Timing RRSP withdrawals

Q: I am retired and I am 68 years old. I have about $92,000 in RRSPs. I also have a very good pension. I would like to take some money out of my RRSP to replace the roof on my house. I have about $7,000 in unused RRSP contributions this year. Can I use that unused amount to offset the amount of tax I will pay if I take out a lump sum for my roof?—Kate

A: Due to the pressure to contribute and the appeal of a tax refund, many Canadians end up with most or all of their savings in RRSPs, especially in retirement. So when you need cash, your options can be limited.

With respect to your $7,000 in unused RRSP contributions Kate, you can deduct these against your income this year or in future years. This assumes you have $7,000 of RRSP room and you’re not overcontributed to your RRSP.

Unused contributions are contributions that you have made, but not deducted, in previous tax years. They can be deducted at any time, up to your RRSP limit, so it has nothing to do with taking an RRSP withdrawal. So you can generate a $7,000 tax deduction, Kate, regardless of how you decide to fund the roof repair.

One thing I’d like to point out is that whether it’s this year, for the roof, or in the future, for another purpose, your RRSP withdrawals may result in more tax than you may otherwise think. This is because Canada has graduated marginal tax rates, so that as your income rises, you may go into another tax bracket and be paying tax at a higher rate on that additional income. Even more importantly, after the age of 65, you may be subject to an effective tax by way of a clawback of your Old Age Security (OAS) pension.

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If you’ve lived in Canada for at least 40 years after the age of 18, your OAS will be the maximum $563.74 per month in 2015. If your net income on your 2015 tax return exceeds $72,809, your Old Age Security gets “clawed back” or taxed at 15% of the amount by which your income exceeds this threshold.

Given that you have a good pension, Kate, let’s imagine you’re receiving $60,000 of pension income, plus let’s estimate CPP of $10,000 and maximum OAS of $6,765. Every incremental dollar of RRSP withdrawals, ignoring any deductions, will be taxed at 33% or more on our estimated $76,765 of income if you’re in Ontario. But because you’d be over the OAS clawback limit on your net income, you’d also pay an additional 15% tax via a clawback of your OAS. So a dollar of RRSP withdrawals would be taxed at a minimum of 48% and as much as 58%.

It’s important that retirees are aware of this. If you can take early RRSP withdrawals to ensure that your post-65 income is less impacted by OAS clawback, you may pay much less tax over your life at the expense of a little bit of tax today.

In a case like yours, Kate, I’d be inclined to consider your future cash flow. In other words, is this just an isolated year where your pension won’t cover your expenses?

If you can take a $7,000 withdrawal this year—or any amount—and offset it with a $7,000 previously undeducted contribution, I think it’s a reasonable idea. I suspect your roof won’t cost too much more than $7,000, depending on the size.

Going forward, try to assess if you’re better off covering extraordinary expenses with RRSP withdrawals or even a line of credit (ideally secured by your home at a low interest rate). Ignoring the unused RRSP contributions, if you take a $10,000 RRSP withdrawal, you may pay tax of 48% and be left with only $5,200 after tax. You then give up a likely mid-single digit return on that money growing in your RRSP going forward. If you instead take a $5,200 line of credit withdrawal, the interest may grow at a mid-single digit rate as well. It might be better to pay 5% interest on $5,200 than give up a 5% return on $10,000 in order to get the same $5,200 after tax. In other words, despite the taboo of carrying or incurring debt in retirement, if one’s income is high, I think they need to at least consider the potential of using some debt to avoid giving away 50% or more of an excess RRSP withdrawal. Especially if you’re in a home that you may downsize at some point during your retirement, this may be a strategy to consider.

You don’t have a huge RRSP to begin with, Kate, given you were in a pension. I’m guessing if you can cover your expenses now from your pension, when your RRSP withdrawals are forced to begin at 72, you’ll just have that much more cash flow. In the long run, that may depend on whether your pension is indexed or not.

I think the key at any age or stage is trying to assess the pros and cons of where to deposit or withdraw your savings from. A long-term retirement plan is a good way to do it at any age. But in the short-term, an RRSP withdrawal to be offset with unused contributions is a good tax and cash flow strategy for you.

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Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.

About Jason Heath, CFP

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.