This COMMON RRSP Blunder Could Cost You 40%! Don’t Let Your RRSP Drain Away!
This COMMON RRSP Blunder Could Cost You 40%! Don’t Let Your RRSP Drain Away!
Many Are Making This Catastrophic RRSP Error — 40% of Your Savings could be at Risk!
The Most Common Missed Element of Retirement Planning
We’re going to go in-depth on a serious issue that could affect your financial future today: the possibility of losing up to 40% of your RSP savings — or more. But don’t worry, — I’m not just here to sound the alarm; I’m here to provide you doable ways to lessen this risk. Permit me to explain what I believe to be one of the most important but underappreciated parts of retirement preparation. Notwithstanding my over two decades of experience helping people with their retirement planning, I’ve seen time and time again that when planning their financial path for their golden years, a lot of people miss this important element.
The worst part is that this problem gets worse the more successful you are at saving for retirement. If this error is not corrected, it will eventually grow more and more difficult to fix. Let’s investigate the specifics of this error now.
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The Ultimate Destroyer of Wealth..
The essential issue? taxes. You may be asking yourself, “Taxation? It’s hardly the biggest worry I have.” But wait a second. I’m not talking about the taxes you pay on your wages right now. Ultimately, the primary objective of investing in an RSP is to reduce your income tax liability. Take a look at this chart, which shows the marginal income tax tables for all provinces, but we will look at the one for Ontario.
Let’s dissect it. The green area, which shows income levels from lowest to highest, is located on the left side of the chart. As you proceed through the page, so does your income. But here’s where it gets interesting: the income tax percentage you pay on the progressive amount you make is shown by the red region. To put it plainly, your tax burden increases with your income.
What about the additional tax tables on the right? They explore many kinds of income taxes, such as capital gains and dividends. However, our main concern is figuring out what this entails for your income tax payments. Basically, you’re trying to save more money as your income increases.
The RRSP — The First Line of Defence
Let’s assume that your starting tax rate is 53.53%. You can reduce your overall tax burden by making an RRSP contribution, which essentially lowers your taxable income. This is one of the main reasons to make an RRSP investment.
Of course, making financial preparations for retirement is the other equally important reason. It’s a widely advised strategy that helps ensure you have enough money to sustain yourself in your latter years. Not a lot of people want to be unprepared for retirement when they reach that age. You can therefore feel certain that your choice to prioritize RRSP contributions is generally in line with sensible financial planning guidelines.
But the problem is that we tend to concentrate mostly on this one element.
Effective tax management is the aim here, year after year. I’m going to give you some insights into your own financial planning, and you should think about whether these apply to you.
Stages of Retirement
Let’s talk about the stages of retirement. The accumulation period, which lasts from age 18 to age 59, comes first. You’re working hard, putting money down, and maybe paying off any bills during this time. There are often conflicting financial priorities during this period. After this, you enter active retirement, where you start to use the assets you’ve accumulated over the years, as you move into what we refer to as the retirement zone.
Now, let’s talk about the final stage: legacy planning. This is where the biggest mistake happens that many tend to overlook. While a lot of attention is devoted to the earlier phases we discussed, the significance of this final stage is often underestimated. You see, it’s easy for some to dismiss this phase, reasoning, “I’ll be gone anyway, so why bother?” But consider this: by investing in the RRSP in the first place — you are someone who likes to strive to minimize your tax burden year after year.
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Very few people know that when you pass away, all those registered accounts (except the TFSA) you diligently sacrificed to contribute to, saved for, and earned — could be included in your final tax return. This realization is crucial, as it underscores the importance of comprehensive legacy planning beyond just the accumulation and utilization phases of retirement. It’s about ensuring that your hard-earned assets are preserved and distributed efficiently, leaving a lasting impact according to your wishes. So, while it may be tempting to overlook the endgame, addressing legacy planning is essential for securing your financial legacy and minimizing tax liabilities for your heirs.
If you’re married, your RRIF typically transfers to your spouse. However, upon the death of the last spouse, the remaining RRIF funds could face significant taxation, potentially up to 40% or more, depending on the RRIF’s size.
Let’s examine this situation closely, by looking at an example through my financial calculator on my website joemacek.com. You’ll gain insight into how much of your RRIF funds could be subject to taxation upon your passing. Let’s explore this together.
joemacek.com is widely regarded as a trusted space where you can explore financial planning, retirement strategies, insurance products, investment options, and a variety of calculators and tools to help you in your financial journey.
As we navigate to the calculators and tools section, you’ll find a specific tool for RRIF withdrawals. Imagine you have a portfolio worth $1 million at age 65. In Canada, the average mortality rate, or the age at which people typically pass away, is around 86. For a bit of cushion, let’s extend it to 88.
Next set use spouse's age to “no”, and then let’s factor in the estimated annual growth of your RRIF. Typically, retirees aren’t aiming for high-risk, high-reward investments with their RRIFs. Instead, they’re focused on preserving and growing their funds to outpace inflation while maintaining a level of security.
Despite the current inflation rate exceeding 4%, let’s maintain it at 4% for simplicity. By doing so, any adjustment above this rate will only result in a larger account balance.
Let’s start the payments in year 1 and do the minimum payments for the rest of your life.
When you scroll down you will see a table of what your RRIF will be worth eventually. Upon review, you’ll notice that at age 65 with a $1 million portfolio, your year-end balance in the first year is $998,400. This slight decrease is due to the minimum withdrawal requirement for a 65-year-old with a $1 million account, set at 4% or $40,000. However, with nearly $40,000 in growth, your overall balance remains nearly unchanged.
As you progress through the years, you’ll observe that your withdrawals increase incrementally. This is a fundamental aspect of RRIFs: withdrawals are based on your age, requiring slightly higher percentages each year. Therefore, you’ll see this withdrawal amount gradually rise over time.
In the second year of retirement when the withdrawal of $41,633 exceeds the actual growth. This means that you’re now withdrawing more money from your portfolio than it’s earning. Consequently, you’ll notice a decline in the portfolio balance.
Scrolling down to the end, let’s consider the individual (no spouse) passes away at 88 with $520,086 remaining in their RRIF. Now, what happens to the funds in their RRIF? For an unmarried individual, all the funds in the RRIF are added to their terminal tax return. This essentially becomes their income for the year.
Now let’s use a tax calculator to find out what the tax liability is on the estate with $520,086 in total income. You can see the average tax rate below in Ontario would be significant at 45.20% — leading to a tax bill of $235,056. So what measures do you have in place to prevent losing over $235,000 or more to Revenue Canada upon your passing? It’s a critical consideration that underscores the necessity of effective tax planning and legacy management strategies.
Now, some people might not worry about taxes after they’re gone, but for many, it’s important to ensure their money goes where they intend it to. Most clients I chat with want to find ways to keep more of their money for their family, charities, or other important things. So, how can you make sure more of your hard-earned cash stays with your loved ones or causes you care about?
One idea? Make the most of your RRSP contributions, then think about getting some life insurance. Life insurance can be a great tool for estate planning and tax minimization at death. It ensures your loved ones get the support they need even after you’re gone.
First off, consider your life insurance needs. These typically cover your final expenses, such as funeral costs, and help settle any outstanding debts. It’s essential to ensure your loved ones aren’t burdened with financial obligations after you’re gone.
Next, let’s address the major taxes on your estate. These often stem from real estate assets and any funds held in registered accounts, like a RRIF. These taxes can eat into your estate’s value, leaving less for your beneficiaries and causes you care about. After all, Revenue Canada probably isn’t on your list of preferred beneficiaries! This is where planned giving comes into play — allocating funds to your loved ones, charities, or causes close to your heart.
Life insurance often gets seen as just another expense, but it’s much more than that — it’s often a multiplier for your money. You are essentially writing a smaller cheque while you are alive, so that the large cheque for your tax bill can be written by the insurance company. Early in your life, the money can stretch as high as a factor of 10, but as you age, it might not stretch as far, maybe having a factor of only 5 or 6 times, but the principle remains: life insurance is not only about expenses, and income coverage, it is about preserving your wealth when you pass away.
By investing some money now, you can watch it grow over time. Eventually, your life insurance policy can expand to cover all your final expenses. That means clearing your debts, settling your tax bill with Revenue Canada, and leaving something behind for your beneficiaries, charities, and causes you care about.
And here’s the kicker: this money from your life insurance policy? It’s most often tax-free, while your estate might have to use post-tax dollars to settle its tax obligations. In essence, life insurance can be a savvy way to offset taxes and ensure more of your wealth goes where you want it to.
Paying taxes to Revenue Canada can indeed be a painful and costly affair. To determine how much money you’ll need to offset these taxes, particularly those stemming from your RRIF and real estate, it’s crucial to get a financial projection done.
I can’t stress this enough in every article I write: a financial projection can allow you to see the consequences of your planning decisions before you make them. It’s an incredibly powerful exercise that doesn’t require much of your time. Any reputable investment advisor portfolio manager should offer financial projections as part of their services — I certainly do for all my clients, at no extra cost.
However, if you prefer, some advisors solely focus on planning and don’t manage investments. You could spend up to $4,000 or $5,000 to have a financial projection done elsewhere, but with me, it’s all included in my services for clients. So here’s the solution: start working with an advisor today to determine your estate’s tax obligations in the years ahead. Then, put insurance in place now that will grow over time to cover those expenses as much as possible.
I hope this information has been helpful for you. It’s been a pleasure sharing it with you. Feel free to share this article with anyone you think could benefit from this information.
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Joe A. Macek, FMA, CIM, DMS, FCSI
Investment Advisor, Portfolio Manager
iA Private Wealth
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This information has been prepared by Joe Macek who is an Investment Advisor Portfolio Manager for iA Private Wealth Inc. and does not necessarily reflect the opinion of iA Private Wealth. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor Portfolio Manager can open accounts only in the provinces in which they are registered. iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. iA Private Wealth is a trademark and business name under which iA Private Wealth Inc. operates.
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