This Monday, Feb. 29 at midnight is not only the RRSP contribution deadline if you want to claim a deduction on your 2015 tax return but it’s also the deadline to recontribute any excess RRIF withdrawals you took out in 2015.
Under the Income Tax Act, you must convert your RRSP to a RRIF (or use the funds to buy a qualifying annuity) by the end of the year in which you turn 71. A RRIF acts as a tax-deferred continuation of your RRSP, but in reverse. With a RRIF, a minimum amount must be withdrawn annually, starting the year after the RRIF is set up.
This required minimum withdrawal amount is based on a percentage factor, listed in the tax regulations, which corresponds to the RRIF-holder’s age (or, if you elected at the time the RRIF is opened, the age of your spouse or partner) at the beginning of the year. This factor is then multiplied by the fair market value of the RRIF at the beginning of each calendar year to determine the minimum required withdrawal for the year.
In the government’s words, the minimum annual RRIF withdrawal requirements “ensure that tax-deferred RRSP/RRIF savings serve their intended purpose, which is to provide retirement income.”
You may recall that last year’s federal budget made changes to the RRIF factors, which were originally based on providing a regular stream of payments from age 71 to 100, assuming a seven per cent nominal rate of return on RRIF assets and indexing at one per cent annually. The factors are capped at 20 per cent for ages 94 and above.
The 2015 federal budget lowered the RRIF minimum withdrawal factors that apply for ages 71 to 94, recalculating them using a five per cent nominal rate of return and two per cent indexing. As the government wrote, these assumptions are “more consistent with long-term historical real rates of return on a portfolio of investments and expected inflation.”
The new, lower factors permit RRIF holders to preserve more of their savings in order to provide income at older ages, while continuing to ensure that the tax deferral provided on RRSP/RRIF savings serves a retirement income purpose. There was no change to the minimum withdrawal factors that apply for those age 70 and under, which are still based on the formula 1/(90 – age).
While the new RRIF factors started to apply last year, many RRIF holders who had established their RRIF in prior years were still taking out the higher amounts in 2015. As a result, the tax changes announced in last year’s budget contained a special rule to permit RRIF holders who withdrew more than the new, reduced minimum amount to re-contribute the excess until Feb. 29, 2016 and claim a deduction on their 2015 tax return.
So, should you recontribute?
For most seniors, the answer is yes, so you can take advantage of tax-free growth on the recontributed amounts while inside the RRIF. On the other hand, if you’re part of the one-per-cent high-income earners, whose tax rate has gone up by four per cent (or more) in 2016, you’ll be thankful you took more out of your RRIF than legally required last year, when your tax rate was substantially lower.