The Registered Retirement Savings Plan (RRSP) makes up a substantial and important chunk of many Canadians’ retirement funds. However, RRSP withdrawals are counted toward your taxable income.
Generally, Canadians have higher tax brackets during working years than in retirement years. Therefore, you’d want to contribute to your RRSP accordingly during your working years to reduce your immediate income tax, particularly during the years when you’re in high tax brackets.
When you retire, you should be in a lower tax bracket. However, it would be outright silly to take your RRSP and withdraw it as cash all in one go, as you’d receive a humongous tax bill from the Canada Revenue Agency — and you’d be tempted to blow up your budget.
In the year you turn 71, you’re required to close your RRSP by the end of that year.
In any case, converting the RRSP to a Registered Retirement Income Fund (RRIF) is a perfect solution that allows you to take systematic withdrawals while growing the remaining retirement fund balance in a tax-deferred environment.
But take note that you can’t make any contributions to your RRSP once you convert it to an RRIF. RRIFs are strictly for withdrawals, as its purpose is a retirement income fund.
RRIF holders at age 71 are required to make a minimum withdrawal of 5.28% of the account balance. This rate goes higher over time. It starts at 4% at age 65 and goes up to 20% at age 95 and older.
With the nitty-gritty out of the way, here’s how you can materially reduce your overall income taxes from RRSP/RRIF withdrawals with this little tip — withdraw more than you need during market corrections.
Save massive taxes in market corrections
For RRIF holders, it’d mean withdrawing more than your minimum withdrawal rate. For RRSP holders, this strategy could only make sense if you’re in a low tax bracket during the year of a market correction (and you expect to be in a higher tax bracket in the future).
The idea is that you can transfer in kind from an RRSP/RRIF to another account, such as your Tax-Free Savings Account (TFSA) or non-registered account. (Just make sure you have sufficient contribution room in your TFSA so you don’t get tax penalties.)
When you transfer in kind, you’re transferring your investments as is. If you’ve held your RRSP/RRIF stocks for a long time, they would likely be sitting on gigantic gains.
As a simple example, you could be sitting on a 10-bagger before a market crash. If the stock falls 50%, you would be sitting on a five-bagger instead.
In summary, during market corrections or crashes, it may make sense to withdraw more than you need to save taxes on those capital gains — the idea being that stocks will make new heights when the market recovers. And that five-bagger stock will become more than 10-bagger stock once the market recovers.
One more thing
As they say, the devil is in the details. There’s withholding tax when you withdraw from an RRSP before retirement. The same tax is only applied to RRIF withdrawals that exceed the RRIF minimum withdrawals for retirees.
The withholding tax is 10% for amounts that are $5,000 or less, 20% for amounts more than $5,000 to $15,000, and 30% for amounts more than $15,000. Notably, the tax is different for residents in Quebec.
As you can see, this tip of withdrawing in-kind during market corrections or crashes has the potential of providing you massive tax savings. However, it can get complicated really quickly.
It’s therefore best to seek professional advice from a certified financial planner to see how this tip may work for your unique situation.
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