Positioning the RRIF minimum reduction

Why this move is so important for affected seniors

On March 30, 2020, the government provided details of the reduction in minimum withdrawals from registered retirement income funds (RRIFs), defined contribution registered pension plans (DC-RPP) and pooled registered pension plans (PRPP).

While all of us are feeling economic stress from this pandemic, things could be particularly problematic for seniors’ saving and spending. Before going into the key measures announced, it’s worth outlining what makes seniors so vulnerable.

General operation of RRIFs

Accumulated savings in a registered retirement savings plan (RRSP) may be taken as a lump sum, used to purchase an annuity that pays a fixed annual amount, or continue to grow tax-sheltered in a RRIF. While this may occur at earlier ages, a RRSP must be matured by the end of the year the annuitant turns 71.

Once in a RRIF, the annuitant/owner is required to take a minimum percentage into taxable income each year. At age 71, the minimum is 5.28%, rising each year until it reaches 20% at age 95 and thereafter.

For RRIFs opened before age 71, it is calculated as: 1 divided by [90 minus age]

Vulnerability of seniors’ savings

Implicitly, the reduction in RRIF minimums is an acknowledgement of the special kind of economic stress many seniors may experience during and following this pandemic. Some of the effects:

  • Despite a senior making efforts to live more frugally or draw from other non/less-taxable reserves, mandatory minimums force RRIF depletion beyond what may be necessary to live on.
  • Funds coming out of a RRIF can’t go back in. That’s a permanent loss of this tax sheltering room.
  • Seniors who are no longer working will have little or no new income as a source for replenishing depleted retirement savings after this episode, unlike those who are able to continue to work.
  • Though the timing is uncertain, an investment market recovery will be expected following this downturn. As a function of age, seniors will have less time to participate in such a recovery.
  • As tax will have applied to RRIF minimums, less net funds will be available to invest in any recovery.
Key measures for RRIF annuitants

The points below are highlighted by the government in the announcement. To reduce the wordiness, only the term RRIF is used here, though again the changes apply similarly to DC-RPPs and PRPPs:

  • The minimum amount that must be withdrawn from RRIFs for the 2020 year is reduced by 25%. For example, the 5.28% minimum at age 71 will be reduced to 3.96%, and at 95 it will be reduced to 15%
  • This measure applies for the 2020 taxation year only, not for future years.
  • For an individual who has already withdrawn more than the reduced 2020 minimum, he/she will not be able to re-contribute to RRIF to bring the withdrawal down to the reduced minimum.
  • The reduced minimum also applies to life income funds and locked-in RRIFs. Such plans have both minimum and maximum withdrawal limits. To be clear, the changes apply to reduce the minimum withdrawal factor, but have no effect on the maximum withdrawal factor.
  • As a general rule, withholding tax is not applied to minimum RRIF withdrawals. The withholding tax rule is unaffected by this special reduction in the 2020 minimum, meaning that withholding tax will continue to apply only to amounts above the unreduced minimum for the year.

Emergency fund advice in a time of crisis

Whether clients are accessing funds or inspired to save for the next crisis, here’s what they need to know

In the sci-fi classic Ender’s Game, gifted children play simulated battle games with aliens at the edge of the universe, until (spoiler alert) the title character realizes during an especially intense sequence that he’s in the midst of the real thing, and everything to that point has just been practice.

When clients last contemplated their emergency funds, a global pandemic would have been well at the perimeter of possibilities. And yet, here we are.

So, those with an emergency fund may now be asking: How do I use it? And those who don’t have one — but are fortunate enough to still be in regular earning mode — should be thinking about how and when they would use an emergency fund as they begin saving.

Regular budgeting addresses recurring expenses, plus reserves for periodic capital outlays. Insurance is for the extreme where there are remote-risk/high-peril events. An emergency fund lies between.

The fund allows a client to sustain their household in a time of crisis — whether that’s an unexpected injury, job loss or a global pandemic — while expenses continue to pile up.

How and when they should use the emergency fund is a function of how they define “emergency.” Encourage clients to commit to the above definition when they begin saving so it’s preserved for truly pressing needs — like now— and not depleted on emotional wants.

Using an emergency fund

Like Ender’s alien battle, we’re no longer practicing. It’s time for clients to actively monitor and log their spending. This will help them manage the current situation, and learn for future planning. This is how clients should use their emergency funds now:

  • The immediate non-negotiable needs are food and safety. Clients can cut down on these expenses by shopping brand-consciously, reducing cost-per-unit by buying in (reasonable) volume, and being vigilant about portioning and waste.
  • Shelter costs like rent/mortgage and utilities are next. Federal government income supports should help indirectly, and housing-specific relief may be on its way, whether from government, lenders, landlords or a combination. Whatever form and amount this takes, clients must understand why this is a top priority: interest and penalties on short/skipped payments will compound the emotional and money stress the very next month, and further impair a client’s finances in the recovery time to follow.
  • Dispensing with all discretionaries may not be practical as clients hunker down for the coming days and weeks, but they should be selective about the prudent pleasures they choose.
  • Suspend luxuries and harbour no regrets. Encourage clients to keep their focus on the present, comforted that their conscientious actions today will improve their prospects tomorrow.
  • Counsel clients to log where their money is coming from and where it’s going, so they can manage within their changing means. That’s a good habit in good times, and critical in a crisis. Many have a bit more time these days to form the habit.
Building a fund for future crises

The emergency fund’s purpose, now or after the Covid-19 crisis, is to have money accessible for a specific number of months. But how many? Clients should start by planning for the most likely emergency: an employment gap.

Based on the client’s industry and where they work, how long do they think it would take to get re-situated? An estimate provides a goal for the number of months of funding.

Second, while losing income is painful, what matters most in an emergency is spending. Help clients review their bank and credit statements from the last year, taking out anything truly extraordinary and deducting items they may be able to defer for a few months. Divide the total by 12 for a monthly average, and multiply by the chosen number of months. This is the client’s lower limit (the upper limit includes those deferred items).

Third, set up a regular deposit to the fund, ideally aligned with the pay cycle. Clients should assign a percentage or dollar amount they can commit to, even if it’s a small figure.

Now, the gut check: divide the emergency fund target by the weekly deposit commitment. This will show how long your client needs to get there. If they feel a knot forming in their abdomen, they may want to bump their commitment. But that unease must be balanced against the discomfort from the current budgetary sacrifice in order to arrive at a manageable medium.

As a kicker, an oft-suggested alternative to an emergency fund is a line of credit at the ready with a bank or credit union. For some people, taking on debt at a time of financial stress may be an uncomfortable proposition. Still, establishing a line of credit can be an effective complement to an emergency fund, knowing that it will be there to fill the gap if an emergency hits before the fund reaches its accumulation target.

Registered or non-registered?

Your RRSP is not an appropriate choice as an emergency fund. With withholding tax as much as 30%, clients will have to take a higher gross amount to net to what they need. And if the withholding is less than the actual tax due, they’ll be scrambling to come up with cash at filing time next year. Withdrawing from an RRSP for an emergency also puts retirement at risk. Keep these two needs separated.

On the other hand, the TFSA is well suited for emergency needs. With no tax to deplete withdrawals, budgeting is much more transparent. Withdrawals are also entitled to the usual re-contribution credit, which can be both the motivation and target for replenishment once the emergency passes.

Basic Personal Amount – Will BPA changes truly provide tax relief

The federal government recently put a key piece of their tax platform in place: an increase in the basic personal amount (BPA). This is expected to lower taxes for close to 20 million of us, and eliminate any federal tax liability for almost 1.1 million Canadians.

To deliver on this promise, the government will increase the BPA to $15,000 by 2023. On the face of it, that’s a nice, round, substantial figure, and no doubt many of us will experience tax savings. Still, to give it some proportionality and context, let’s take a closer look to understand how, when, to whom, and to what extent this will provide tax relief.

DEDUCTIONS AND CREDITS

Most non-tax professionals likely don’t pay too much attention to the difference between a tax deduction and a tax credit. Both can reduce a person’s tax bill, but in a very real sense they are applied at opposite ends of the income spectrum.

A deduction reduces the amount on which tax is calculated. Because we have a progressive personal tax system (i.e., higher rates applying to income at higher brackets), a deduction reduces tax exposure at a person’s uppermost or marginal rate.

In terms of tax credits, a non-refundable credit reduces your initially calculated tax due, whereas a refundable credit is more like a subsidy in that it is paid even if you don’t owe tax. In either case, a maximum amount is legislated for a given purpose, against which the appropriate credit rate is applied. With a few exceptions (mainly charitable and political donations), the credit rate most often is at the lowest bracket rate. For federal tax calculations the lowest rate is 15%, but a person’s own income dictates the marginal rate, which may be as much as 33%.

Connecting those dots, a deduction is generally more valuable than a credit.

The most common non-refundable credit is the basic personal amount, sometimes called the basic personal credit.

Either way, it’s referring to the same thing — effectively negating tax on income from zero up to the set level. For instance, when you file your upcoming return for the 2019 taxation year, you’ll claim this credit on your first $12,069 income. At the 15% rate, the value of the credit is $1,810.

While it may seem an obvious point, note that the amount is larger than the credit value, since it is multiplied by the credit rate. Keep this in mind as we turn our attention to the change in the amount, and contemplate the value of that change.

ENHANCED BPA

Over the course of the next four years, the BPA will be bumped beyond its usual inflation indexing until it reaches $15,000 in 2023. The rollout schedule is shown in the first three columns of the table here, reproduced from the Department of Finance backgrounder. The two right-hand columns are my own calculations for the sake of some analysis to follow.

The additional BPA will initially yield $140 in annual tax savings, rising to about $300 in 2023, as featured in official communications. In that last year, the $15,000 amount will equate to a full value for the BPA of $2,250, a 13% improvement over what current indexing would have given.

However, it will be almost four years until early 2024 tax filing when that extra $300 may be claimed. Using the approximate 2% indexing employed by the Department of Finance, that discounts back to about $277 in current dollar value.

To be clear, I’m critiquing, not criticizing; my aim is to couch expectations of the practical implications for individual and household budgets. That last point is especially important, as there are parallel changes to the spousal and eligible dependant amounts, the effect of which will be to double the impact to as much as $600 for families claiming either of those credits.

INCOME CEILING AND TIME HORIZON

Not everyone will enjoy this enhanced BPA. Extra components will be added to the BPA definition to reduce the enhancement as income enters the 29% fourth bracket, until it is eliminated for someone whose income exceeds the 33% top/fifth bracket. For 2020, those thresholds are $150,473 and $214,368. For your curiosity, a $300 loss across this range is a clawback contribution to a marginal effective tax rate of just under 0.5%.

The BPA and brackets will continue to increase each year according to the existing indexation formula, but the BPA enhancement will remain at $15,000 after 2023. This means that the value of the enhancement will continually erode each year thereafter. Using that 2% index factor as a proxy, the BPA would overtake the enhancement by about 2030. Whether this will still be a feature of our tax system a decade from now is anyone’s guess.