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By Jonathan Chevreau
National Post
FP Investing
Thursday, June 30, 2005 |
With increasing longevity and meager investment returns, Ottawa's forced withdrawal rates on RRIFs impose a serious threat that retirees will outlive their money.
Adrian Mastracci, investment counsel at Vancouver’s
‘fee-only’ KCM Wealth Management, says,
“The accelerated RRIF withdrawal schedule more heavily affects those between 71 and 77.”
The last time the Department of Finance altered rules for minimum annual withdrawals from Registered Retirement Income Funds, it went in the wrong direction.
It lowered the age at which an RRSP must be converted to a RRIF (or annuity) from 71 to 69, robbing retirees of two years of tax-sheltered saving.
More seriously, it raised minimum withdrawal rates to percentages that frequently outpace the probable investment returns from fixed-income investments or the stock market.
The predictable result: an increasing danger retirees will outlive their money, or at least the part of their capital that is tax-sheltered.
This is an issue the Canadian Association of Retired Persons raises in pre-budget consultations every year. It's also one on which Tom Hockin, outgoing president of the Investment Funds Institute of Canada, has urged reform.
"It's a huge issue. We get lots of complaints from people who don't want to withdraw the whole amount," says CARP director of government relations Judy Cutler. "They're worried they won't have enough money to last their whole lives."
What irks retirees is they may be forced to withdraw more than they need in the early years of retirement -- and pay tax on it. This means capital is depleted prematurely, lowering the chance money will be there later in old age, when it might be needed for major medical or long-term care needs.
RRIF withdrawal rules were last changed in the early 1990s. RRIFs set up after Jan. 1, 1993, conform to newer higher annual withdrawal rates.
While 69 is the age at which you must collapse an RRSP, you can establish a RRIF earlier. Below age 68 the formula is one divided by 90 minus your age. Thus a 50-year-old could withdraw 2.5% a year.
According to Vancouver-based advisor Adrian Mastracci, of KCM Wealth Management Inc., the accelerated withdrawal schedule more heavily affects those between 71 and 77. Under the new rules, the annual withdrawal rate over that time rises from 7.38% to 8.15%. The percentage eventually hits a whopping 20% a year at 94.
Since most retirees shift portfolios to bonds, their interest income won't keep up with those withdrawal levels. Inevitably, RRIF growth ceases and starts to fall.
RRIF capital forced out ends up in the non-registered or taxable pot, says Steve Salter, developer of RRIFmetic, who views the current rules as unfair. "The RRIF minimum rules were designed for a time when rates were generally higher."
Fred Kirby, a portfolio consultant, has created simulations of living expenses showing how today's withdrawal requirements would have affected retirees in the deflationary depression of the 1930s or inflationary 1970s.
He found the most important factor curtailing RRIF longevity is inflation. But in deflation, those with RRIFs would have fared relatively well since the purchasing power of what capital remained would have been proportionately greater.
Kirby ran scenarios for those taking early retirement at 55 and another for 70-year-olds. If either retiree opted to begin withdrawals in 1929, their RRIFs (invested in balanced portfolios) would have lasted into their 90s. In both cases, the dramatic decline in their portfolios was mitigated by a deflation in prices, leaving the RRIF payout schedule to determine withdrawals.
By contrast, a retiree in 1968 faced soaring inflation and choppy markets. Both the early retiree and the 70-year-old would have run out of money in 15 years, well short of the former's and dangerously close to the latter's life expectancy.
Unlike the 1929 case, these retirees would have to annually withdraw 10% to 20% of their funds, more than the mandated withdrawal amount, just to keep up with increased living costs.
Kirby recommends annual RRIF withdrawal rates be pegged at 4% of an annuitant's initial balance. Each year, the dollar amount would rise with inflation. This "dramatically increases the chance a RRIF holder's money will outlast him."
Had this approach been used in 1968, the RRIF would have lasted 26 years, a full 10 years longer than under the current system.
While economics may determine the life of a RRIF, Ottawa's need for a constant flow of tax revenue determines its rules. Therefore, Kirby says, "formulaic withdrawal rules based on non-economic issues such as the annuitant's age and a payout table designed to reduce the time that assets are held in a tax-deferred account outweigh concerns that retirees will outlive their money.
If Ottawa truly cared about pensioners, it would address this problem. If you think it should, send this column to your MP.
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