5 RRSP Withdrawal Strategies to Save Huge on Taxes! (RRSP Meltdown)

If you have an RRSP and aren’t sure what to do with it when you retire, this is the right article for you!

One of the most common questions I get is, “When should I start taking out my RRSP, and how much should I withdraw?” And the answer is… Well, it depends. In this post, I’ll go over 5 different RRSP withdrawal strategies that will hopefully answer that crucial question for you.

Key Takeaways

• An effective RRSP withdrawal strategy is crucial for minimizing taxes.
• Delaying government pensions like CPP and OAS can significantly increase benefits.
• Various strategies exist to reduce tax burdens and maximize financial security.

Why is a RRSP Withdrawal Strategy Crucial?

Many people focus on contributing and growing their RRSPs while they’re working but often overlook the importance of a strategic withdrawal plan. 

You might be thinking, why even bother with an RRSP strategy? Shouldn’t I just take out the minimum amount possible each year after I convert it into an RRIF to grow my RRIF as long and as possible tax-sheltered? Well, while that is a great strategy for many, there are a lot more things to consider.  

The first thing to consider: Avoiding the Tax Bracket Creep

Withdrawals from RRSPs are taxed as income in the year they are taken out, which can push you into a higher marginal tax bracket.

Here’s a quick look at the 2024 combined federal and Ontario tax brackets:

• First $51,446: 20.05%
• $51,446 to $55,867: 24.15%
• $55,867 to $90,599: 29.65%
• $90,599 to $102,894: 31.48%
• $102,894 to $106,732: 33.89%
• $106,732 to $111,733: 37.91%
• $111,733 to $150,000: 43.41%
• $150,000 to $173,205: 44.97%
• $173,205 to $220,000: 48.29%
• $220,000 to $246,752: 49.85%
• Over $246,752: 53.53%

As you can see, the tax brackets can get really high in Canada, even getting over 50% for some high-income earners! Plan your withdrawals for years when you anticipate being in a lower tax bracket to minimize your tax burden. 

Now, let’s get into some strategies and examples of how we can actually manage our RRSP withdrawals. I’m going to go from the easiest strategy to implement to the most complicated. 

RRSP Withdrawal Strategy #1: Strategic Early RRSP Withdrawal to Maximize CPP and OAS

This approach focuses on maxing out by delaying your CPP (Canada Pension Plan) and OAS (Old Age Security) to prioritize withdrawing from your RRSPs and RRIFs (Registered Retirement Income Funds). Let’s break down why this strategy can be a game-changer for your retirement planning.

Strategic RRSP Withdrawal Plan to max out CPP and OAS – How it Works in a nutshell

Instead of starting CPP at age 65, delay it until age 70. If you need the income, start withdrawing from your RRSPs and RRIFs to cover your expenses until you reach age 70. This can lead to a huge 42% increase in your CPP – for example, If you were going to receive a $1,000 a month CPP at age 65, now you’ll be getting $1,420 at age 70!

Note that you don’t have to delay it until age 70, you can delay until age 66, or 67 if you really need the income.

For a little more detail, here how changing your CPP and OAS works: 

• CPP Benefits:
  • At age 60: You will receive 0.6% less per month if you start taking your CPP at age 60 vs. age 65, for a total of 36% less.
  • At age 70: You will receive 0.7% more per month than if you start taking your CPP at age 70 vs. age 65, for a total of 42% more.
• OAS Benefits:
  • At 65: Full benefit amount.
  • At 70: Approximately 36% more than the full benefit at 65.
• For example, if Jane’s full OAS benefit at 65 is $600 per month:
  • By delaying until 70, she would receive about $816 per month, also another significant increase

The Benefits:

1. Increased CPP and OAS Payments: By delaying CPP and OAS, Jane will have way higher payments from these programs when she starts taking them at age 70. 
2. More financial security: This is great for someone who likes certainty because you’re basically trading the uncertain returns of an RRSP for the guaranteed returns of your CPP, which also increases each year and is indexed to inflation.
3. Another great benefit of this strategy is the potential avoidance of OAS clawbacks. If your net income exceeds $86,912 as of July 2024, you will see a reduction in your Old Age Security (OAS) benefits due to clawbacks. By spreading out your withdrawals, you can keep your income below the limits once you turn 70 and start collecting your OAS. With the maximum monthly payment amount being up to $784.67 per month for OAS, this can equal to over $9,000 gained each year by managing your income well.

While the Strategic Early Withdrawal approach can be beneficial, it’s not suitable for everyone. The biggest reason it might not work for you is if you are in poor health and are worried about how long you will live. 

Longevity Uncertainty

Delaying CPP and OAS benefits makes sense if you expect to live longer. If you have health issues or a family history of shorter lifespans, starting your benefits earlier might provide more total benefits.

On the other hand, if you’re in great health and have a family history of people living into their 90’s, this strategy makes even more for you.

#2: Minimizing RRSP Taxes on Death

Why Minimizing RRSP Taxes on Death is Important – When you pass away, the ENTIRE balance in your RRSP is considered as income for that year and taxed accordingly. Here’s why minimizing these taxes is crucial:

1. Preserve Wealth for Beneficiaries: By reducing the tax burden, you see more of your hard-earned savings go to your loved ones.
2. Avoid Large Tax Hits: Without planning, your RRSP balance will likely push your estate into a higher marginal tax bracket, resulting in huge taxes.
3. Efficient Estate Planning: Proper strategies can help streamline the transfer of your wealth, making the process smoother for your beneficiaries.

Example of RRSP Taxes on Death

To give you a concrete example, let’s look at a scenario where no planning is done:

• Example: Tom has an RRSP balance of $500,000 at the time of his death.
• This $500,000 is added to his income for that year.
• Assuming an average marginal tax rate of 40%, Tom’s estate would owe approximately $200,000 in taxes.
• This means only $300,000 would go to his beneficiaries after taxes.

 Strategies to Minimize RRSP Taxes on Death

Let’s explore some effective strategies to minimize the tax impact on your RRSP when you pass away:

1. Utilize the RRSP Meltdown Strategy

The RRSP Meltdown strategy involves gradually withdrawing funds from your RRSP during your retirement years to reduce the balance over time:

• Early Withdrawals: Start withdrawing from your RRSP in low-income years to reduce the balance.
• Example: If instead Tom had started withdrawing $20,000-$30,000 annually from his RRSP at age 60 using the funds for living expenses. This reduces his RRSP balance and minimizes the tax hit upon his death.

2. Spousal Rollover

Naming a spouse or common-law partner as a beneficiary allows the transfer of your RRSP or RRIF to them tax0free

• Spousal Transfer: If your spouse is the beneficiary, the RRSP can roll over to their RRSP or RRIF without immediate tax consequences.
• Example: John names his wife as the beneficiary of his RRSP. When he passes away, the balance is transferred to her RRSP, deferring taxes until she withdraws the funds.

Note that it’s important to look at the overall picture of this strategy. If you have a large RRSP amount, this might make sense for you.

#3: RRSP Income Splitting

1. Convert RRSP to RRIF: To start, you need to convert your RRSP to a RRIF once you turn 65. This allows the income from your RRIF to be eligible for income splitting. Note that you must be at least 65 for this strategy to work.
2. Allocate Pension Income: You can allocate up to 50% of your eligible pension income, including RRIF withdrawals, to your spouse. This is done on your tax return.
3. Tax Benefits: By allocating income to the lower-earning spouse, you reduce your combined taxable income, which can lead to significant tax savings. Example: Let’s look at an example. Jane and Bob are both 67. Jane has a RRIF and withdraws $50,000 annually. Bob has no RRIF and earns $20,000 from part-time work. By splitting Jane’s RRIF income, she allocates $10,000 to Bob. Now, Jane’s taxable income is $40,000, and Bob’s is $30,000. This income-splitting strategy lowers their combined taxes significantly, and all it takes is a little bit of calculations and paperwork. 
4. You can play around with the withdrawal amounts to maximize your tax savings.

How to claim on your Tax Return: Both spouses must complete Form T1032, Joint Election to Split Pension Income, and include it with their tax returns. This form makes sure that the income split is correctly reported and both parties benefit from the tax savings. Contact an accountant if you don’t want to do this yourself.

#4: Using Your TFSA Wisely With your RRSP

How does withdrawing from your TFSA fit into your retirement strategy with your RRSP? The key is to use TFSA withdrawals to supplement your income while minimizing taxes. Here’s how it works.

TFSA Tip #1: Strategic TFSA Withdrawals

Let’s say you have multiple sources of retirement income: an RRSP, CPP, OAS, and a TFSA. RRSP withdrawals are taxed as income, which can push you into a higher tax bracket. CPP and OAS are also taxable. The key thing to note here is that TFSA withdrawals do NOT count towards your income. 

Example:

Meet John. John is 68, retired, and receives CPP and OAS, totalling $20,000 a year. He needs an additional $30,000 to cover his living expenses. Instead of withdrawing the entire $30,000 from his RRSP, John takes $10,000 from his RRSP and $20,000 from his TFSA. 

The RRSP withdrawal is taxable, but the TFSA withdrawal is tax-free. This keeps John’s taxable income lower, helping him stay within a lower tax bracket.

The key point here is that you can use the TFSA in many cases to control how much your taxable income is each year and help to keep you in your desired tax bracket.

TFSA can also help to Manage Excess Funds from your RRSP

Using your TFSA for excess funds can help you manage your tax burden and optimize your retirement income.

Example:

Meet Sarah. Sarah is 65 with a sizeable RRSP and TFSA. She needs about $40,000 annually for living expenses. She withdraws $40,000 from her RRSP, which is taxable income. To manage her tax liability, she withdraws an additional $20,000 from her RRSP each year and contributes it to her TFSA. Since TFSA withdrawals are tax-free, she can access these funds whenever needed without additional taxes.

By moving excess funds from your RRSP to your TFSA, your investments continue to grow tax-free. Also, since TFSA withdrawals don’t count as income, you still qualify for government benefits like OAS or GIS.

#5: RRSP Meltdown, or the RRSP Freeze

The most complex strategy is called the RRSP meltdown strategy or RRSP Freeze. This involves taking out a large loan to invest, where the interest payments on the loan are tax-deductible. Withdrawals from your RRSP are then used to pay the loan interest, offsetting the taxable income from the RRSP. Now you might think to yourself, why on earth would you complicate things like that?

Example: 

Let’s look at an example. Meet Mike. Mike is 60 years old and has $500,000 in his RRSP. He’s retired and his income is relatively low. Mike decides to take out a $100,000 investment loan at an interest rate of 5.0% (I know this is low, but this is just for simplicity) . He uses the loan to invest in a diversified portfolio that he hopes will return 7% annually.

Host: Every year, Mike withdraws $5,000 from his RRSP to cover the interest on the loan. This $5,000 is added to his taxable income, but because Mike’s income is low, he falls into a lower tax bracket, reducing his tax liability. At the same time, the $5,000 interest payment on the loan is tax-deductible, offsetting the RRSP withdrawal tax. This, in effect, “melts down” the RRSP.

Now, let’s talk about the benefits of this strategy. One major advantage is the tax savings. Because the interest payments on the loan is tax deductible, Mike minimizes his tax impact. Also, the investment loan grows in a non-registered account, benefiting from capital gains and dividends, which are taxed at a lower rate than regular income. 

However, this strategy isn’t without its risks. 

• The biggest risk is market risk. If Mike investments don’t perform as well as expected, he could end up losing money, making the loan repayments a burden. 
• Also, interest rates could rise, which would increase the cost of borrowing which adds even more risk.
• The strategy is also quite complex and involves a lot of steps. Managing a loan while making strategic withdrawals and investments requires careful planning and monitoring. It’s not a set-it-and-forget-it strategy. You need to stay on top of your investments and be ready to adjust your plan as needed.

Who this strategy is for?

I would not recommend this for the vast majority of people in Canada. This strategy might work for someone with a very high-risk tolerance, high passive income, a large RRSP portfolio, and other significant retirement income sources. 

Only consider this strategy if you are willing to accept potential big losses in your RRSP portfolio.

Putting it all together

Think of managing your RRSP like orchestrating a symphony. Each instrument must play at the right time for the music to sound perfect. Your RRSP, TFSA, OAS and CPP, and must all work well together to be in harmony and maximize your tax savings. 

Strategic timing of your RRSP withdrawals ensures you get the most out of your retirement savings without paying unnecessary taxes or losing benefits.

For example, if your RRSP withdrawals are too high, they might drown out the benefits of your OAS and GIS, just like a too-loud drum can overwhelm the melody in a symphony.

We went through 5 different strategies here, and what I want to stress is that there is no one-size-fits-all method for everyone. For some people, it might make sense to withdraw their RRSP early to get a larger CPP, and for others, it might make the most sense to take out the minimum. 

Also, maybe it’s not that important for you to minimize RRSP taxes at your death, and you’d rather have the security of having a nice and big RRSP. It all depends on your financial goals and specific unique situation.

At Blueprint, we use financial planning software that will help you answer these important questions, such as when should you start CPP and should you start withdrawing your RRSP sooner and how much, and what will happen if you take out a combination of your TFSA and RRSP and how does that affect your total estate upon death? 

We will also run multiple scenarios to figure out how much money you can spend in retirement, and what will happen to your retirement if your RRSP investments don’t perform as well as you thought. You can check out our services on this website!