SWRs, RRBs, and taxes

[adrian2]

Take your 4% of *that* and consider it your safe withdrawal.

The portfolio doesn't care about your tax liability; a simpler way is to take the 4% and estimate the tax liability out of that. It may seem a pedantic correction and argue it's going to yield the same, but to me it's a better way of guestimating.

[Springbok]

Indeed, I ran into this problem when I decided to put together my own spreadsheet and run some numbers. Once I got into the detail of the analysis, I started to realize how complicated this could get based on both allocation and the taxation of that allocation.

partly snipped

Finally, in retirement, as you have highlighted, the taxation of your gains should be considered since this can vary significantly from a 100% bond portfolio to a bond-preferred-equity portfolio to a 100% equity portfolio.

FWIW, I posed this question sometime over a year ago on this forum, and the fairly unified response I received was "to do that type of complicated determination, you need advanced software like RRIFmetic". The permutations and combinations do make it a fairly complicated bit of DIY spreadsheet work. But I do agree that your tax concerns are not trivial.

Coupon strip - Actually making the x% withdrawal for a few years does provide a better picture than looking at theoretical scenarios. We have been withdrawing 4% of our original retirement capital. Over the first 5 years, the withdrawal dropped as a % of our portfolios, but with the current markets, it is once again about 4%! But at least our capital is intact!

I have been in retirement for about 6 years and have been trying different tacks to minimize taxes. The income that we draw, is now almost all in form of dividends or ROC so at the moment, tax on income is minimal. We have also done tax-loss selling and applied this to previous years.

This allows us room to start withdrawals from RRIFs that we have set up early. Our situation is that we have 2/3 of our savings in registered accounts. Withdrawals are of course taxed at marginal rate.

Once we have to make RRIF withdrawals, the picture will change again. This will change the base income that I mentioned in a reply to Shakespeare above. It will now be CPP+OAS+RRIF withdrawal - all fully taxed.

It is complex, but one simple idea I had, is to look at a withdrawal of 4% of (unregistered + 60% of registered), to allow for the heavy tax on RRIF withdrawals. This would (in our case) mean a safe withdrawal of under 3%.

[Springbok]

How about, for a rough calculation, to include in your portfolio a tax liability for existing capital gains and RRIF/RRSP assets that will be taxed upon removal? Overestimate it slightly to be on the safe side. Take your 4% of *that* and consider it your safe withdrawal.

I guess that is what I also suggested in my last post (last sentence). It would work as a rough guide and the 4% is just a rough guide anyway.

But in thinking about it, the studies that resulted in the 4% withdrawal would not be concerned about taxes. But we do need to consider taxes when determining what type of lifestyle the 4% withdrawal rate might cover.

I am in process of doing my 2008 taxes. Income is CPP/OAS/small pension, investment income from unregistered a/c plus $10k withdrawal from registered accounts. I did another run that included the full RRIF withdrawal that will be required after 71. Indicates a tax rate of 36% on the RRIF withdrawal.

In other words, the government owns 36% of my registered savings.

A safe spending rate might be more like 2.75% in my case because a large part of my savings are registered.

I would suggest that others do their own calculation - taxes DO matter!

PS to Moderator - The last page or so of posts got away from the RRB subject - maybe they should be moved to a more appropriate place.

[queerasmoi]

Take your 4% of *that* and consider it your safe withdrawal.

The portfolio doesn't care about your tax liability; a simpler way is to take the 4% and estimate the tax liability out of that. It may seem a pedantic correction and argue it's going to yield the same, but to me it's a better way of guestimating.

Well the reason I suggest it is because you may have the choice of different types of withdrawals that will or won't trigger taxes. So if I withdraw my 4% in a way that triggers zero tax (for example, from TFSA) but a lot of my portfolio is in an RRSP that does have a tax liability... Unless I account for the liability on the whole portfolio, I may have overestimated the effective size of my portfolio for the purpose of withdrawal.

[Shakespeare]

investment income from unregistered a/c plus $10k withdrawal from registered accounts. I did another run that included the full RRIF withdrawal that will be required after 71. Indicates a tax rate of 36% on the RRIF withdrawal.

Your portfolio tax rate is still less than 36%.

But there is a greater distortion: an RRIF is designed by the government to be exhausted, because of the high withdrawal rate in later years. This distorts the tax picture as well.

[Springbok]

]Your portfolio tax rate is still less than 36%.

Yes, it obviously is???? But that's not the point.

The point is that the spending power of the RRIF is lower due to higher taxation when withdrawn. Any retiree should be aware of this and figure out how much of the safe 4% portfolio withdrawal (from all accounts) will end up in his/her pocket. This is not a trivial calculation.

As you point out, the tax on RRIF withdrawals can become even more onerous in later years depending on the yield and depletion rate of the RRIF. My wife has a spreadsheet that tries to predict this ( She wants to know how much money she will have to pay the bills )

If part of the RRIF withdrawal is reinvested in an unregistered account, any income on it will be further taxed. And, because the RRIF withdrawal may push taxpayer into a higher bracket, the tax rate on investment income could be higher than it was. Another factor to dial into any calculation.

In the end, our portfolios may provide less retirement income than we figured especially if we had only taken a rough guess at the taxation rate.

[adrian2]

If part of the RRIF withdrawal is reinvested in an unregistered account, any income on it will be further taxed. And, because the RRIF withdrawal may push taxpayer into a higher bracket, the tax rate on investment income could be higher than it was. Another factor to dial into any calculation.

Don't forget the TFSA option for part of RRIF withdrawals.

[Shakespeare]

Yes, it obviously is???? But that's not the point.

And here I thought the point was the portfolio tax rate not merely the RRIF tax rate.

Or perhaps it changed somewhere along....

[Bylo Selhi]

In the end, our portfolios may provide less retirement income than we figured especially if we had only taken a rough guess at the taxation rate.

In the end, our portfolios may provide more retirement income than we figured especially if we had only taken a rough guess at the taxation rate.

Why?

Because the tax rules and tax rates change all the time. In recent years marginal tax rates have come down. Dividend tax rates have come down. Capital gains tax rates have come down. The mandatory RRIF conversion age has gone up. Last year and likely until the economy improves RRIF minimum annual withdrawal amounts have been reduced by 25%. Pension splitting has been introduced. If you're in ON your PST is about to be harmonized.

And so it goes...

Now that's just in the past 5 or so years. This year we have new $40+B annual deficits to "stimulate" spending. That money will have to be repaid at some point. That means new and/or higher taxes. How? By how much? When? Your rough guess is as good as anyone else's.

Whether you plan to retire in 10 or 20 or more years or even if you're retired today, any planning you do now is necessarily going to be only "a rough guess" of the future.

The only constant is change. Good luck planning for it

[Springbok]

If part of the RRIF withdrawal is reinvested in an unregistered account, any income on it will be further taxed. And, because the RRIF withdrawal may push taxpayer into a higher bracket, the tax rate on investment income could be higher than it was. Another factor to dial into any calculation.

Don't forget the TFSA option for part of RRIF withdrawals.

It would be great if they would allow all of the RRIF withdrawal to go into a TFSA.

But unfortunately it is presently only $5k. That IS where we are putting our current small RRIF withdrawals.

[Bylo Selhi]

It would be great if they would allow all of the RRIF withdrawal to go into a TFSA.

It would, but that's not realistic. All the money in your RRIF has so far been tax-free. (It originally went into your RRSP without tax and it's grown over the years without any tax.) So if all RRIF withdrawals could go into a TFSA tax-free then that money would never be taxed. And even when you die that money still passes to your heirs tax-free.

Count your blessings that you can get $5k/year of your income 100% tax-free forever.

[Springbok]

Count your blessings that you can get $5k/year of your income 100% tax-free forever.

How does the TFSA provide $5k per year of your income 100% tax-free forever?

Is it not just the income on the $5000/yr contribution from your after-tax contribution that is tax free?

[Bylo Selhi]

My error. You have to pay tax on the $5k RRIF withdrawal (for the first time since you earned it, perhaps decades ago) then you can continue to let it compound tax-free until your (or your spouse's) demise. Still, it's a good deal compared to the alternatives.

[Doug]

For beginner investors, an excellent calculator for retirement withdrawal can be found at the following site:

http://www.fireseeker.com/

Unfortunately, it's American. It got a good writeup by Jonathan Clements, when he was at the WSJ in 2002.

[ghariton]

Yet another article dumping on the 4% rule, and what to replace it with.

Use annuities instead of bonds

Pairing the most plain-vanilla type of annuity—called a single-premium immediate annuity—with stocks, retirees can generate income more safely and reliably than if they use bonds for that piece of their portfolio, says Wade Pfau, a professor who researches retirement income at the American College of Financial Services in Bryn Mawr, Pa.

<snip>

Follow the tax man's tables

One way to manage retirement withdrawals is to use life-expectancy tables such as the one the Internal Revenue Service uses to establish required minimum withdrawals from individual retirement accounts. This works almost as well as more-sophisticated modeling done by retirement-research experts at Morningstar Inc., those experts say.

<snip>

Peg your withdrawals to stock valuations

If stocks are pricey when you retire, suggesting lower returns over subsequent years, you should be cautious about how much you pull out; it's clearer sailing if stocks are at bargain prices. Hence, the approach devised by Michael Kitces, research director at Pinnacle Advisory Group Inc. in Columbia, Md. He determines what he considers safe withdrawal rates by using the P/E 10 for the Standard & Poor's 500-stock index. The P/E 10 is a measure of current stock prices relative to the companies' average inflation-adjusted earnings over the past 10 years.

When using a portfolio of 60% stocks and 40% bonds, he found that three rules worked for determining an initial withdrawal rate for 30 years of retirement and adjusting withdrawals each year for inflation. Mr. Kitces says he focused on returns during the first half of a projected 30 years of retirement, because preserving your nest egg for the first 15 years means you would be in good shape for the rest.

His rules: If the P/E 10 is above 20, in which case he considers the market overvalued, you would withdraw 4.5% in the first year of retirement, adjusting that initial amount for inflation every year thereafter. If the benchmark falls between 12 and 20, where he considers the market fairly valued, the initial withdrawal would be 5%. If it's below 12, or undervalued, you can pull out 5.5% the first year. (If you aren't comfortable taking out that much, you might use lower percentages but incorporate the same approach.)

George

[CJOttawa]

Yet another article dumping on the 4% rule, and what to replace it with.

Use annuities instead of bonds...

Rick Ferri wrote an article on annuities late last year:
http://www.rickferri.com/blog/investmen ... -everyone/