How to retire early in Canada with an RRSP

[Demosthenes]

I had always been under the impression that you get massively dinged if you withdraw money early from an RRSP. Quick internet searches show withholding taxes ramp up surprisingly fast:

$5000 -> %10
$5000-$15000 -> %20
> $15000 -> %30

I know that it gets easier when you convert your RRSP into an RIF, but I thought you couldn't do that till you were 65. Turns out you can do it any time. RIFs let you withdraw a certain percentage of RRSP holdings every year withholding tax free. The equation is

1 / (90 - current age)

If you retire at 35, you can withdraw 1.8% of your portfolio with no tax.

So for implementation, say you have yearly spending of $20,000. By the 4% rule, you need 500,000 in retirement assets. Ignoring TFSAs for a moment, if you had all this money in an RRSP and convert to an RIF, you can withdraw $750 monthly. This leaves $916 extra monthly that you will need to come up with. You can withdraw extra funds from your RIF to cover the deficit. You would be taxed 5000*0.1 + 6000*0.2 for a total of $1700 per year of withholding tax.

Compare this to the scenario where you withdraw directly from your RRSP. The calculation would be 5000*0.1 + 10,000*0.2 + 5000*0.3 totalling $4000. Therefore, rolling your RRSP into an RIF saves you $2300 in upfront withholding taxes per year.

Note that withholding taxes are just upfront taxes taken off the top when withdrawing, which is the government assuming that you are going to be paying around that much in income taxes when tax time comes. If it turns out you only have ~$4000 in taxable income, your "personal amount" more than makes up for it, meaning the government would have to give you a $4000 refund.

https://en.wikipedia.org/wiki/Income_ta ... _tax_rates

This means that the government "borrows" $4000 from you the whole year, and then gives it back saying "oops, I guess we taxed you too much...".

Give me a shout if my math is off somewhere.

I'll have to sit and think about how TFSAs will balance this equation out so you can pay 0 withholding taxes.

[slsdly]

Correct me if I am wrong, but as far as I understand it, the withholding tax is merely what they "withhold" when you withdraw money from the account. It is not the same as what you owe when you actually file your taxes. You will pay at whatever your marginal rate is. The exact same is true of RRIF withdrawals -- no withholding taxes, but you still owe income taxes on that, they just don't make you prepay.

If you live in a province like Ontario which has a non-refundable tax credit for eligible dividends under 40k-ish incomes, you can use that credit to minimize the tax owed on the RRSP withdrawals. (Edit: Assuming those eligible dividends are generated in your taxable account.)

[slsdly]

To verify my claim, you can use StudioTax or TaxTips calculator (for the quick/dirty estimate) and pretend your source of income is an RRSP or RRIF. Throw in some eligible dividends and you should see your taxes drop as long as your income is low enough. If you have foreign stocks in your taxable account, you will pay the foreign withholding taxes but as long as the foreign tax rate is <= 15%, you can get the full amount as a non-refundable credit.

[JuliusFC]

Agree with slsdly. By rolling an RRSP into a RRIF, you're not "saving X in taxes per year". You are definitely shifting when you pay the taxes though and the RRIF option gives you more cash in your pocket until tax time rolls around.

[Demosthenes]

Sure but the personal exemption rate from your employment years still applies in retirement right?
https://en.wikipedia.org/wiki/Income_ta ... _tax_rates
In 2017 your first $11,600 is income tax free. If DW and I withdraw $11,600 from two RIFs we get the first 23,200 income tax free.

[slsdly]

Yes, in practice. You will need to look at both the federal and provincial exemptions, but even though Ontario's is lower than the federal, they seem to give some extra credits for such a low income. One thing you lose from your employment years is the $1000 employment tax credit, although after 65 we get a similar credit for RRIF payments (RRSP will only count if it is an annuity).

Another thing to keep in mind is the Ontario Health Premium that kicks in as you go up in income. McGuinty did not lie when he said it was not a tax. Tax credits don't offset those obligations, so strictly speaking, it is worse than a tax .

[Demosthenes]

Thanks for the clarification Slsdly. Soon I'm going to get my hands on a bunch of RRSP cash and I'm going to have to decide how to invest it. With the low time horizons of ERE folk, value investing doesn't sit right with me. Going for small cap with good dividends and REITs is more my bag now that I understand how the retirement strategy works with RRSPs.

[OrganicRain]

Why not use a couch potato index strategy?
http://canadiancouchpotato.com/model-portfolios-2/

When you withdraw from a RRSP/RRIF it is taxed as income. If you are living on a low enough amount, you can get away with paying very little tax.

[BlueNote]

If you owe $0 tax for the year you withdrew then you'll get the withholding tax refunded as part of that years tax return. Ultimately if you become FI then it's just a nuisance that is imposed upon you by a system designed to assume everyone who withdraws from their RRSP will not realize that there will probably be a large lump sum tax due in April of the next year. The small cadre of people who retire early are, for better or worse, pretty much off the radar when it comes to government tax policy.

So your math was probably right, the problem is that you didn't have to do it.