The Art of Decumulation
Marc André Castonguay, CFP, CIM
March 5, 2022
There is no "one-size fits all" in retirement income planning. Thoughtful decumulation is key to making the most of your savings.
When it comes to withdrawing money from your investments in retirement, or “decumulation”, choosing the right mix of income can help make your retirement savings last longer. The main reason for this is our tax system. It uses progressive rates, the higher the income the higher the tax, different types of income have different treatments, many types of tax credits are available, and there are “additional taxes” (a.k.a. “clawbacks”) on certain income-tested government benefits such as Old Age Security (OAS).
Let’s look at a simple example to see how different decumulation strategies can impact retirement. Sandra, age 65, is a NB resident and has just retired. She will need $81,000 after-tax annually ($6,750 monthly) to cover her lifestyle expenses in retirement. In addition to receiving $16,000 per year from CPP and OAS combined, Sandra has the following investment assets:
$1,000,000 in an RRSP (which will be converted into a RRIF for withdrawals, no later than the year she turns 71 to avoid having the full amount taxed at once). We will refer to this account as “registered account”;
$125,000 in a TFSA; and
$300,000 in a non-registered (or taxable) account.
We’ll assume her balanced portfolio will generate an annual net return of 5%. This will be made up of: 25% interest, 15% Canadian dividends, 15% foreign dividends, 45% deferred capital gains. We consider the typical basic tax credits available to a taxpayer such as Sandra. To keep this illustration simple, we will ignore inflation and assume Sandra’s retirement expenses are the same every year. Here are the results.
Scenario 1: Using the “defer RRSP withdrawals as long as possible” approach, which seems to be quite popular, we start by withdrawing money from the non-registered account, then the TFSA and finally the registered account (although the required minimum withdrawal will start the year after the RRSP was converted to a RRIF). With this approach, Sandra can fully cover her lifestyle expenses until age 95. Even though her income taxes are low in the first years of retirement, later she will find herself with only fully taxable income, putting her at a higher marginal tax rate and triggering OAS clawbacks.
Scenario 2: In this “diversified income sources” approach, we draw from more then one type of account at a time. During the first years of retirement, we withdraw $35,000 per year from the registered account and the necessary balance to cover expenses from the non-registered account. The withdrawals from the registered account will increase the year after the entire RRSP is converted to a RRIF (age 71) since a minimum annual withdrawal based on the account value must be made. Once the non-registered account is liquidated, withdrawals from the TFSA will be made. With this approach, total OAS clawbacks are lower than in the first scenario and we have better control of Sandra’s taxable income to keep her at a better tax rate throughout retirement. In this scenario, Sandra can fully cover her expenses until age 98.
For some, when comparing these scenarios, covering an extra three years of retirement expenses may not seem like much, but since this is possible simply by adjusting the decumulation strategy, it is certainly worthwhile for the extra $243,000 in after-tax income.
This does not mean that the best solution for Sandra is the best for everyone. Each situation is unique and there are many variables to consider. There are also elements like corporate investments, large, unexpected expenses, and splitting pension income between spouses that will add to the level of complexity in a decumulation strategy. The main point to remember is that when it comes to your retirement income, general rules of thumb are not the best approach. Taking the time to work with your professional advisor to establish a decumulation strategy adapted to your situation could result in more money in your pockets.
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This writing is for general information purposes only and is not intended to provide legal, accounting, tax or personalized financial advice. If you are not sure how to proceed with a request for further information, seek help from a professional. Any opinions expressed are my own and may not necessarily reflect those of Louisbourg Investments.