Making the Best of a Bad Economic Situation

Economic and stock market news over the past couple of months has left just about everyone feeling a little less financially secure. Declines in the market, along with  increases in the cost of food and home heating fuels (for Canadians, perhaps the ultimate in non-discretionary expenses) have left Canadians feeling squeezed in both directions. And while nearly everyone is affected, it is those already in retirement or just about to retire who are probably feeling the pinch the most.

Retirees and near-retirees looking at their shrunken portfolios wonder, reasonably enough, what their options are in the current environment. Specifically, many wonder whether it’s possible to avoid or minimize annual withdrawals from their registered retirement income funds (RRIFs) or, at least, to postpone those withdrawals until the investments held in the RRIF have recovered somewhat from their current lows. Others wonder whether there might be some tax relief available to cushion the impact of the losses their RRSPs or RRIFs have incurred over the past couple of months.  

Unfortunately, the answer to both questions, at least under current law, is "no". Taxpayers over the age of 71 who have transferred their RRSP assets into an RRIF are required to withdraw a set percentage of the balance in the RRIF each year — without exception. For just about everyone, that balance was higher at the beginning of this year than it is now. And unfortunately, the rules provide that it’s the amount in the RRIF at the beginning of the taxation year that is used to calculate the required withdrawal for that year.

The answer to the second question on the availability of tax relief for losses experienced by an RRSP or RRIF is also negative. All funds inside registered retirement savings vehicles (whether RRSPs or RRIFs) exist, in a manner of speaking, “outside” our tax system, in that amounts earned (or lost) inside those plans have no immediate tax consequences. Just as the gains experienced over the past five or so years by most RRSP portfolios weren’t included in income or taxed in the hands of their owners, so any losses experienced inside such plans can’t be deducted from the planholder’s income. When amounts are withdrawn from an RRSP or an RRIF (whether before or after retirement), those amounts are treated as ordinary income, and no recognition is given by our tax system for any losses (or gains) that were incurred or earned while those funds were inside the RRSP or RRIF. (Note that this information is specific to investments held inside an RRSP or RRIF. Those who have investment portfolios which are not part of an RRSP or RRIF are generally able to claim losses incurred during a taxation year where investments are sold at a loss. The decision of whether to sell and claim those losses is, of course, determined by a taxpayer’s individual circumstances. In making that decision, it’s worth remembering that an old but still valid maxim of tax planning holds that investment decisions should never be driven by tax considerations alone.)

While the current situation is discouraging, there are still options available to retirees. Beginning in January 2009, all Canadians over the age of 17 will be able to set up a Tax Free Savings Account (TFSA). Retirees who have had to withdraw funds from an RRIF can deposit up to $5,000 of those funds (or any other funds) annually in a TFSA, where they can be invested and continue to grow on a tax-free basis. It’s possible to hold, inside a TFSA, the same investments or types of investments that were held in the RRIF. Consequently, retirees who believe that the investments (for example, stocks or mutual funds) which they held in their RRIF will, in time, recover can re-purchase the same investments at their current low values, using funds that they have been required to withdraw from the RRIF (or any other funds), and hold them within a TFSA. And unlike RRIF withdrawals, funds (including accumulated investment gains) can be withdrawn from a TFSA at any time, for any purpose, free of tax. Finally, in the event funds are withdrawn, the same amount can be re-contributed to the TFSA, in addition to the usual $5,000 annual contribution.

For retiree couples, it’s possible to “double up” on contributions to maximize the benefit. Although each taxpayer must make his or her own TFSA contribution (in other words, there’s no such thing as a “spousal TFSA”), it’s possible for one spouse to give funds to the other to make that contribution. While such a strategy would usually attract our tax system’s attribution rules, those rules don’t apply when it comes to TFSA contributions. And finally, retirees who are receiving federal benefits that erode as income increases, such as Old Age Security, don’t need to worry about TFSA withdrawals. Such withdrawals aren’t included in income for purposes of determining eligibility for such benefits. Many of the major financial institutions are now marketing TFSAs in anticipation of the January 1 start date, and so it shouldn’t be at all difficult to find an institution at which a TFSA can be set up.

Although watching the hard-earned savings that were counted on to provide a retirement income dwindle can be frightening for retirees and near-retirees, there are options and strategies still available that can allow them to minimize losses and participate in the future growth of their investments.