As part of its Economic Response Plan to the COVID-19 crisis, the federal government lowered the required minimum withdrawals from Registered Retirement Income Funds (RRIFs) and Life Income Funds (LIFs) by 25% for 2020.
The lower minimums recognize the fact that the recent market volatility has had an impact on the retirement savings of seniors. This new measure will provide considerable flexibility and tax savings for retirees, and it will extend the length of time that they will have to withdraw from their RRIF/LIFs.
Reducing your RRIF Withdrawal Amount in 2020 - What You Need to Know
- Adjustments are optional
- If you have:
- not made a withdrawal for 2020 yet, and you decide that you don’t need the previously required minimum amount in full, you may choose to withdraw only 75% of that amount.
- already begun regular withdrawals based on the previous 2020 minimum, you can adjust your subsequent withdrawals so that your total withdrawn in 2020 is reduced by 25%.
- already withdrawn for 2020 based on the original minimums, you will not be able to re-contribute 25% of the minimum required withdrawal back into your RRIF.
Lowering Your RRIF Minimum in 2020 Can Reduce Your Taxes
One of the benefits of reducing your withdrawal amount this year is that you can leave more of your money invested, allowing your portfolio to gain from any potential market growth. However, investors who choose to reduce their withdrawal amount can also benefit by lowering their taxes. Here’s how it works.
Consider Mary, an 80-year-old retiree who is single and has a $1,000,000 in her RRIF as of January 1, 2020. Normally, her minimum withdrawal for 2020 would be 6.82%, or $68,200. Combined with her other sources of income for the year, Mary’s taxable income is estimated to be approximately $95,000. If we assume an average tax rate of 22.79%*, she will owe approximately $21,652 in taxes for 2020.
In contrast, if Mary were to take advantage of the lower RRIF withdrawal rate this year, she will only have to withdraw $51,150 (5.115%) in income. That means she will leave $17,050 of her capital invested in her RRIF account to continue to grow tax-deferred. By reducing her withdrawal, Mary also moves into a lower income tax bracket for 2020, resulting in an estimated tax savings of approximately $5,572*, which can be used for cash flow or remain invested to grow over time.
Making Withdrawals in a Volatile Environment
Making withdrawals from a portfolio during a market downturn exposes investors to what is known as “sequence of returns” risk. Essentially, selling investments when their market values have fallen, particularly during the early years of retirement, accelerates the rate at which the portfolio’s assets are depleted. This is especially true for the equity portion of a portfolio. Even though markets may recover, the losses due to a withdrawal are permanent. That’s because once equities are sold, and the capital is withdrawn from the portfolio, it can no longer benefit from any subsequent market growth.
Personalized strategies abound when it comes to effectively withdrawing invested funds to create a stream of retirement income - and for good reason. Investors have many factors to consider, including multiple income sources, differing withdrawal options, a graduated income tax schedule, as well as the various tax credits and clawbacks. All of this can make for a complex environment.
Given the current market conditions and the new RRIF withdrawal rates, investors can evaluate a few additional financial planning strategies.
Planning Strategies to Consider
The following are some general strategies that an investor can consider for 2020.
Strategy #1: Reduce Planned Withdrawals
If you planned to withdraw more than the required minimum in 2020, you might want to reduce this amount if you can afford to. This will leave more of your capital in your RRIF account to continue to grow tax-deferred and participate in any future market recovery.
Strategy #2: Modify the Timing of Withdrawals
Annual RRIF withdrawals can be made at any point in the calendar year. Postponing a withdrawal creates the opportunity for investors to benefit from any market recovery in the remainder of 2020. It also offers investors the flexibility to make one or more withdrawals at any point over the rest of the year.
It is sometimes advised to wait until the end of the calendar year to make RRIF withdrawals. This allows you to keep more of your portfolio invested throughout the year, allowing it to benefit from continued growth and the compounding of interest and dividends.
Based on your situation, however, you may want to consider making a withdrawal earlier in the year exclusively from the fixed income portion of your RRIF, as this may improve the dynamics of a subsequent rebalancing in your portfolio. We explain this in the next two strategies.
Strategy #3: Withdraw from Cash and Fixed Income Portions of a Balanced Portfolio
Most diversified balanced portfolios have experienced a significant decrease in the value of their equity allocation. A withdrawal that necessitates selling equities while prices are relatively low is sub-optimal and should be avoided, if at all possible.
Where possible, required withdrawals should be made from securities that have either held their value or decreased by the least amount. This would typically be from the cash and fixed income portions of a diversified portfolio. So for this year, fixed income investments have experienced an increase in value, up 4.17% year-to-date as at April 21, 2020^.
Strategy #4: Rebalance in a Timely Manner
After withdrawing funds from the fixed income portion of a portfolio, the portfolio should be rebalanced to move it back to its long-term asset mix (for a balanced portfolio, that’s typically a mix of 60% equities, 40% fixed income).
The question is, after a market has declined, is it possible to execute both a withdrawal and a subsequent rebalancing so that it does not include the sale of equities in a balanced portfolio?
While it may sound unusual, making a withdrawal and then rebalancing a portfolio while equity values have declined can be an effective long-term strategy. For this to occur, equities must have decreased by a certain percentage amount to create the conditions where a portfolio can be rebalanced by selling additional fixed income and purchasing equities.
After withdrawing from the fixed income portion of the portfolio, whether or not equities have to be sold to rebalance will depend on two important variables:
- The percentage decrease in the value of the equity allocation.
The larger the decrease in the value of equities, the more a subsequent rebalancing will also sell fixed income assets and purchase equities.
- The size of the withdrawal (for RRIFs, this is usually a legislated minimum amount based on your age or the age of your spouse).
The larger the required withdrawal, the more important it is to rebalance a portfolio when equity markets have moved significantly lower.
As a result of the new lower RRIF minimums, the conditions for Strategy #4 are improved. Depending on the above variables, a withdrawal may result in the sale of fixed income holdings and the rebalancing achieved through the purchase of equities when prices are relatively low.
Based on your circumstances, there are numerous factors to consider in determining whether one of the above strategies may be right for you. Call my office today to discuss adjusting your RRIF withdrawal strategy for 2020.
*Ontario resident. Sources: PWC Canada, TaxTips.ca.
^Based on the return of iShares Core Canadian Universe Bond Index ETF (XBB), as a proxy for the FTSE Canada Universe Bond Index at April 21, 2020.
Disclaimer: The above should not be construed as tax planning advice, as each individual’s situation is different. Please consult your own tax planning advisor. Investment Planning Counsel Inc. is a fully integrated wealth management company. Counsel Portfolio Services is a wholly-owned subsidiary of Investment Planning Counsel Inc. Trademarks owned by Investment Planning Counsel Inc. and licensed to its subsidiary corporations. Mutual Funds available through IPC Investment Corporation and IPC Securities Corporation. IPC Private Wealth is a division of IPC Securities Corporation. IPC Securities Corporation is a member of the Canadian Investor Protection Fund.