Preparing to Take Assets Out of RRSP

Early in the year, we talked about taking time to think and analyze the possibilities surrounding future withdrawals from our investment accounts. In the initial stage, our reflection concentrated on questions like how? And how much? At this point, we will sadly report that our efforts have not significantly paid off. We have not demystified the 4% rule yet. Neither did we develop or stumble upon a better alternative.

All that analysis still eventually oriented us towards the when?

Too Much RRSP May Equal Too Much Tax

As a result, we recently discovered our RRSP value may be too high and are now considering withdrawing money from it sooner than expected. In that context, it looks like we will deregister an important portion of our RRSPs to avoid future tax problems. Essentially, we discovered that too much money in our RRSPs may result in paying a lot more tax later in life or having a big tax bill attached to our heritage, mostly destined to our lovely daughter.

We will admit having too much money is a good problem to have. But it’s important to start taking measures now to possibly avoid wasting an important chunk of it later. With retrospect, investing more in TFSAs instead of RRSPs would have been a better choice, from a fiscal standpoint at least. Fortunately, it’s not too late for some type of gradual rebalancing.

Our RRSPs grew up faster with larger contributions and higher returns than projected. In that regard, part of the credit can be attributed to our successful DIY investing approach.

Changes in our pension plan conditions also greatly impact our future financial situation. Unfortunately, planning for an early retirement kind of goes against the grain. Consequently, we made very conservative assumptions during the last round of negotiations as initial talks amputated pension benefits by almost half for early retirees like us.  

The final agreement was better or less bad than anticipated, we will only lose about 10% of our retirement payouts. Again, this will probably end up generating additional taxable income later.

With all those factors combined, the perspective of paying more tax during retirement than in active life unexpectedly becomes very probable.

As an example, you can see from the Leaving Money in RRSP Chart that, just a 100K$ portion accumulated in your RRSP today, at 45, could generate a nasty tax bill of more than a million bucks 40 years down the road. RRSPs can be a great tool to avoid paying taxes now as it differs your fiscal obligation. But if your ultimate tax rate is high like in this example at 50%, you might end up paying a big chunk of that deferred tax back.

Now that we know we are going to take money or stocks out of our RRSPs, it’s time to explore related technicalities.

Gradual Transfer to Tax-Friendly TFSA

Let’s briefly get back to how much? Projecting income and corresponding tax levels over an extended period is far from exact science. You can still have a general idea of fiscal implications and take actions that should improve the situation.

We will spare you from too-much boring details. Let’s just tell our overall strategy will be to try, every year, to take my income up or close to the basic tax bracket. That federal tax level is 45916$ for 2017. Corresponding provincial tax levels in the same vicinity are for instance, 42201$ for Ontario and 42705$ for Quebec in 2017. That should be sufficient to gradually bring down my RRSP balance and avoid possible future juicy tax bills.

Taking money out of RRSPs has fiscal implications you should not ignore. For one thing, in our familial context, we will be extra careful about only withdrawing from my regular RRSPs, not any of our spousal RRSPs as my wife may contribute to them again. The same way, we made sure to properly separate RRSP and spousal RRSP accounts to prevent attribution tax rules from applying. Under the attribution rules, inadvertently withdrawing from any spousal RRSP within 3 calendar years of last contribution would mean it will be taxed in the contributor’s hands. In our case, it would mean paying a lot more tax on my wife’s much higher salary. 

To follow up on our initial example, the Gradual Transfer from RRSP to TFSA Chart presents a better alternative. Despite more fees, paying taxes of only 30% on withdrawals from 45 to 65 would result in accumulating over 400K$ more. Cumulative taxes would only be 62746$! A lot better than the previous million… 

This rudimentary example is quite similar to our situation as my taxable income should remain relatively low as I should continue to work less in decades to come. The real key is the difference in tax rates: 30% with a low salary now versus 50% with higher revenues in retirement or after death. 

Note that we suppose TFSA contribution room would be sufficient. It’s not that big of a reach contributing 10K$ per year for a couple as we each should be entitled to contribute at least 5500$, the current 2017 TFSA additional contribution limit.

Also note that with such a tax gap (30% vs 50%), gradual transfer to unregistered accounts still would be a better choice than RRSPs. Again, the tax gap is the key and those alternatives would lose their advantage if tax levels were equal or lower in retirement.

Beware Negative Short-term Pitfalls of Selling Stocks

The next hurdle, somewhat major, in to have enough liquidity to cash out from RRSPs. Assets invested in stocks are not as easily accessible. In that context, being forced to sell some positions may pose a problem.

We would have to conciliate short-term stock gyrations with our long-term investing approach. We’ve always said we consider investing (long-term stock trading) a healthy financial exercise but speculation (short-term stock trading) a dangerous financial endeavor. Withdrawing from your investment accounts can hazardously pull the spectrum towards short-term operations.  In some circumstances, it can force you to unwillingly sell a fallen stock or another one on the verge on an impressive rise.

It’s never a good thing to go against the stereotypical yet very true adage «buy low and sell high».

In practice, we don’t really need to get a hold on that money. We only wish to transfer it out of RRSPs to remain as tax efficient as possible. So, we are now looking for the best way to retain these still-very-adequate stocks in the process.

But any way you look at it, there will be a short-term tax cost associated with deregistering these RRSP funds. There’s no real possibility to get around it.

Fortunately, we have plenty of liquidities we can use to settle these deregistration tax bills. Regular dividend payments will also help. With that cash, we won’t be able to acquire additional shares of our favorite stocks like we usually do but at least, we should manage to keep the ones we already have and cherish.

Technically, it’s possible to transfer stocks in-kind (actual shares not transformed in cash) from an RRSP to a TFSA. That maneuver will still trigger unavoidable conditions like generating TFSA contributions and paying withholding tax on RRSP withdrawals.

Under these requirements, TFSA contribution room must be sufficient and your broker will have the obligation to send money to the governments to cover RRSP withholding taxes and that’s where in-account liquidities are crucial to avoid automatic selling of other positions (you may not know or have control on which ones) to cover these costs. You also have to realize that the final amount you pay in taxes will be adjusted when you file your taxes the following spring.

Be careful about instructions you give your broker because taxes will be included in your total withdrawal amount. For instance, you don’t want to transfer 10K$ worth of stocks and end up paying an additional 3K$ in taxes (it goes directly to the fiscal authorities and you won’t directly get your hands on it) for a total of 13K$ if you only wished to deregister 10K$ (stocks valued just under 7.7K$ would do the trick in this case).

To some extent, you may lack control if you transfer stocks directly between your RRSP and TFSA. For instance, you won’t know the exact value of your stocks when the transaction is triggered. This will affect actual TFSA contribution and precise RRSP tax withholding amounts.

Even though it’s not major, because of that reduced control, we are tempted to accomplish the transfer ourselves, kind of manually. Isn’t having more control what DIY investing is all about?

Not necessarily in that order, we would sell the desired stocks in our RRSP, make RRSP withdrawal in-cash, make corresponding deposit in our TFSA and buy the equivalent stocks in our TFSA. This technique would also give us extra latitude as amounts would not have to exactly match. It could also give us opportunities to rebalance some of our stock positions. For instance, the amount deposited in our TFSA could be a little more or a little less than what we got out of our RRSP. Or there could be a variation between the number of stocks bought and sold.

We realize the price to pay for that extra control and leeway will be two (maybe unnecessary) transactions, generating (maybe useless) fees.

It’s probably not worth the risk, but we are also curious about trying what we will call «micro market timing». The goal of that strategy would be to time the buying and selling of the involved stocks to cover fees and maybe make a tiny profit along the way. For instance, if the stock is trending up, we would make the TFSA buy first and the RRSP sell just afterwards at a price a little higher. If the stock is tending down, we would do the opposite: selling first and buying afterwards. Maybe a little risky, surely stupid and foolish but still fun… Then again, certainly not our investing style at all!

Before we leave you, we must insist you be extra careful about tax considerations. We are not tax or fiscal experts and suggestions discussed here may have completely different implications in your own financial context and situation. In doubt, don’t hesitate to seek professional qualified financial help to avoid nasty unrepairable consequences on your finances.

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