Q&A: Draw down RRSPs?

Question: Please give me some advice about my situation. I am 57, retired with a pension, have RRSPs and savings. I was thinking of starting to draw down my RRSPs ($10,000 annually) to minimize the total tax on the RRSPs including the final tax (estate tax), which would occur in one tax year. Is this a good idea or do you believe it would be better to spend my non-registered savings first? – Ed D.

Gordon Pape answers: Stop and think about what you are saying. You are proposing to pay tax on your RRSP savings many years before you have to, in the hope (not the certainty) that you’ll end up paying less tax in the end. It seems a lot of people are thinking the same way. I suggest that in most cases the strategy is deeply flawed and will actually end up costing you more.

For starters, you don’t have to draw any money from the RRSP for another 15 years (the year after you turn 71). That means you will lose years of tax-sheltered compounding for every dollar you withdraw prematurely. If you currently have a marginal tax rate of 30 per cent, you will effectively be depriving yourself of 15 years of growth on $3,000 when you make that first year withdrawal of $10,000. At a 5 per cent average annual compound rate of return, that $3,000 would more than double to $6,237 by the end of that time. Even if your marginal tax rate were higher at that point you would still come out well ahead.

And how do you know it will be higher? With 15 years of bracket creep due to inflation, you could be paying at the same rate or even less by age 72. As for the final year, there is no estate tax in Canada. If there is no surviving spouse, your RRSP or RRIF would be deemed to have been cashed in the year you die and the money will be included in your final tax return. If you live a long time, there may be very little left.

As far as I’m concerned, it’s never a good idea to pay taxes sooner than you have to — especially 15 years sooner!

Photo ©iStockphoto.com/ Feng Yu

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