FP Answers: Does it make sense to make early RRIF withdrawals for my 4 kids to avoid tax?

FP Answers: Does it make sense to make early RRIF withdrawals for my 4 kids to avoid tax?

What is sometimes forgotten with RRSP/RRIFs is the real advantage of the tax-free compounding they provide

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By Julie Cazzin with Allan Norman

Q: I am a 64-year-old widow with four adult children who are the beneficiaries of my estate. My pension is adequate for my living expenses. I have $620,000 in registered retirement savings plans (RRSPs), which will be taxed at 40 per cent upon my death. I plan to convert a portion of my RRSP to a registered retirement income fund (RRIF) and withdraw $20,000 annually starting in 2024. I would rather pay tax on this additional income every year.

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As I don’t need the money, I plan to open an investment account with my kids and transfer the assets in-kind, equivalent to $20,000 annually. This way, upon my death, my kids can divide the investment assets in the account equally without having to pay tax. Whatever is left in my RRSP/RRIF will be subject to 30 per cent to 40 per cent tax, which I am aware of. Is this a good strategy? Am I missing something? — Christian

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FP Answers: Your question is fascinating because it’s really asking: “Is making early RRIF withdrawals, or amounts more than the minimum, a sensible strategy for reducing estate tax and leaving more money to my children?” I am thinking this is your real question and it is the one I am going to answer.

I am assuming you have indexed pension income of $65,000 per year, including Canada Pension Plan (CPP) and Old Age Security (OAS) in addition to your RRSPs. The generally assumed inflation rate is 2.5 per cent and investment returns are 5.5 per cent. For illustration purposes, I will also assume you convert your entire RRSP to a RRIF at age 65 and withdraw the annual minimum of $24,800.

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FP Answers table

The accompanying table compares starting your minimum RRIF withdrawals at age 65 and age 72. The results show the estate value going to your children and tax owing at age 90, your assumed life expectancy.

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A few things are plain to see. The type of non-registered investments you choose impacts the estate value even if all three types of investments earn 5.5 per cent. Conservative investors may be better off delaying RRIF withdrawals. Investing more aggressively to earn dividends or capital gains is showing a slight advantage when starting minimum RRIF payments early, but the data assumes a buy-and-hold strategy from age 65 to 90. Chances are, there will be some trades and, at some point, some interest-bearing investments in the portfolio over that time.

Also note that the investment strategy providing the most money to children, capital gains investing, is also the one with the largest estate tax. The bottom line of the table shows the results of drawing enough money each year to deplete the RRIF by age 90, or, in this case, $45,000 per year. Doing this means reducing estate tax, your goal, but it also means reducing the amount left to your children.

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What is sometimes forgotten, or poorly understood, with RRSP/RRIFs is the real advantage of the tax-free compounding they provide. It can make sense to draw money from a RRIF and add it to another tax shelter such as a tax-free savings account (TFSA), but it is difficult to make the case when adding to a taxable non-registered account.

Chrisitan, I am assuming you have maximized your TFSAs. What other tax shelters do you have available? If you are sure you have more money than you need over your lifetime, perhaps it makes sense to start thinking about family tax shelters.

Your adult children may have first home savings accounts (FHSA), RRSPs, TFSAs, registered education savings plans (RESPs), debts and mortgages, and cash-value life insurance, all multiplied by the number of children you have. Potentially, there is a lot of “family money” you can tax shelter.

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Gifting the minimum RRIF payments to your kid’s TFSAs leaves them with a total of $1.73 million on your passing and an estate tax of $241,000. That is about $300,000 more than aggressively investing in a non-registered account seeking only capital gains.

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It’s also important to remember that once you give money to your children, it is their money and out of your control. You may face similar issues if you set up a joint account with your children.

A way to try to maintain some control when gifting to children may be to contact a lawyer and set up a formal loan agreement with your children. In a situation I’m aware of, 10 years ago, a father provided a substantial four per cent demand loan to his son for a down payment on his matrimonial home. The intention was not to collect interest payments, and the loan would be forgiven upon the parents’ death. Fast forward to today, and a divorce is taking place, and the father is calling the loan, with interest.

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Christian, I love that you are thinking about ways to minimize tax. Setting up a joint account with your four children works to some extent, but the distributions will be taxable, your kids have access to the money, it may be exposed to marital break-ups and there may be some tax to pay upon your death. If you decide to ultimately set up the joint account, you will want to talk to an accountant first.

Allan Norman provides fee-only certified financial planning services through Atlantis Financial Inc. and provides investment advisory services through Aligned Capital Partners Inc. (ACPI). ACPI is regulated by the Canadian Investment Regulatory Organization ciro.ca Allan can be reached at alnorman@atlantisfinancial.ca

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