The solution to this problem is to convert to a Registered Retirement Income Fund [RRIF], purchase an annuity, or may withdraw funds in advance for a longer period of time. TFSA has created another strategy that may be useful in certain situations.
What is wrong with the current strategy?
What is the answer, but the restrictions may not be suitable for some people. In the case of RRIF, once you are 71 years old, how many exits you have now, and there is almost no choice. Once you reach 94, you will have to withdraw 20% of the RRIF in order to cancel all funds in a short time. You can withdraw more than the specified amount, but you will be subject to tax penalties. If you purchase an annuity, you will be bound by the annuity contract rules. As with any complex contract, you need guidance on the best terms and there is no guarantee that your benefits will be taken care of at retirement. Other solutions may be more complex, which usually means implementing more cost and expertise.
What is a new strategy?
Under the current RRSP rules, you can donate and get a tax refund when you pay. However, you will pay taxes after the refund. TFSA is just the opposite. You do not receive tax benefits in advance, but you will not be taxed after the tax refund. The strategy is to slowly withdraw funds from your RRSP, pay taxes when you do so, and then deposit the money into TFSA. In theory, if you do this in the 1950s or 1960s, you might have 20 or 30 years to invest in the money. If you can pay taxes in advance and then let the funds grow within TFSA, you can have a tax-free portfolio and there won't be any surprises in the future. If the power of compounding can increase your money in the RRSP, it can do the same thing in TFSA. More money generated by the investment means that more taxes are usually paid. However, as far as TFSA is concerned, this is not the case.
There is no tax bill at the end of the compounding period. The problem is that you pay taxes when you first withdraw from the RRSP, but this will be remedied in the future TFSA. This assumes that the current tax rules remain the same. If they change and TFSA withdrawals are somewhat restricted or taxed, then this strategy is useless. Any rules for registering an account can be changed at any time, so this risk exists in RRIF, RRSP or any other registered account.
How do you actually implement this idea?
Every year, you can withdraw money from the RRSP. You will be taxed at the time of withdrawal. Then you deposit the money into your TFSA account and invest in the same way. For example, if someone is 55 years old, they pay $50,000 a year for work, and they earn $300,000 in their RRSP. They have about 15 years to convert funds to RRIF. Since the TFSA limit is only $25,500 per person and increases by approximately $5,000 per year, we will use these limits as the maximum amount that can be transferred. In this example, assume that $25,500 has been used up, so only future transfers will be considered. If the person leaves the funds in the RRSP and then transfers to the RRIF, they will be forced to withdraw about 7% of the funds each year when they retire. This percentage will increase every year, but we will use this as a conservative estimate. It will also be assumed that the minimum tax rate will be used when retiring - this may mean that they are accepting CPP, OAS, RRIF income and possibly small pension payments, but not more. Their income is less than $35,000 a year. This means that their work tax rate is about 30% and 20% when they retire. Their return on investment over the life of the RRSP and TFSA will be assumed to be 5%.
Please note that 7% of the withdrawn RRSP accounts will reach an annual income of $21,000. Since the TFSA limit is currently $5,000 per year, we will use $5,000 per year as the transfer amount. The remainder of the RRIF exit will add significant revenue to retirees, as by the age of 71, the $300,000 RRSP will be close to $600,000. A 7% extraction rate for this amount would mean an additional $42,000 in additional income, resulting in a higher tax rate. Assume that the total income after the age of 71 will exceed $70,000, assuming a tax rate of 40%.
If the person leaves the funds in the RRSP and then withdraws the funds as RRIF, they will pay the RRIF at a rate of 40% per year. At $5,000 a year, 40%, they will pay $2,000 a year in taxes until they die. If the person has lived to 85 years old and is about average life expectancy, they will pay a tax of $30,000. If they withdraw $5,000 from their RRSP before retirement, they will pay about $1,500 a year from the age of 55 and then pay $2,000 a year after the age of 71. This will add a total of 1500x16 years plus a tax of $2000x1500 or $54,000. However, TFSA funds are now tax-free. If they invest the money in TFSA for $5,000 a year and earn 30% a year [85 years old minus 55 years old], they will receive an additional income of more than $147,000. The extra tax savings will exceed $52,000, which almost offsets the extra tax prepaid by the RRSP. If they live at least 85 years of age, this will save about $28,000 in taxes during their lifetime. The reinvestment return of the prepaid tax is also considered in this calculation.
what is the benefit?
If you have a variety of sources of income, this strategy may allow you to tax some of your income when you retire, thereby lowering your income threshold. If you are accepting old age protection, this may allow you to increase what you get. If you receive a private pension or RRIF payment, this strategy may reduce your overall tax revenue by reducing your total income in any given year. The specific details of this time must be resolved by your tax professional, because in some cases, everyone and every year will be different.
Who can benefit from the strategy?
If you only receive CPP and OAS at retirement and generate a very large RRSP when you retire, this may result in an increase in RRIF revenue, which may be enough to reduce your income and increase your OAS payments. If your retirement income drops, or if you retire early, you can use this strategy between retirement age and 65 or 71 depending on the account you have.
What are the restrictions?
Currently, you can only contribute $25,500 to TFSA. However, if the government continues to increase its quota each year, it will increase at least $5,000 a year, and an additional $50,000 in 10 years. If you have a spouse, these amounts can be doubled. This could be $150,000 and a strategy that may be affected by this tax. If inflation rises, these numbers may be higher because the government seems to be keen or keep these limits in line with inflation. The additional $500 added in 2012 is consistent with this argument. You can also continue to retire using this method. If you don't need income, you can postpone your income indefinitely until you really need it and lower your taxes year after year because the future income of your investment will be increasingly tax evaded.
The funds in your RRSP are assumed to be pensions, which means you don't need funds other than retirement purposes. If you quit RRSP, move to TFSA and then spend it because it's easy to do, this strategy won't be good. You can also use TFSA as an emergency account, which is great, but you must choose your intent to get the most out of the work you want to do. Long-term deposits in TFSA accounts will overcome the taxes you must pay in advance and avoid future taxes. The traditional view is that you should defer taxation as much as possible, but you always have to pay taxes somewhere, so the ideal situation is to weigh the choices and optimize the choice that suits you best based on your lifestyle, income needs and preferences. If the wisdom of paying taxes in the future is always the case, then there will be no problem of imposing a large tax on the withdrawal of the RRSP, or a large amount of inheritance tax will be imposed when transitioning to the next generation.
From an investment perspective, TFSA can hold most of the same investments as RRSPs, so there is no loss from an investment perspective. No matter what is sold in the RRSP, you can repurchase it in TFSA. The difference here is strictly the time of tax payment.
TFSA can be used with RRSP and RRIF accounts to enforce taxation where appropriate and at the appropriate time. As you can see from this article, there are a number of assumptions to check. The best way to do this is to do a few scenarios and see which one is best for you. Even if you do this, things can change, so whenever the assumptions change, you should reconsider the calculations: tax rate, return on investment, income or RRSP, and so on.
Orignal From: Convert RRSP to TFSA before retirement
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