Saturday, November 21, 2015

RIFs, TFSAs and Asset Shifting

The following is important. Please read. I am NOT a financial adviser. I am a retired photojournalist trying to make ends meet. Do NOT take anything that I say as gospel. Before acting on anything you read here, do some research and talk with a professional adviser. If you do discover I am wrong on some matter, please post a comment. I do not mind being corrected. ___________________________________________________________________________

Asset Shifting for Retirees In a Nut Shell

  • Allow 12-month's of dividends to accumulate in your self-directed RIF (retirement income fund). Keep dividends in an investment savings account within the SDRIF to enjoy better interest on the accumulating cash.

  • In January call the financial institution managing your SDRIF and have them make the minimum withdrawal demanded by the government but have this done as an in-kind transfer from your SDRIF to your TFSA (tax free savings account). Ensure you have adequate contribution room before making the transfer. Do not involve yourself in the transfer other than to request it be done.

  • Remove 4% of the total value of your SDRIF in cash. Ideally, this money is available in your investment savings account. Have the withdrawn money deposited in a bank account of your choosing. Consider a high-interest savings account as these can pay from .75% to 1.5% annually.(ScotiaBank Momentum Savings account pays 1.5% today.) Stay alert for fees.

  • There is no withholding tax on the in-kind transfer as long as it is not greater than the minimum withdrawal that must be made. But be aware the transfer is treated as income and tax must be paid at tax time the following year. When it comes to the cash withdrawal, there is withholding tax that increases as the withdrawn amount grows.

I've discovered my approach to withdrawing RIF savings in retirement has a name: It's called asset shifting. I meet my annual minimum withdrawal obligation by transferring stocks and mutual funds from my RIF to my TFSA in an amount equal in value to the minimum withdrawal.

This is an in-kind transfer. It must be done by the financial institution holding your self-directed portfolio. You cannot have any direct, hands-on, involvement other than making the request for the in-kind transfer. I have found TD Waterhouse has a good grasp of what is required.

The bank knows, right to the penny, your minimum withdrawal. If you have a LIF the bank also is aware of your maximum withdrawal. This year the TD had this information available by January 4th. If you have a self-directed TD Waterhouse account, the minimum withdrawal can be found by clicking on Payment Information near the top right of the Account Details (Holdings) page. Note: the withdrawal is considered a payment from your RIF and so the amount is shown under the words Minimum Payment.

As far as my overall portfolio is concerned this is a transfer and not a withdrawal. The value has not been removed but only shifted. This leaves me free to withdraw four percent in cash from my RIF. Four percent is the widely accepted safe withdrawal rate. As my RIF portfolio yields more than four percent in cash annually, finding the cash is easy.

The withdrawal is deposited in a high-interest account offering the bonus of double the interest on any funds untouched for 90 days or more. Today (Jan. 6th, 2016) this amount to 1.50% interest.) There are no charges for making deposits or withdrawals from this high interest account as long as everything is done online. Go to the bank for counter service and risk paying $5.00 for a simple withdrawal.

My other bank account is one that is no longer offered by the bank but it has been generously grandfathered. It is an account that was only offered to seniors. it charges no fees -- not even for cheques printed with one's name.

Any excess money remaining in the RIF that will not needed in the future can be reinvested. Money that is being accumulated for removal next year should be parked in an investor savings account. My TD investor savings account (TDB8150) is paying .75% as of today (1/6/16).

Keep in mind that although minimum withdrawals do not trigger a withholding tax, the withdrawal is income. When income tax time rolls around the following spring, tax must be paid. On the upside, those dividend producing investments (stocks, REITS, ETFs and mutual funds) transferred in early January 2016 will collect dividends tax free in the TFSA for more than year before the 2016 taxes are due. The accumulated dividends will help cover some of the tax that now must be paid. (Be careful that you do not pay too much tax in one lump sum in the spring. The government does not like waiting for its money. If you pay too much at tax time, you will be asked to pay your tax in installments in the future. Check with Revenue Canada for more information.)

The minimum withdrawal is a percentage of the total value of a RIF at the end of the previous year. The percentage is related to the age of the RIF owner on the following January 1st. If the RIF owner has a younger spouse, the RIF owner can elect to have the age of the younger spouse used to determine the withdrawal percentage. The benefit in doing this is that the percentage that must be withdrawn is less. The RIF may last longer. Clearly, this decision demands some careful thought. And remember, whatever decision you make, the decision is permanent.

I elected to have my wife's age determine my withdrawal rate. But now that I am making in-kind withdrawals, I'm not sure that using the younger spouse's age is still the best approach. I'll leave that for you to decide. Me? In a few years I'll look back and re-evaluate my decision. At that time I'll know whether I did the right thing or the wrong.

When one reaches the age of 70, the withdrawal rate reaches five percent. This is a lot to withdraw and it only gets worse with each passing year. A safe withdrawal rate is often claimed to be no more than four percent. If one withdraws more, the risk of early depletion of a RIF increases. Of course, this is the government's goal. They want you to deplete your RIF in retirement. In 2015 the federal Conservatives backed off a little on this forced depletion when they brought in new, lower rates.

Asset shifting provides one possible solution to this forced depletion problem. I'm going to try and never remove more than four percent in cash from our RIFs annually. The cash dividends accruing in a TFSA during the year provide cash to to live while the withdrawals increases TFSA contribution room in the following year. The maximum TFSA contribution room for 2016 is $46,500 for those who have all their TFSA contribution room intact.

It is not hard to envision a scenario where $46,500 in a TFSA could add more than $3000 in tax free income to a retiree's budget. And the cash from a TFSA not considered income and because of this it does not figure in the calculations of such things as the OAS clawback or the GIS (guaranteed income supplement). And a final perk is that the following year the contribution room will be the sum of the annual $5500 contribution room increase plus $3000 to allow replacement of withdrawn funds.

Clearly contribution room of $8500 will not be adequate to handle the entire RIF withdrawal demands faced by most retirees but for most of us it is a big percentage. The remaining investments can be transferred in-kind to a non-registered self-directed account.

Be careful when making these transfers. Do your research. You do not want to trigger more income tax than necessary. For a good essay touching on the problems of dividends and taxes, please follow this link to the blog My Own Advisor: Dividends. Consulting with an adviser might be a good idea if you have any questions. At the very least, give the government tax folk a call. I've gotten good advice in the past from the government people.

One last thought. When the government brought in the TFSA, they believed these would encourage new savings, new investments. There is no mention anywhere of promoting asset shifting by seniors. For this reason, I would not be surprised to see the government limit or eliminate this use of TFSAs. And as TFSAs grow in number and in average size, the government may put a lifetime cap in place. Similar tax free plans in other countries have been capped in some fashion.

And one warning: I found financial advisers did not want to discuss the in-kind transfer of funds from RIFs and LIFs to TFSAs. I even found banks that did not want to admit that such in-kind transfers were even allowed. I have found TD Waterhouse to be quite knowledgeable. Originally, I had my retirement investments spread evenly between two banks. The TD was a delight and the other was a pain. I cancelled my two accounts at the one bank and the TD covered the transfer costs of about $300.

I'm sure some of you are wondering how it is possible to earn more than two or three percent in this present low-interest rate environment. Some years ago a reporter at the local paper, The London Free Press, warned that retirees may find themselves eating pet food because of the low interest being paid on savings. So far, since I retired in 2009, I have found this fear to be groundless. Some of my investments and the associated yields:

  • Dream Office REIT: 12.31 percent (long term hold as neither unit price nor yield are certain)
  • Norbord Inc. : 1.45 percent (but it is up 14.24 percent in share price since I bought it)
  • Royal Bank of Canada: 4.15 percent
  • Sun Life Financial Inc.: 3.50 percent (and it is up 110.31 percent since purchase)
  • CIBC Monthly Income fund: 6.05 percent (sounds good but I don't advise buying)

The above is just a sample of the mix of stuff into which I have shoved my retirement funds. I find diversity gives me confidence and confidence allows me to sleep at night. I'm not greedy. I just want to pay my bills. So far, six years into my retirement, I see no problem keeping my budget balanced. I'm leaving pet food for pets.

I wonder how much the reporter who wrote the piece has saved toward retirement in the intervening five years. I know this reporter makes enough to save at least $5000 a year. If they had done that, today that reporter could easily have $45,750 saved. And that's after only five years. (It would be a little less today as the market is down as of 1/1/16.)

Don't believe me? Check the info below. Click on the image to enlarge. I put half the reporter's savings into the TD Monthly Income fund and the other half into the TD U.S. Index e-Fund. These are very conservative investments. I have both of these in my retirement portfolio. An adviser at the TD warned me to always have exposure to the American market. He was right. The reporter not so right.

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