abolishing age limits for retirement savings altogether, along with eliminating the need for annual minimum withdrawals. After all, the government will eventually collect its deferred tax revenue when the funds are withdrawn, or upon death of the plan holder (or their spouse or partner), when the entire fair market value of a RRIF must be taken into income.
In 2020, Conservative MP Kelly McCauley (Edmonton West) requested the Parliamentary Budget Officer cost out the elimination of the annual RRIF minimum withdrawal amount. The estimate released by the PBO concluded it would cost the government approximately $1 billion annually, since RRIF holders would withdraw less each year, reducing their taxable income.
If $1 billion is too high a price for the government to swallow, another withdrawal-reform option recommended by the authors is to eliminate the requirement to withdraw amounts below a certain threshold value — say $8,500 — to avoid premature depletion of nest eggs.
There is precedent for lowering the RRIF withdrawal factors. Indeed, the entire table of RRIF factors was revamped in 2015, with the starting factor lowered by approximately 25 per cent at age 71, before gradually converging with the old factors. And in 2020, the government temporarily decreased the required minimum withdrawals from RRIFs by 25 per cent for the 2020 calendar year as part of its COVID-19 response plan.
We may find out as soon as next month whether the RRIF rules will be reformed as the Department of Finance wraps up its RRIF study. The study was in response to Private Member’s Motion M-45, introduced by Liberal MP Kirsty Duncan (Etobicoke North), and adopted by the House of Commons last June. The motion recognized that many seniors are worried about their retirement savings running out, and asked the government to undertake a study “examining population aging, longevity, interest rates, and registered retirement income funds.” The report is due by June 2023.