Retiring in Canada - Part Two: How Success in an RSP is a Double-Edged Sword

Once during my financial management class in college, we were working on a project that involved building a mock financial plan for a family. My teacher, a former financial planner, told the class a short story about a client who had a very rare problem with his RSP. He had too much money.

You might be asking, how can having too much money create a problem? The entire class raised their eyebrows at this too. When you're a student, having barely enough money is a common problem, but having too much is unfathomable. The problem for the doctor was that his minimum RIF withdrawals well exceeded his needs. Subsequently, these large withdrawals also trigger that second certainty in life - taxes.

My teacher never gave us real figures, obviously for privacy reasons, but his withdrawals requirements were so large, he was paying more in income tax than he was using for all his expenses. It would be like withdrawing $100,000 a year from the RIF, paying $45,000 in taxes, but only being able to spend $40,000! Withdrawals from the RIF accounts are treated as income, even if they were earned as capital gains or dividends.

The problem that the doctor encountered is symbolic of most Canadians and their level of financial education. You see, during our working life, we are bombarded with the benefits of an RRSP: a tax refund and a tax shelter are the two main talking points. But who here actually knows what happens when it is time to take it out? Or better yet, do you even know what a RIF is?

At the age of 55, every citizen has the option to change their RRSP (contribution account) into a retirement income fund account (RIF). The RIFs work in reverse of an RRSP, requiring minimum withdrawals every year. You can make these monthly, quarterly, or annually. At the age of 55, the minimum withdrawal amount is 2.86%. At 65, it is 4.00%, and at age 75, it is 7.85% (see full table courtesy CIBC Wood Gundy website).

As we get older, the minimum increases to allow for an expected drop in capital from withdrawals and to allow the account to collapse on its own. The main problem the doctor had was that his plan lacked clear direction and was ill-informed about the withdrawal process. This is why it is important for Canadians to sit down with a well-trusted advisor who can create a strategy that factors in both the contributions you can make today and how much you will need at retirement. It is even more important to review these goals and make sure you are still aligned with them. Consider new events, new retirement plans, new income needs and discuss this with your advisor.

The truth is, probably only a dozen of my friends will read up to this point and will take this tip into consideration, but how many of you will actually talk to your planner (or me if you really want) next week about this? In Part One, I tried to emphasize on early savings habits to fulfill your retirement needs. This week, I'm hoping to make sure you get a real plan in place before you realize that it may be too late.

For the doctor, he is probably unhappy that he has to pay more taxes than he can even spend on himself. He could have probably saved a little less while he was younger and spent it on his family, on trips, luxuries, or donations. But all of this could have been avoided if he had a good plan with a good advisor guiding him every step of the way.