Tax Planning and Additional Withdrawals from Registered Accounts
by Jim Steel, CFA, CFP
When the holder of a registered account (RRSP, RRIF, LIF, LIRA, etc.) dies, the assets can usually be transferred to the surviving spouse without any tax implications. However, when the final holder of a registered account dies, the assets in the account will be taxed in the year of death as if all the income were received in that one year. If the registered plan is sufficiently large, or if the estate has other income, this could lead to the registered account assets being taxed at the highest combined federal and provincial marginal rates. In Ontario, the highest combined federal and provincial tax rate is 53.5%. This may result in a tax payment of more than half the value of the registered account.
When the holder of a registered account turns 72, they will be forced to make annual withdrawals from their account. If the registered account is large, these forced payments could lead to very high rates of tax owed. It could also lead to a claw back of Old Age Security (OAS) benefit.
Holders of registered accounts should reduce the value of their accounts while they are in a lower tax rate (and still living) by making larger than required withdrawals each year.
Two things to watch for when doing this:
- Holders of registered accounts should make sure they do not put themselves into a situation where the taxes paid on these withdrawals is greater than the average tax rate at death.
- Holders of registered accounts should make sure they do not cause the claw back of OAS. In tax year 2019, this begins gradually when net taxable income reaches $77,580. After this, OAS is clawed back by the rate of 15% of benefits received above $77,580. For example, an additional $10,000 in income above $77,580 will lead to 15% of $10,000, or $1,500 in OAS claw back. By the time net income reaches $126,058, the OAS would be fully clawed back.
Keep in mind that once a holder of a registered account takes money from an account, they will need to pay tax on the earnings generated each year. This means the benefit of tax-deferred compounding within the RRSP is lost. However, this can be mitigated by investing this money in securities such as ETFs or index-style mutual funds (e.g. Dimension Fund Advisor funds). These types of securities typically defer a large portion of their capital gains into the future (similar to a registered account). When these securities are eventually sold, only 50% of the gains are taxable. Had these been left in the registered account, 100% would be taxable upon withdrawal. Also, these types of securities pay dividends each year. Dividends from Canadian corporations usually benefit from the dividend tax credit – which may mean even less tax to pay. In addition, if the individual has any unused TFSA contribution room these withdrawals can be sheltered (up to the contribution limit) inside a TFSA account. Then, when a withdrawal is made from the TFSA account, there are no taxes to pay.
Taxes can be complicated. Always check with a tax professional before making any final decisions.