Are excess savings in RRSPs going to create a problem for you in the future?
In our practice, we quite typically see retirees in receipt of pension incomes, CPP, OAS, — often doubled up in a household — whose core sources of predictable, inflation-adjusted income are adequate in themselves to pay the bills and still provide for lifestyle choices. Maybe they were ‘savers’ during their working years — or at least, people who didn’t waste money with extravagant spending – but they don’t feel that they are denying themselves anything in retirement and just don’t need or want any more income.
Through mandatory participation in employer and government sponsored pension plans, they accumulated this core retirement income, but they also tended to save money in RRSPs and/or accumulate non-registered funds along the way for retirement or a rainy day. Fast forward to retirement, and they might have $300,000 or more in their RRSPs and are not motivated to draw on them. We see this all the time. They don’t need the income and they don’t want to pay the tax on withdrawals. But the requirement to turn their RRSPs into RRIFs by the end of the year they turn 71, and then having to start the minimum annual withdrawal in the year they are 72, looms large. If the funds are invested for growth and/or they inherit extra RRSP balances when a spouse pre-deceases them, that liability increases with every year they defer withdrawals. By the time they must withdraw, the required minimum withdrawal may be large enough to not only attract higher marginal tax rates, but also cause them to lose the Age Credit and possibly have some OAS clawed back. This is a form of ‘double’ taxation. To top it all off, the Canada Revenue Agency stands to become a primary beneficiary of the balance in RRSPs and RRIFs at the last passing.
So, people who find themselves in this position can throw in the towel, take the withdrawals, pay the tax and increase their excess cash balances sitting in the bank — or they can consider the following strategy:
Melt down your RSP and the tax liability through a donor-directed charitable giving fund and direct your tax dollars to causes you care about.
We are frequently proposing this strategy to clients with surplus funds who want to manage the tax liability for RRSPs over the long term. Many money management firms offer an option to set up a donor-directed fund within a larger charitable giving foundation. You make an irrevocable donation to the foundation, but your portion is uniquely identified in the manner you wish (e.g. The John and Mary Smith Giving Fund) and you or your representative name the beneficiary organizations through standing or annual instructions.
Say you withdraw a lump sum from your RRSP, you can donate the gross amount – within the 75% rule — and generate a tax credit which is at the highest marginal federal/provincial rate. Depending on your situation, you may find that the tax credits significantly reduce your overall tax bill from what it would otherwise be. Even though you might be claiming additional taxable income before making an offsetting donation, the generous tax credits afforded to charitable donations could help you reduce your overall tax bill and leave you with more spendable income from your basic sources!
The donor-directed charitable giving fund strategy also offers a great option for shareholders with surplus funds in a personal corporation or holdco to get the funds out tax-effectively. Granted, you are transferring capital which cannot be accessed again, but you retain some control over its ultimate use (other than going to government tax revenues.) These charitable foundations often have a $10,000 – $25,000 minimum for the first contribution to a donor-directed fund, with additional contributions in the $1,000 – $5,000 range. And you can leave a final bequest to your fund in your will. Your legacy will continue long after you are gone.
This strategy is also applicable to taxpayers who regularly make generous charitable contributions anyway. It may be easier to do so on an ongoing basis by setting up a donor directed fund to make annual donations to your core causes.
Here’s an example of how the strategy might work for an individual taxpayer who draws $25,000 from his RRSP to donate to his donor-directed fund:
In this example, the taxpayer will lose some of the Age Amount tax credit, but he benefits from a charitable donation tax credit which is higher than his highest marginal tax rate on Net Income. His donation tax credit not only offsets the RRSP withdrawal, but actually contributes additional tax credits to his tax payable on the other income, so he ends up with more spendable income than he had before. And in a rising market, it might be that the contribution amount withdrawn from an RRSP invested for growth is soon replaced by the growth in the plan!
Every situation and provincial calculation is different, and requires careful planning with professional help to maximize the outcome for the individual and determine the effects of clawbacks and provincial assessments based on Net Income, but it is well worth considering. If withdrawing from an RRSP or RRIF to deposit to your fund, an optimal time to do that would be near the year end.
Here are some links which you may find helpful as you mull over the idea: