Cashing out RRSP | RRSPs and RRIFs | Discussion forum

That may not have been a good move.

RRSP is close to a TFSA when the taxation of the RRSP withdrawals is close to the tax rate saved by the RRSP contribution deductions. We had a previous discussion about that.

RRSP is the same as a TFSA when the tax rate plus any clawback rate on the RRSP withdrawals is the same as the tax rate when the RRSP contribution are deducted.

Odds are that OP did the right thing, but it depends on knowing more details about your situation. There are a great many factors involved, and much depends on your individual situation and future unknowables. i"m glad I finally got rid of mine last year; no more unknowable tax liability, transfer fees, crappier GIC rates, worry about effect on OAS , and a lot more flexibility. For these and other reasons, the best deal for me. Don't be confused by recommendations about what you should do or should have done; it's a complex assessment involving many factors that most people aren't fully aware of before they retire. Generally, most FIs will promote them for everyone because they bring in long term deposits.
Many people now prefer TFSAs. If you have extra to save, there are lots of options outside of RSPs, and some will likely be preferable.

Note that withholding "penalty" is actually a prepayment on the tax you will be assessed that year; it is not a fee. If you took out over 15k from the RSP and had a low income for the year, you will likely get some of it back in the end.

I didn't contribute to RRSP until about mid-way through my career, when my salary was taxed at marginal 40% rate. Even then, I only contributed what my employer did match, which were about 3% of salary. It was like getting extra 3% of income from employer, made sense.

Then, it were the day when corporation I worked at downsized near the year end, and termination bonus I've got for 10 years working there were in the amount of my at that time annual salary. Paid in November-December same year I were terminated, in full.
That made my income double the usual, with marginal rate of over 50% for that tax year. This is when I took a lot of my unused RRSP contributions to match my extra annual salary, and more.
My tax refund was huge. It were delayed by 2-3 weeks comparing with other people returns I helped to file that year. Must have been some extra approval required at CRA.

After that, kept working at good jobs with marginal tax rate of above 40%, contributed diligently to RRSP.

Now I am taking from RRSP, at average income tax rate of 15%.

I think that by a bit of luck I managed to get from RRSP maximum I could.

The RRSP can still be worthwhile even if the tax and clawback on the withdrawals are a bit higher than the tax rate when the contributions were deducted.

A case earlier has contributions deducted from 25% to 40%, averaging 32½%, and withdrawals taxed at 40% on average. Net tax on the gains is 16.05%, about half the 32½% they would be taxed at outside the RRSP, as if the gains were capital gains with a ½ inclusion.

if one already max out TFSA and currently still working and at a high tax bracket, I just don't see how RRSP contribution can be a bad idea under any circumstances.
Of course if one's ultimate goal is to try to maximize GIS, OAS, one can purposely try to have the extra cash earning zero return I suppose. And that makes even less sense to me...

mordko said
RRSP is a very good pot to have despite of what some people on the internet say. Can be circumstances when one might want to stop contributing and times of need when withdrawing puts dinners on table but purposefully destroying/“melting down” one’s RRSP pot is unlikely to be efficient.  

I agree it is highly unlikely in a vast majority of situations BUT if one needs cash flow pre-taking OAS and CPP at age 70, it may not a bad way to disproportionately fund one's cash flow needs between retirement and age 70 with RRSP/RRIF withdrawals. It depends on the various cash flow streams, marginal tax rate, and the size of an RRSP relative to other investable assets, particularly if one falls into OAS claw back territory when OAS payments start. It is situational.

Overall, RRSPs do get a bad rap on the net. Too many have short memories of the value that has been extracted through all the years of contributions and deductions... as a DB pension plan alternative, which is what it was essentially designed to replace.

Alexandre said

Very much in agreement with that position. Case study: myself.

Age up to 55
Maxed TFSA contributions
Maxed RRSP contributions when my marginal tax rate exceeded 40%
Have solid savings
Debt free (mortgage paid, no car loans, no credit cards balance)

Retired at 55, no employment income since then.

55-65 (currently in this age bracket)
Taking just enough funds from RRSP not to exceed 15% annual income tax rate
Using funds from non-registered savings to cover remaining of living expenses
Contributing maximum allowed to TFSA from non-registered savings (reduces interest income tax, albeit slightly)

65-71
Will apply for OAS+GIS
Will use funds from non-registered savings to cover remaining of living expenses
Will NOT take funds from RRSP (this will lower taxable income and maximize GIS)
Will contribute maximum allowed to TFSA from non-registered savings

71 ->
Will apply for CPP
Will convert RRSP to RRIF and start making minimum required withdrawal
Will not be eligible for GIS with the above income
Expect CPP + mandatory RRIF withdrawals to cover loss of GIS
Will use funds from non-registered savings to cover remaining of living expenses. When/if these are depleted, will start taking from TFSA

--------------

Is there any flaw with that plan you can point at?  

Looks logical to me but I don’t think its possible to truly optimize a plan like this without a little modelling. Its just too complex and the best path forward depends on returns. Also, a lot depends on amounts in each pot and your objectives.

I plan to play with MoneyReady App when the time comes (I am 55 and for now enjoy working). That software does Monte Carlo simulations for future returns, so you can optimize withdrawals from each pot accounting for uncertainties.

You can also do this type of modelling with a spreadsheet but using explicit assumptions rather than ranges for returns. I did that.

usephrase said

Can you please explain why you optimize a plan like this?
I understand in order to be eligible for GIS, have to postpone CCP and RRSP withdrawal until 71, but why will this plan maximize the benefits ? why did you separate in group of 65-71 and 71 -> ?  

Alexandre split it into these periods, so you should really ask him/her. I suspect 65 was picked to start OAS and GIS and 71 because of the forced conversion to RRIF and minimum withdrawals. CPP will have to start at 70 but its close.

I don’t know if that particular plan will maximize the benefits; depends on amounts in each pot, returns, withdrawal rate, plans to leave inheritance (or not), etc. This plan is designed to maximize GIS over a 5 year period which might make sense financially but there are other considerations.

Loonie said

The only tax advantage you get from an RSP is the deferral on tax on your contribution; when you cash it, you will always be taxed at your highest marginal rate.  

It's the other way around. When you put money into an RRSP you typically get tax refund at your marginal rate. When you withdraw from a RRIF, you pay tax at your average rate.

Also, deferral in itself is a massive advantage over non-registered investments. The latter lose money to tax not just once but annually (on dividends and interest), so even if your average tax in retirement is the same as your marginal rate when working (unlikely), RRSP still wins.

There are other tax advantages which an RRSP provides. For example you can use RRIF for pension tax credit. And RRSP gives you flexibility to rebalance your investments without paying capital gains. Can’t do that in a non-reg account.

There are other issues with some of the claims. Saying “very low tax on the income for life” for a non-reg annuity is technically true. Then again, Its similar to saying “you can pay high taxes on your salary, put cash in a box and then pay zero taxes on taking money from the box”, but missing out the front part. It’s important. You pay low tax rate on annuity income because much of it is return of your already taxed cash.

Claiming loss in non-reg allows you to offset it against gains; tax loss harvesting allows to defer capital gains. Within RRSP you don’t need to bother with loss harvesting; all taxes are deferred anyway.

Loonie said
Whether it is marginal or average rate depends on how you perceive it. I perceive that, since the RSP was optional, you decided to add its income to your tax liability from other sources, thus it is marginal.
You have chosen to minimize how you perceive the RSP's tax burden by bundling it into all tax owed

 

Let's put it another way to avoid “perception”. We are comparing two strategies for funding retirement: with and without the use of RRSP.

During working years you are clearly getting RRSP tax refund at your marginal rate. If you are contributing a lot, it could be “averaged” over several tax brackets, starting with the highest but using the strategy properly, you are limiting contributions to one or (at most) two tax brackets.

When you are withdrawing in retirement situation is similar. You are right that when comparing 2 strategies, RRIF income for the RRSP strategy is optional so it's “added” to other sources and is therefore marginal. Again, it's a blended rate between several tax brackets.

However RRSP strategy involves contributing over your working life and investment growth over many decades which makes up most of the RRIF pot. RRSP strategy used properly means that annual contributions are much smaller than withdrawals. For this reason in practical terms in retirement you should be averaging over multiple tax brackets and your blended marginal tax rate should fall into a lower average tax bracket. That's a properly executed RRSP strategy.

The other scenario involves less income, smaller rrsp pots and then you are trying to withdraw small amounts so your marginal rrsp tax rate is below your working life marginal tax rate.