A study released this past summer by the C.D. Howe Institute claims mandatory withdrawals from registered retirement income funds beginning at age 71 will erode seniors’ purchasing power.

Pointing to the increase in life expectancy and the decrease in real returns on investments in recent years, the study, entitled A Better Riff on Retirement, argues that minimum RRIF withdrawals should be lowered or, ideally, scrapped.

That is not likely to happen, say many financial services professionals, although they agree with the report’s reasoning.

One reason the suggestion is unlikely to be instituted is the federal government wants to maintain its income levels by receiving tax revenue in regular increments — not wait until an investor’s estate is settled, says Tom Thomas, investment sales manager for Manitoba and northwestern Ontario with Bank of Montreal in Winnipeg. “And if we enter into a recession,” he adds, “the government will be even less likely to consider lowering or abolishing minimum withdrawals.”

A second reason, says Lee Anne Davies, Royal Bank of Canada’s head of advanced retirement strategies in Toronto: the boomers will want to keep spending. “The boomers’ spending patterns in retirement will be more elevated than their parents’ were,” she says “If anything, they’ll want to spend too much.”

But there are strategies you can use to help your clients manage their RRIFs in a way that optimizes tax efficiency and earnings.

As it stands, RRIFs can be opened as early as age 55 by Canadians who want to draw retirement income. But the tax-sheltered plans are usually opened in the year in which the planholder turns 71. For RRIF holders under 71, minimum withdrawals are calculated using a formula set by Ottawa. At 71, the minimum withdrawal rate jumps to 7.38%, escalating to 20% at age 94 and onward.

The withdrawals are considered taxable income. The difficulty comes when the mandatory withdrawals put your clients into a higher tax bracket and exposes them to old-age security clawbacks.

One way clients who are approaching 71 can avoid those mandatory withdrawals is by purchasing annuities with their RRSP assets. Annuities provide a set monthly income determined by the interest rates when each annuity is purchased. The more money your client puts into an annuity, the more income he or she will receive.

“But with low interest rates today, few people are taking the annuity route,” says Leslie Behun, an investment and retirement planner with BMO in Winnipeg.

RRIFs do have offsetting advantages. “RRIFs provide more flexibility,” Behun adds. “You can make a major withdrawal, such as to pay for a grandchild’s wedding or a new vehicle, although you’ll pay extra taxes on it.”

RRIFs also appeal to clients who want to leave inheritances. Upon a client’s death, his or her RRIFs can be transferred tax-free to the surviving spouse. While contracts differ, payments on many annuities stop upon the death of the annuitant.

It’s imperative, however, to tailor the RRIF to your client, says Behun: “Does he or she have a company pension or other assets? Will withdrawals be used as income, and how much income will the client need? Will the assets in the RRIF be an inheritance?”

Your client’s risk profile will determine the asset mix, as will responsibilities in retirement, Davies says, such as having a dependent family member.

Andrew Beer, manager of strategic investment planning at In-ves-tors Group Inc. in Winnipeg, believes investors of all risk-tolerance profiles should hold equities in their RRIF portfolios. “We overlook the effects of inflation,” he says, “which will really have an effect on our purchasing power.”

Looking at the performance of the S&P/TSX composite index over a five-year period from 1976 to 1980, which Beer describes as “a period of hyperinflation, with an average inflation rate of 8.9%,” he notes that the average rate of return of the index was 14.4%; $100,000 invested in equities in that period would have grown to $196,000.

“This speaks volumes about the importance of equities in a portfolio — along with fixed-income investments to add stability, and cash,” he says. “In market downturns, stocks take the biggest hit but have the best chance of recovering. Holding a cash component for income needs is ideal, rather than depleting equity and fixed-income investments.”

How much cash? “Markets typically recover within a three-year period,” Beer says, “but it might not be feasible to hold cash for three years’ income needs. Instead, you could look at holding between 12 and 18 months’ worth.”

@page_break@How much of the portfolio is in equities will depend on the client: “It may be as little as 20% or 30% of the portfolio,” Beer says.

There are other steps your client can take to soften the sting of RRIF withdrawals. Some experts recommend a mix of RRIFs and annuities. Davies suggests clients who have younger spouses consider making withdrawals based on the younger spouse’s age. She cites the example of a client aged 72 with a spouse aged 64. “The client who uses his own age of 72 would have to withdraw at a rate of 7.48%,” she says. “If he elects to use the age of the younger spouse to set the minimum withdrawal rate, it would be only 3.85%. For each subsequent year, these percentages would increase.”

Clients can also split pension income. (See “Strategy could save thousands,” page B8.) Under the new rules, up to 50% of your client’s RRIF income can be attributed to a spouse for tax purposes. This may lower the client’s tax bracket, protect against OAS clawbacks and make the spouse eligible for the $2,000 pension-income tax credit.

If the RRIF withdrawals aren’t needed for living expenses, they should be immediately invested, and the new tax-free savings account provides attractive opportunities. (See “TFSAs a versatile planning tool,” page B8.)

“For estate-planning purposes, non-registered investments get a better tax treatment,” Thomas says, “because every dollar that comes out of the RRIF is taxed as income.”

Clients who have built up sizable RRSPs and are comfortable with acquiring debt may consider RRSP meltdowns, Behun says. This leverage strategy involves borrowing money to put into a non-registered investment.

“You take the [withdrawals] from your RRIF to make the payments on your loan, and the tax deduction on your investment loan will offset the taxes payable on the RRIF withdrawal,” she says. “The object is to melt down the RRIF and put the assets into a non-registered
investment.” IE