Q&A: “Tax-free” RRIF money

Question: A friend suggested I consider withdrawing from a RRIF early in my future retirement because the first $2,000 withdrawn is tax free. Here is her logic:

Starting at age 65, the first $2,000 of pension income is tax-free. CPP doesn’t count as pension income. Money coming out of a RRIF or an annuity is pension income for this tax deduction, but money coming out of an RRSP is not. You can convert to a RRIF any time (I think after 55) and you don’t have to convert all of your RRSPs at any particular time, until you reach 71. You can convert just some.

So, as far as I can see, it would make sense to set up a RRIF for $20,000, and then draw out $2,000 per year. There is no minimum withdrawal amount before the age of 72 and you can withdraw as much as you want. After six years (age 66 to 71) you’ve drawn out $12,000 tax free. When it’s drawn out, it could then be put into your non-RRSP investments (or spent on a trip to Florida).

Does this make sense, and is it legal? Could you start this before 65 if you retired earlier? – Ross P.

Gordon Pape answers: The strategy is basically correct but some of your facts are wrong. For starters, the first $2,000 of RRIF income is not “tax-free” as you suggest. It qualifies for the pension income tax credit, which means it earns a 15% credit against your federal taxes (worth $300) plus whatever provincial/territorial credit applies. So the only people who would receive the money tax-free are those in the lowest bracket.

You also state there is no minimum withdrawal from a RRIF until age 72. Again, this is not correct. The minimum becomes effective in the first year after a RRIF is set up. The formula for calculating it is different up to age 71, however. It is the value of RRIF at the start of the year divided by 90 minus your age on Jan. 1. So for a 65-year-old with $20,000 in a RRIF, the minimum withdrawal that year would be $800. There is no maximum.

But those are technical points. The idea itself is valid and is used by many people. As you correctly point out, you don’t need to convert all your RRSP assets, only enough to take advantage of the pension income credit.

To answer your last question, no you cannot do this before age 65 except in certain limited circumstances. Check the the Canada Revenue Agency website for more on that.

Do you have a money question you’d like to ask Gordon? Send it along and then check out our Q&A section regularly to see if it was chosen for a response. Sorry, we cannot send personal answers.