Which savings should retirees draw down first?

Working as a financial planner, I am often asked, “What is the most tax-efficient way to draw down on investments?” From the outset, I question if a decumulation plan based on tax efficiency is the best use of someone’s money. I wonder whether it is even possible to design “the best” long-term, tax-efficient withdrawal strategy.  

I have modelled many different combinations of withdrawal strategies, such as RRSP first, non-registered first, blending the two, depleting registered retirement income funds (RRIFs) by age 90, dividends from a holding company, integrating tax-free savings accounts (TFSAs), and so on. In most cases, there is no significant difference to the estate over a 25- or 30-year retirement period, with the odd exception.

You may have read articles suggesting the right withdrawal strategy can have a major impact on your retirement. The challenge when reading these articles is you don’t know the underlying assumptions. For example, if the planner is using a 5% annual return, is it all interest income and fully taxable? What is the mix of interest, dividends, foreign dividends, capital gains and turnover rate that makes up the 5% return? There is no standard all planners use, which leads to confusion and can make things seem more complicated than they need to be.

Think spending, not decumulation

Here is my approach to designing a decumulation plan. First, think about my opening. You have about 20 years of active living left to get the most out of your money. What do you want to do? Twenty years from now, do you want to look back on your life and say, “I sure was tax-efficient,” or would you rather say, “I had a great time, I did this and that and I helped…” I write this because it is not uncommon for me to see people be too restrictive on their spending in the name of tax efficiency, or not wanting or having the confidence to draw down their investments when they could.

Stop thinking decumulation; that puts the focus on the money. Instead, think spending. How do you want to spend your money? I know you can’t predict over 20 years, so focus on this year. How can you make this a fantastic year while living within your means? Do you even know the limit to your means? 

Now prepare an expense sheet so you can see where you are spending your money and where you want to spend it. This is where a financial planner with sophisticated software can help. Have your expenses modelled and projected over time. Will your income and assets support your ideal lifestyle or even allow you to enhance your lifestyle?

Now do the math

Once you have a spending plan supported by your income and assets, do the projections showing different withdrawal strategies. You need the spending plan first, because the amount and timing of your spending dictates the withdrawal plan. Plus, detailing your spending gives you a better view behind the curtain to see the impact of spending amounts and frequency on tax and capital changes of different withdrawals. What does spending on things like vehicles, special vacations and renovations mean?

I suspect that as you work through this exercise, ideally with a planner capable of using sophisticated software, you will see that the withdrawal order doesn’t matter too much and can be easily influenced by various assumptions. If that is your result, you are in a good position. It allows you to manage your affairs so you are tax-efficient each year. 

At the beginning of each year, anticipate your spending and natural taxable income sources such as CPP, OAS, RRIF minimum, pension, salary, dividends, etc. Is there an income gap? If so, you can now pick the account(s) that will give you the most tax-efficient result this year and then repeat the next year.  

Donna, developing a meaningful spending plan is probably the hardest part of the process. The withdrawal strategy that follows is just math, best done using software. I will also argue that the real value in using software is revisiting it on an annual basis. That is what instills spending confidence for people concerned with drawing down investments. It also allows you to make minor corrections to accommodate changes in your life. 

Read more Ask a Planner columns:

• Annuity vs. GIC: What makes sense for retiring?
• Which types of pension income can be split with your spouse?
• A parents’ guide to home down payment gifts and loans
• Is now the time for retirees to sell stocks and buy GICs?

About Allan Norman, MSc, CFP, CIM

With over 30 years as a financial planner, Allan is an associate portfolio manager at Aligned Capital Partners Inc., where he helps Canadians maintain their lifestyles, without fear of running out of money.

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