Falling RRIF’s and Governments

Well last week I had it all planned out.  I was going to write about that proposed one time reduction of RRIF withdrawals to help out seniors.  Yet now it starting to look like the government that proposed that change might not survive the vote to get passed into law.

Yet despite that fact I think the issue is still important to discuss.  You see there seems to be a fair amount of confusion on being forced to sell assests when you take money out of a RRIF (Registered Retirement Income Fund).

A RRIF is sort of the inverse of an RRSP.  It’s used to draw down your RRSP amounts to ensure all that tax sheltered money you have made over the years eventally gets taxed at some point.  Starting at age 71 you have to close out your RRSP.  One of your choices at that time is to convert the RRSP to a RRIF.  That way most of the money stays tax sheltered and you still control your investments.  The only problem is now with a RRIF you have to take out a mimimum amount of money from your account each year.

That amount is determined at the start of a year with your RRIF balance at that time.  So for this year a lot of seniors are faces a problem.  If, for example, a 71 year old has a new RRIF with a $500,000 in January 2008 they have to take out a minimum of $36,900.  Yet because of the recent market drop if they had half bonds and half stocks their current balance is likely closer to $400,000 or less.  So that $36,900 is a much larger % of their current RRIF value than normal.

So to help this out it was proposed to reduce the minimum withdrawal this year only by 25%.  So potentially that would get a lot of seniors out of a tight spot this year, because all of them don’t want to sell their stocks in a down market.  The issue with the idea is it ignores a little fact.  You don’t have to sell stocks to make a RRIF withdrawal.  You could get move it to a TFSA or taxable account in kind.  That way you don’t sell anything until a later date.

Of course the downside of that move is you don’t have any cash to pay off the amount you owe from moving the asset out of the RRIF.  In our example above assuming no other income the tax bill would be about $6500 without the new rule.  So if you don’t have any cash reserves or bonds you can tap you might be in trouble and have to sell a stock at reduced value.

So that’s today’s lesson.  Don’t assume you have to sell anything from a RRIF when you make a withdrawal and make sure to keep some cash and fixed income investments on hand to help cover issues that come around like this year’s poor performance.

4 thoughts on “Falling RRIF’s and Governments”

  1. It has been frustrating watching so many reporters miss this key fact. As you point out, you’re not required to sell your assets, just transfer them out of the RRIF.

    The other key point is that anybody past the age of 71 really shouldn’t be heavily invested in stocks, for precisely the reasons we have seen in this latest downturn. I find it hard to have a lot of sympathy for those who have screwed themselves over by failing to have an asset allocation that is appropriate for their age and situation.

  2. That is an interesting topic.

    How people are forced to sell stocks due to a government regulation aimed at insuring the government gets to tax the money while one is still alive.

    It would certainly be a contributing factor driving the markets lower.

    Would it then be fair to say…that the Canadian Government regulations are helping to hammer the stock markets?

    CM

  3. I agree with MGL. Anybody who is fully invested in stocks (bear market or bull market) at retirement age either has a fundamental problem in their asset allocation or is presumably so wealthy that they can weather any kind of market downturn. If they are the latter, then the so-called “forced withdrawals” shouldn’t make too much of a difference to their pocket.

    Unfortunately the myth of the 8% annual return from equity investments is deeply ingrained and it will take more extreme volatility before it is finally washed out. This is what is underlying those faulty investment allocations and I am sure many baby boomers are doomed.

  4. MGL and Philippa,

    Oh I agree with that. It seems a lot of people forget that at the later stages of your investment life capital preservation should be a top priority. Obviously some stocks exposure isn’t bad for inflation protection, but not too much.

    CM,

    No I don’t think the regulations are doing that much to drive the market lower. I do think we are seeing some tax loss selling over this month.

    Tim

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