Withdrawal and Tax Strategies for early retirees in Canada

 If you came here looking for a smoking gun, I’m sorry to say the answer is:

“It depends”

An unfortunate truth of retirement—especially early retirement—is just how complex your finances can become. When it comes to optimal withdrawal strategies alone, retirees often ask:

• How can I maximize spending, especially in my “go-go” years when I’m young and healthy enough to seek adventures?
• How can I pay less taxes?
• What about those dreaded OAS clawbacks?
• What about maximizing my legacy and financial estate for my kids?
• What about the high taxes at death I keep being told to watch out for?
• When should I take OAS?  CPP?
• What is an RRSP meltdown and should I use it?
• How to best use my TFSA?
• What should I do if I have a pension?

To explore these questions and to provide guidelines to financial planners, FP Canada, the national credentialing body for financial planners, commissioned Doug Chandler, an actuary specializing in retirement research and an Associate Fellow of the National Institute on Ageing, to study this exact topic.  He wrote an 80 page research paper on the topic (a two page summary of his findings can be found here). He came up with few clear guidelines and noted that “the key for financial planners is to consider each client’s situation based on their specific circumstances”.

In my own analysis, I used Conquest financial planning software to simulate a wide range of withdrawal strategies.  I modeled couples who:

• Retire at the age of 60
• Live to 95 (acknowledging that the results would be sensitive to longevity assumptions)
• Hold low-cost 60/40 globally diversified index ETF portfolios (with portfolio return assumptions modeled to FP Canada guidelines)
• Each get 80% of maximum CPP and 100% of OAS
• Experience 2.1% annual inflation (aligns with FP Canada Guidelines)

The scenarios included couples with:

• $485,000 in investment assets
• $700,000 in investment assets
• $1.3M in investment assets (with a large spousal asset imbalance)
• Solid pensions plus $450,000 in investments
• $3.3M in investment assets

I also included risk assessments for each couple with sequence of returns risk, higher than expected inflation, lower than expected returns, and Monte Carlo simulations to gauge the relative strength of each plan under each scenario.

Similar to the conclusions reached by Doug Chandler in his paper, I found there are very few certainties or solid “rules of thumb” that can be used to plan optimal withdrawal strategies, and that circumstances can vary.  Having said that, below are some ideas and tendencies that appeared frequently in modeling while still noting they were still highly dependent on individual situations and assumptions.

1.      Focus on Bigger Planning Decisions First

Other planning considerations such as:

• when to retire
• what is your retirement spending goal (and does it change as you age)
• what is an investment strategy you can stick with

are more important to work out than building optimal withdrawal strategies.  In fact, nailing down these other important goals will help build better withdrawal strategies due to all of their interdependencies.

2.      Get a Financial Plan

As I noted above, and consistent with Doug Chandler’s detailed look at the same question, individual financial circumstances, financial and life goals, psychological behaviors, and belief systems yield a dizzying number of variables and the best withdrawal strategy will be the one you and your financial planner devise for your specific circumstances.

Sitting down with a fee-for-service financial planner (ideally 5+ years before retirement, but any time will do) is almost certainly going to provide you with a solid financial roadmap and yield more in money-saving strategies over your retirement than the one-time plan fee will cost you.

3.      Income Splitting Requires Early Planning

Income splitting is one of the best ways couples can save on taxes.  However, your options to split income are limited before age of 65, especially for those without a registered pension (most Canadians).  Difficulties usually arise when there is a large imbalance between a couple’s investment assets.  This can happen, for example, when one spouse has stayed home with the kids and/or held a lower paying job.

You can avoid these situations by contributing to spousal RRSPs and maximizing TFSA contributions for both partners, but this does require advance planning, usually at least 5 years before retirement (and ideally even earlier).

4.      Consider deferring CPP and OAS

This was true in most, but not all, of my simulations.  That is, deferring CPP and OAS to age 70 while strategically drawing down RRSP accounts from age 60 to 70 often resulted in greater plan success, more available overall spending, and larger legacy estate values at death.

This is in large part due to the enhanced CPP and OAS benefits you will receive by delaying to age 70 along with the fact that both are indexed to inflation.  This provides a hedge against both longevity and inflation.

Of course, there are other issues to consider when making this decision such as financial need and health, so this is not a one-size-fits-all proclamation.

5.      Consider Modest Early RRSP Withdrawals

In most of the situations I tested, at least modest withdrawals of RRSP funds (in the $15K range per year per spouse) produced better results than no RRSP withdrawals.  Because of the federal and provincial basic personal amounts, many retirees can withdraw roughly $15,000 of taxable income with little or no tax payable, depending on province and other income sources.

It should be noted, however, that in some cases where the Guaranteed Income Supplement (GIS) comes into play, it may be wise to not take any RRSP withdrawals (or take very limited RRSP withdrawals) in a given year.

6.      Don’t Miss the Forest for the Tax Trees

Focusing too heavily on reducing income taxes today, avoiding OAS clawbacks, and limiting end-of-life taxes may lead to suboptimal outcomes.  Aggressive drawdowns of RRSPs in early retirement may lead to lower OAS clawbacks and lower taxes on your final estate, but may also lead to lower margins of error and, ultimately, lower final estate values which can undo the perceived tax optimizations.

Sometimes having a withdrawal strategy that minimizes OAS clawbacks works best, but sometimes it doesn’t.  Don’t assume that paying less taxes now and performing financial gymnastics to avoid OAS clawbacks will produce the best outcome – it may or it may not.  You need to run the numbers based on your key goals and needs to find the optimal path.