It’s hard to believe that we are just a week away from December and, as I joked with someone, we are only a few more weeks away from escaping this crazy year. I would say that we all deserve some joy and happiness. While we will soon be unwrapping boxes, we also have to remember that there are some financial boxes that need to be checked as well. Our Managing Director of Tax and Estate Planning, Jamie Golombek puts out a great list of year-end tax tips and you can find the latest one here.  For today, I want to focus on your Registered Retirement Income Fund, or RRIF.

First, if you turned 71 this year and have an RRSP, it must do one of the following by December 31st – transfer the assets into a RRIF, use the funds in the RRSP to purchase an annuity or simply withdraw the funds. Clearly, next to no one choses the third option and very few purchase an annuity since at age 71 life expectancy is still too far off to deliver an adequate retirement income stream based on where interest rates are. Option one it is.

Now, some Canadians may have already set up a RRIF before they turned 71. This would be the case for someone who was at least 65 and converted in order to create pension income, either because they needed it or because they were advised to start reducing their registered assets in order to minimize a projected estate tax hit down the road. For those that have accumulated a considerable amount of wealth in their RRSP during their working lives, the way in which our tax code works means that they could easily be put in the top tax bracket at death. Our clients share one thing in common and that is they were hard workers and good savers, so doing some engineering work by creating RRIFs before age 71 helps them keep more of their wealth.

If you are creating a RRIF for the first time this year, you will be required to take out a minimum amount starting next year. That value will be calculated by taking the year-end closing value of the RRIF and multiplying it by a percentage that corresponds to your age next year. It’s important to note that this amount can be taken any time during the coming year. If someone needs the money from their RRIF for day-to-day expenses, then they will either take the full amount at the start of the year or spread it out across 12 months. For those that do not need the funds, the best approach is to leave the funds in the RRIF until the end of the year. The reason is that investment income generated by that capital is tax deferred inside the RRIF, compared to being taxed in the year it is earned if invested outside the RRIF.

Okay, so let’s assume you have had a RRIF longer than a year and that you are in that group where the payment is left in until December. What is the strategy for getting that money out? The starting point is to have a look at your RRIF portfolio and review whether all investments are still suitable. Assuming they are, what is your asset allocation relative to target? Given that we have seen fairly impressive gains in stocks this year, it is possible that your exposure to equities might be above target.

The above chart shows the TSX composite index against the Solactive Canada Universe Bond index since the start of the year. If a RRIF account’s asset mix was on target back then, it will have shifted in favour of stocks and could possibly be outside of the individual’s variance threshold. If so, a larger percentage of your RRIF payment should probably come from stocks versus a smaller percentage from fixed income or cash. Even with advance in equities, some may still be underweight in which case you can make an argument for taking a larger chunk from fixed income.

The focus is to make sure that the portfolio is properly balanced after the RRIF payment is taken out and not distorted by the draw. In a blended portfolio, which is reviewed and rebalanced on a fairly regular basis, this approach is straight forward. Where I have seen this break down is when individuals have RRIF accounts in more than one place and where they are not all aligned to the person’s asset allocation strategy. This risk can be mitigated if the individual is keeping a close eye on those multiple accounts to ensure they are aligned.

The bigger risk is when a balanced RRIF portfolio has been designed by holding equity investments in one account and GICs in another, where they are laddered in such a way that the maturing GICs each year are used to make the RRIF payment. This might not appear like a bad strategy on the surface, but if it is followed over a number of years, it can create a major distortion to that person’s RRIF. For example, let’s say Ms. Smith has a RRIF worth $500,000 in year one and let’s assume she has a balanced asset allocation strategy – 50% in an equity mutual fund and 50% in GICs, invested as a five-year ladder.

Each year, a $50,000 GIC matures, and the proceeds are used to pay her minimum payment. If she is turning 72 next year, that amount would be just below $27,000. If she is turning 88, that amount is closer to $50,000.  Over the course of five years, she will have removed anywhere from $140,000 to $250,000 from her non-equity account. Instead of maintaining a 50% equity strategy, she is now anywhere from 70% to 100%. Forgetting the obvious, that as she gets older, her asset allocation might even become more conservative, we have now moved Ms. Smith into a much higher risk situation than she should be in.

I have seen this in real life, where an advisor thought that this two-account approach was simple and easy to maintain. The person in question had just used the last GIC in her RRIF to make a payment in 2007. Yes, at the start of the Great Financial Crisis, she had an asset mix that was 100% equity, and she was 81. By 2009, she had lost half of her remaining RRIF.

Bottom line, the investment approaches we use for your RRIF account should be no different than what you employ for your individual and joint investment accounts, corporate accounts and TFSAs. Just like when we add money to an account, we have to be just as careful not to distort a portfolio when we take money out.

Andrew's latest Market Call is now available for replay. Please find the playback details below.

On behalf of the Pyle Wealth Advisory team, have a wonderful weekend.   

Andrew Pyle