RRSPs for Huge Tax Savings When Retiring Early

Normally, being a public employee with a decent-ish DB pension plan, I would say it's not ideal to contribute to RRSPs first. After the RRIF post, you can see how a fully taxable pension income and massive RRSP income is a recipe for tax disaster.

After the Pension Adjustment, I would be able to contribute a maximum of about $6,000 a year in my personal RRSP. If I do that from the time I'm 25 until I'm 65, I've got a $1,000,000 personal RRSP account that will generate $50,000 a year until I die.

Then add in my pension of $75,000+ after 40 years of service to my community and I'm getting taxed at some ugly rates. After all sanity lost during 40 years of this work, I'm grimly staring at OAS clawbacks, big mandatory RRIF withdrawals when I turn 71, and huge tax bills.

Fortunately there's another way. If my spending is low I can still max my RRSPs (and TFSAs of course), collect the juicy tax return at higher rates now, and pay super low tax rates on withdrawals later.

Enter early retirement...

Cutting That Tax Bill Way Down

Early retirement to me means retiring before the age of 60. At 60 years old we can collect CPP payments and other seniors benefits—so not really special to me. When you retire before 60, you must be able to live off your investments because nothing else is coming in.

This also means you have full control over your tax situation and can use this time to deplete your RRSP at relatively low tax rates. If your RRSP withdrawals are under $25,000 per year, your effective tax rate is around 10%. Add in some Canadian dividend income from your Cash/Margin Account and your tax bill can actually be reduced in many provinces!

Example Case

Let's pretend I'm single, earn a flat $100,000, live in BC, and don't contribute to a pension plan. I spend $40,000 a year. At my salary level, I can contribute 18% of my gross income to my RRSP, plus $5,500 to my TFSA, plus $16,500 to my Cash/Margin Account.

As soon as I meet the 30x Rule, I am going to pull the plug. If I invest in a Growth/Balanced Portfolio (around 6% annual returns after inflation) over all those years, it's going to take me 18 years to save enough for retirement. I start saving at 27 years old so I retire from work at 45 years old.

At 45 years old, my RRSP will be worth $581,000, my TFSA will be worth $177,400, and my Cash/Margin will be worth $480,200 for a total combined value of $1,238,600. At 30x this will generate $41,266 in safe income each year. We'll estimate my Cash/Margin account holds ETFs which pay $14,000 in Canadian dividend income each year.

In B.C., I pay negative tax rates on the Canadian dividends up to $45,900 total income. I want to deplete my RRSPs first, so I will set up my account to withdraw $26,000 annually from my RRSP ($40,000 spending - $14000 dividend income). On this income, I will pay just $2,165 a year in tax (5.4% blended rate).

To cover the tax liability and maintain my $40,000 spending level, I can withdraw some money from my Cash/Margin account and realize some Capital Gains Income which is likely to be very minimal as gains only make up about one-third of each withdrawal (the other two-thirds is taking my contribution back).

By using this strategy, I was able to benefit from a 35% tax return on my RRSP contributions while paying just 6% tax on withdrawals later. A huge tax savings!

During my working years, I reinvested the $6,320 tax refund. This sped up my retirement by about 2 years—or more than 10% thanks only to tax savings.

Again, it's even more efficient when you're married or common-law as you can set up a Personal and Spousal RRSP to split income very evenly and keep taxable income low. You also benefit from contributing to two TFSA accounts instead of one.

Comments & Questions

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10 Replies to “RRSPs for Huge Tax Savings When Retiring Early”

  1. I’m curious about this strategy. As a public servant with a decent pension plan I always thought saving was ridiculous until I discovered MMM and the opportunity to retire early. My wife also has a decent DB pension, we’ve been saving into RRSP to save on the tax bill at the end of the year. We plan to contribute to our TFSA once we run out of RRSP room then pay off the mortgage. When we retire early we would use the RRSP to fund retirement until the pensions kick in. Would you push the CPP withdrawals to a later time for the bigger payout?

    1. Mr. Rich Moose says:

      It’s important to point out that this post is not about filling RRSPs before TFSAs. It’s about not being afraid to fill both to the max if you can and not being afraid of RRSPs just because you have a good pension.
      Stuff the TFSAs first. When you contribute to a decent pension plan, you are generally at least doubling up your RRSP contributions as it is. However, it is being invested in a lower return, but (more or less) guaranteed portfolio. You can almost think of it as a big fat bond. You can always work on that RRSP room to make a nice payment “bridge” later.
      Deferring a pension depends on the plan. Is it being indexed while you defer, how long do you have to wait, and would the 25x return on the invested commuted value be better than the expected pension?
      CPP withdrawal issues are as much a health question as a financial question. I might dig into this a bit more in a future post.

  2. Hi! Have you done the calculations if said couple left their 1.2 mil for another 12 years and it doubled to 2.6m then turned into Riff? I’m not very know.edgab,e about taxes – wouldn’t the increased value of the RIFF still give you more money over the lifetime even of you pay more taxes?

    1. Mr. Rich Moose says:

      The problem with a large RRIF is the mandatory withdrawals. In situations where you have an overly large RRIF, the minimum withdrawals can vastly exceed your spending. This means you pay way more taxes than necessary, or compared to a properly managed portfolio withdrawal strategy.
      Using $2.6m, at age 71 your minimum withdrawal is nearly $140,000 (5.28% of RRIF value). By the time you’re 80, this has increased to $160,000 (6.82% of RRIF value).
      Using Ontario as an example, even if you split the RRIF income equally between spouses, you would be paying blended tax rate of nearly 25%.
      However, if you bled down the RRSP before age 71 as I described through strategic withdrawals, offsetting taxes with Canadian dividends, and mixing in some low tax capital gains, you could easily achieve a blended tax rate closer to 10%. This means the net value of your RRIF increases substantially.
      Naturally it’s never this simple. The right answer depends on your current investments, province of residence, planned retirement age, annual spending requirements, pension income, life expectancy, portfolio allocation, risk tolerance, and so on.
      If you’re unsure about tax implications and have a larger portfolio, it doesn’t hurt to sit down with a fee-only financial planner, or accountant knowledgeable in personal tax, and develop a tax efficient withdrawal strategy. It might cost you $1,000 – $2,000 for this service, but you can save that in taxes alone in one year.

  3. Thank you so kindly for your careful reply. Hard to find a fee only planner here on Ont. 🙁

    So if I’m getting this- get the $ out at low tax rate and reinvest in non- registered account but try to be prudent with the taxes incurred depending on the “instrument” ? Could I ask then what to invest in to get 10% tax rate?

    1. Mr. Rich Moose says:

      It certainly is! Often it’s easier to find an accountant specializing in personal tax / retirement planning. That’s not always simple either as most specialize in business dealings, but most medium size offices have at least one partner or senior associate that can help.
      With RRSP/RRIFs the best strategy is often to start withdrawing early (as soon as you stop earning paycheques). Then do a planned, strategic account depletion over your retirement years taking into account taxed benefits (CPP/OAS), RRIF mandatory withdrawals starting at 71, and your life expectancy based on your family history and current health. Be generous of course.
      Then make up your additional income needs through capital gains and Canadian dividends in your non-registered account, plus add some TFSA withdrawals for larger one-time expenses (big vacay, new vehicle, etc). This ensures smooth income and low taxation.
      This post here covers investing by account/taxation: http://therichmoose.com/post20170428/
      This post covers alternative ETFs to reduce tax bills, especially for foreign exposure: http://therichmoose.com/post20170419/

  4. Ps is there a way to find my comments easily? I left another one somewhere and can’t find it.

    Again, Thx for this! DH About to retire at 55. 🙂 still nervous though!!

    1. Mr. Rich Moose says:

      Sorry, the free search function tools I am able to find in WordPress are a bit lacking. Best to search by post name, or use the archive tool if you can remember approximately the month the post was published.

  5. Oh I see- you mean capital gains/div in non reg account – Thx. You can delete these posts, I dnt want to clog up your blog with silly questions.

    Still at the spreadsheet trying to figure out if better to keep working and let next egg grow or stop working to get the $ out of rrsp.

    Still I do the calculations then look at the effects of inflation, and think – nope gotta keep working.

    1. Mr. Rich Moose says:

      Not a problem at all, if you have these questions chances are other people will as well.
      I can tell you from my personal calculations it is very advantageous to withdraw from RRSPs sooner than later. The government basically designed RRSPs because it works out very well for them tax-wise when people have fat accounts and turn 71. The tax taps get turned on big time!
      If you have 25-30x your annual spending in investments, you could seriously consider retirement in your 50s and be very successful. If things get hairy, you got CPP coming at 60 and OAS at 65. If you really mismanage your investments (unlikely if you got this far), you can always get a part-time gig.

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