Dangers of keeping an overly large RRSP in retirement

BY FAZAAD BACCHUS

Having an RRSP is probably one the best retirement decisions that you will make. It will provide you with peace of mind and money, something to depend on in your retirement years. There is nothing quite like this peace of mind and knowing that you do not have to depend on any one for handouts during your golden years is quite invaluable. As a result many, if not most Canadians save vigorously in their RRSP and the most important thing during the accumulation phase is the growth of this savings plan. But when is it a possibility that have having a large RRSP may actually not prove to be at an advantage?

It’s all about timing. Let’s consider what the tax implications are for a RRSP. When you save in an RRSP you are actually deferring taxation, which means that you have to pay it later on. The idea is that you save taxes on large income during your working years and pay little tax on small income when you retire, a very good tax strategy. However what happens when a person passes away and has a large amount money in their RRSP? If that person is married, it can be rolled over to the spouse on a tax free basis, or if that person has a disabled child it can also be rolled over tax free.

But if the deceased person has neither of these types of beneficiaries then the entire amount of the RRSP is a deemed disposition on the year of death and taxes are calculated on that amount. So for example, a person passes away with a $200,000 RRSP and has no spouse or infirmed child, taxes of approximately $90,000 has to be paid back to CRA, leaving the beneficiaries with just about $110,000. There is no way to avoid the repayment of this tax bill.

So here is the million dollar question…should the deceased have taken out  more money each year at lower tax rate rather than leave it all and pay the higher rate on death. Well the answer depends on something financial advisors refer to as the cross over point. You should withdraw as much as possible each year below the OAS claw back threshold so that you do not interfere with your government benefits. However withdrawing that amount from your RRSP does not mean that it is to be spent, it only means that it is to be withdrawn.

The secret is to withdraw your money at an average tax rate lower than the rate you saved at, and then re-invest  the withdrawals. Usually retirees, now short of income do not save in a TFSA, and this provides an amazing opportunity to pass money over to any beneficiary tax free. Most retirees are worried about outliving their money and therefore withdraw as little as possible to keep the funds as intact as possible, but if they were to pass away, a large portion of it will pass over to CRA.

This decision of whether to withdraw or not, or how much to withdraw is not an easy one and requires the help of your financial advisor. Sit with your advisor, discuss your family relations, your expected life span and he will help you to make the right decision.