Tuesday, July 7, 2015

RRIFs and in-kind withdrawals

My TFSA portfolio beats the TSX index while pumping out income (yield).
 
As a retired fellow I am concerned with managing my RRSPs. Recently I've been wondering, should I convert them now to RRIFs or should I leave them be as long as possible as RRSPs? At age 71 the problem solves itself. One must wind up one's RRSPs by the end of the year in which one turns 71 unless one's spouse is younger and then one has the option of choosing instead to base the wind up on their spouse's age.

Some advisers with whom I have talked have told me to leave my retirement funds sitting in RRSPs as long as possible. Convert at the last possible moment, they say. Others have advised me to convert my retirement savings to RRIFs as soon as possible. When you hit 65 and retirement, convert they say.

There are, of course, at least two other options. One can use the RRSP funds to buy an annuity of some type or one can simply close the RRSP account and take the money. With interest rates at historic lows, annuities are not the attractive option they once were. Very few advisers have suggested I should buy an annuity at this time. I believe the annuity option remains on the table even after one makes the switch from a RRSP account to a RRIF.  (For another take on Which is better, a RRIF or an annuity?, read the linked article in The Globe and Mail.)

Taking the money itself is not much of an option for most of us. The full amount of the withdrawal would be treated as income, as I understand it. The tax hit would be enormous. Very few people take this route for obvious reasons.

So far, I have steered clear of converting. In the great scheme of things, and in my case in particular, it seems the only gain would be saving the $56.50 withdrawal fee applied to RRSP funds. There are no fees for making the annual withdrawal demanded by an RRIF.

So what are the advantages of an RRIF over an RRSP? As best as I can figure, the advantages are:

  • There are no charges for making the mandatory annual withdrawal from a RRIF. This offers a savings of from $28.25 to $56.50, in my experience. You'd be wise to check the charges with the financial institution at which you have your RRSP.
  • If you deduct only the minimum amount from a RRIF, you will not be hit with a withholding tax. You will receive all the funds withdrawn - no withholding. But be aware, the withdrawal is treated as income and will be treated as taxable income at tax time. You must pay the tax piper at some point. You must have the money to pay the tax available. Any amount withdrawn over the minimum will have taxes levied at the time of withdrawal similar to the withholding taxes on RRSP withdrawals.
  • A RRIF withdrawal is treated like pension income by Revenue Canada. This means if you don't already have pension income, the RRIF payments will allow you to take advantage of the $2000 pension income tax credit. This can be a nice perk if you have no other pension income, but for those who already have enough qualifying pension income to take advantage of this deduction, this benefit offers no extra tax savings.

And what are the disadvantages of a RRIF over an RRSP?

  • I think the big drawback to RRIFs are the minimum withdrawals demanded by the government. For instance, when I retired the government at the time insisted on a minimum withdrawal of 7.38% upon reaching the age of 71. This withdrawal rate increases with each passing year. A recent budget lowered the mandatory withdrawal to 5.28% at age 71. The rates are progressively lower for those under 71. Withdrawal rates still increase annually but now one must hit 95 before maxing out at the 20% withdrawal ceiling. 
  • Another drawback is that unlike my company pension, a RRIF or registered retirement income fund, carries some risk. The income is not guaranteed. I'm comfortable with the risk today but if I had to face a repeat of 2008 would I still be so sanguine? I doubt it.

Yet after some thought, I've decided to merge my RRSPs and convert my retirement portfolio into a RRIF. I see an immediate advantage to the no withholding tax on the minimum withdrawal rule. My true tax rate is much lower than the withholding tax rate. This offers a small advantage but still an advantage.

On the other hand, there is no doubt in my mind that anyone with a locked in RRSP should consider the transfer to a locked in RRIF. Getting money out of a locked in RRSP is difficult in retirement. There are forms to fill out and then taken to the bank. Plus, there are the withdrawal charges to consider and the withholding tax.

Want to know more? Here's a link to Financial Hardship Unlocking Forms for 2015. These forms are important if you have a LRSP and desperately need money in retirement. Converting a LRSP to a LIF puts an end to the need for these forms.

Now that I have converted my RRSPs to a RRIF, the biggest question for me is this: What is the best way to remove my money?  If one has a sheltered portfolio of equities, getting the money out demands some thought. If the market is down, you don't want to find yourself forced to sell shares into a sagging market.

I decided that, as much as possible, I'm going to remove funds using the "in kind" approach. The government allows retirees to transfer stock and other holdings from one's RIF to say a TFSA, if one has the headroom in the TFSA. When moving equities, the FMV (fair market value) is calculated on the equities when they leave the protection of the RIF.This value will be important when income tax time rolls around. Because of the manner in which this transfer is done, the FMV for the withdrawal is the same as the FMV for the deposit.

I found this surprising but my bank claimed there was one wrinkle in the "in kind" transfer. The equity transfer, the bank rep said, cannot be carried out directly from the RRIF to the TFSA. The equities must be parked in a non-registered cash account first and then moved from there to the TFSA. In order to complete in kind transfers, I was asked to open a new account to be used only when moving equities, etc., from my RIF to my TFSA. I thought this was weird to say the least.

According to an article that ran in the Toronto Star, the expert consulted by the newspaper agrees:

"most institutions will allow you to transfer your investments 'in kind' to a non-registered account or TFSA account. . . . So if you have 100 shares of BCE in your RRIF priced at $32 a share, you can transfer these shares directly to your TFSA account as a $3,200 contribution. Because there is no withholding tax required when the minimum amount is withdrawn from a RRIF, you won’t have to sell RRIF assets to generate the cash to cover the tax. For withdrawals in excess of the minimum amount, RRSP withholding tax rates apply . . . "

Rather than do battle with the folk at the bank, I moved my self-directed accounts to another bank. I moved my portfolio to TD Canada Trust. The online support was especially quick and oh-so-polite. I sent my first e-mail on a Sunday and immediately got back a reply. The TD has online staff answering client questions on Sundays. I found this amazing as my original bank didn't answer the e-mail I sent to them for four full days. And the TD says it does these in kind withdrawals frequently and all is done without my involvement. I do not have to open a new account as was demanded by their competitor.

My first choice when it comes to which equities to move will be underperforming stocks that also pay a poor dividend. These are stocks that may be down but which I hope will recover eventually. I will pay tax at time of withdrawal, this is only fair, and the tax will be based on the depressed FMV at the moment the equities leave the protection of the RRIF.

Funding fun in retirement is important.
I want to keep my biggest dividend payers in my RRIF as long as possible. I want to accumulate some cash in my RRIF to give myself wiggle room as I withdraw money. I don't want to be forced to sell stock at the wrong time.

Most of us have lots of headroom in our TFSAs. I want to take advantage of this to the greatest extent possible. With luck, I hope to get enough dividend paying stock shifted into my TFSA to make that account an important source of funds in retirement. The nice thing about funds removed from a TFSA is that they do not count as income and do not trigger a claw-back of one's OAS.

One advantage of my TD Direct Investing account over the now closed accounts at the other bank is that the TD account information can be downloaded and linked automatically to an Excel spreadsheet. I no longer have to fill in the fields myself. Nice. Now I have more time to spend with my grandchildren.

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