Taxes or not – why the RRSP rocks
The RRSP is a kick a$$ retirement account for these two main reasons:
- There is a tax deduction for your contribution, and
- There is tax-deferred growth.
With your tax deduction you can reduce the taxes you pay today.
With tax-deferred growth investments can grow over time without being taxed as long as the money made stays in the account.
For most Canadians, to reap the benefits of this tax-deferred account, they should consider maximizing their RRSP contributions in their highest income-earning years when they have a plan to withdraw RRSP/RRIF monies when they are in their lowest income-earning years (likely retirement). This is because when you take money out of the RRSP you will likely have to pay income tax on the money withdrawn.
Now to the question: Can you have too much in your RRSP?
When it comes to the OAS clawback, absolutely.
However, at Cashflows & Portfolios, we believe having an OAS clawback concern to navigate is an excellent problem to have!!
Instead of a cash flow issue in retirement, you have a tax issue.
In our opinion, having to navigate the tax system with more efficiency in retirement is absolutely a great problem to have, all other things being equal. Assuming you have your health, tax issues really come into play for higher-income earners including those in retirement.
We’ve worked with a few clients this year, who have an objective to avoid OAS clawbacks as much as possible. We don’t blame them and we’ve been happy to help them map out what is possible.
To illustrate this point, see below for an example and real-world work into OAS clawback issues.
Maximum RRSP values to avoid OAS clawback
Given you can have a number of income sources in retirement, the decision about when to draw down your RRSP/RRIF can make a HUGE difference in OAS clawback avoidance. Such decisions need to be coupled with any of the following retirement income sources in particular:
Government Benefits (CPP and OAS)
For some individuals, who have lived and worked in Canada for the better part of their careers, they may receive about $15,000 per person or close to $30,000 per couple from CPP and OAS when combined. That’s a great base for any retirement income needs. In fact, that base could be more if CPP and/or OAS are deferred benefits to age 70.
Make sure you read up on these pillar posts:
Defined Benefit (DB) or Defined Contribution (DC) Pension Benefits
For some individuals, beyond just working and living in Canada, they might have been very fortunate to have participated in and contributed to either a DB or DC pension plan from work. In fact, when it comes to some federal government employees, in particular, some of these workers may expect to receive upwards of 60-70% of pre-retirement income from their DB plan alone!
If you expect a modest let alone a large workplace pension in retirement, the typical tax-efficient recommendation is to build up your TFSA before topping up your RRSP. We agree with this logic and it may be especially true if your spouse/partner also has a workplace pension as well. Lucky you!
Again, if your net world income exceeds the OAS threshold amount ($79,054 for 2020), you have to repay part of your entire OAS pension (15% of every dollar that exceeds the threshold). So, assuming you and/or your spouse/partner want to maximize OAS, you will need to stay under this individual income threshold.
Using our Projections Tools, let’s look at an example of how much money is too much inside your RRSP?
Sally works in the technology sector in Waterloo, Ontario, Canada. She is currently single, and a great saver. Since she is in a higher tax bracket, she realizes the advantages of putting as much as possible in her RRSP.
Here are the details:
- Age: 41
- Province: Ontario
- Salary: $120,000 (increasing with inflation annually)
- RRSP Balance: $200,000 (100% equities pre-retirement; 60% equities/40%fixed income during retirement)
- TFSA Balance: $0
- Non-Registered Balance: $0
- No DB pension
- No Debt
- CPP: Assumed pushed to age 70, assuming she qualifies for 80% of maximum at age 65.
- OAS: Lived 40 years in Canada, so assumed maximum (minus OAS clawback)
- Goal Retirement age: 65
- Goal Retirement Spending: $50,000 after-tax and increasing with inflation annually.
- Inflation rate: 2%
- Cash return: 1.5%
- Fixed income return: 2.5%
- Equity return: 6.5%
As you can see, at 41, she has already done a great job at building her RRSP. With a recent promotion at work, she now has the capacity to max out her RRSP every year until the age of 65. However, is this the best financial move to make? Will she have “too much” RRSP when she retires at 65?
The results of maxing out her RRSP every year ($21.6k/year increasing with inflation):
To start, Sally will be able to easily meet her goal of spending $50k annually (after-tax) starting at age 65. In fact, the projections show that her net worth will continue to grow over time with an after-tax estate value of a whopping $3.9M at age 100 (or $1.2M in today’s dollars) – check out the chart below.
Assuming Sally continues to max out her RRSP every year, at age 65, Sally’s RRSP will grow to approximately $2M at which point withdrawals will start to fund her day-to-day expenses at her desired retirement age. Everything is pretty smooth until she reaches age 72 where her RRSP is forced to be converted to an RRIF (which comes with a set withdrawal schedule).
With such a large RRSP/RRIF balance at age 72, the mandatory withdrawal schedule results in a taxable income that crosses into OAS clawback territory. At age 72, in addition to income tax, over 40% of her OAS is clawed back. By age 100, her total OAS collected will be approximately $458k.
Is there a better way? Yes!
Sally is happy that she can meet her spending goal, but with Sally’s career, she is focused on efficiency and she is wondering if there is any way to reduce the OAS clawback if she were to make changes today?
Since Sally still has a lot of time until retirement, there is one major change she can make that will make a significant long-term difference in the amount of OAS she collects over her lifetime. What change is that? She should consider maxing out her TFSA first, every year until retirement, then putting the rest of her savings towards her RRSP. This will help keep her net worth growing (tax-free) while helping to reduce her RRSP balance (i.e., in a tax-deferred way) when it comes time for RRIF withdrawals.
In addition to reducing OAS clawback, the main benefit of this strategy will result in a much larger final after-tax estate value of $5.77M (vs $3.9M). If a larger estate value is not important, this also means that she can spend much more during retirement using this strategy including money that is tax-free and not income-tested against benefits like OAS.
So how much OAS will Sally collect over her lifetime? With this strategy, she will collect a considerable amount of OAS benefit income: $612k in OAS by age 100. That’s almost 34% more OAS just by making one change to where she puts her savings and investments first.
Can you have too much in your RRSP Summary
Everyone has different retirement income needs and wants. Common questions related to retirement drawdown options seem endless:
- What registered accounts do I draw down first?
- How much income will my investments generate?
- Do I have any idea how long this income might last?
- What amount of taxes will my RRSP withdrawals incur?
- When should I take my workplace pension?
- Is it more beneficial to draw down non-registered money before RRSPs and TFSAs?
- Can I avoid OAS clawbacks?
- And much, much more…
At the end of the day, based on our experiences with clients and looking at our very own portfolios, having a nest egg in your 50s and 60s that forces you to navigate the tax implications of your RRSP/RRIF to avoid any OAS clawback is a great problem to have.
What do you think? Can you have too much money in your RRSP? Is this a good or bad problem to have?