I wrote most of this blog entry at the beginning of the year before COVID hit, which now seems like a life-time ago. I lost track of it in midst of the pandemic, kept busy with assessing the economic impact of business closures on our investment portfolio and dividend income (more on that in my annual Year-End in Review to be posted in January). Much of the content of this posting may not be relevant for the foreseeable future, since it was predicated on an exceptionally strong year for the stock market (i.e. 2019 - as I said, a life-time ago!). Since 2020 is coming to a close, I decided to publish this anyways in hopes that one day, we will see good times again.
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I have long complained about how unfair and paternalistic the rules
are for a Life Income Fund (LIF), which places restrictions on the
maximum that you can withdraw from it each year. These rules are based
on the premise that, left unchecked, an individual would blow through his
retirement savings and have nothing left towards the end of his life.
As someone who is very good at managing money and planning for the
future, I feel unnecessarily constrained by these restrictions and have
looked for every opportunity to increase the rate at which I can "free my
money" into my own control.
At the beginning of 2020,
which marked my second full year of making LIF withdrawals, I was
surprised by the calculation for my LIF maximum. Up until now, I was
only aware of the rule that calculates my expected LIF maximum for the
year based
on my age on January 1, my LIF balance at the end of December 31 of the
previous year, and the posted annuity factor. This slowly increasing factor is meant to make your money last until age 90. I even have a spreadsheet listing the annuity factor and projected LIF maximum for each year. Accordingly at age 56, I was
expecting to only be able to withdraw around 6.57% of the value of my LIF.
Imagine my surprise when my LIF maximum for 2020 came to about 27% of
the value of my account! I thought this was a mistake and tried to get an explanation from my
discount broker Scotia iTrade. Unfortunately the agent on the phone did not know
the answer and I did not get a response from the question that I posted on
the Communications page of their website until three weeks later (by which time, I had already figured it out - Thank You Google!). Left on my own to find the
answer, I read up in more detail about LIF Maximum Withdrawal Rules on the Financial Services Regulatory Authority of Ontario (FSRA) website
which controls my locked in company pension (converted into a Locked-In
Income Fund in 2018) and clarified the rules for Ontario. This is what I discovered:
When I finally received an official response from Scotia iTrade, it clarified the second rule even further. This value is calculated as:
With this new knowledge and understanding, I will be able to better predict and plan for my LIF withdrawal going forward.
Then came the quandary. Should I take advantage of what could
potentially be a one-time opportunity to take an unexpectedly large sum
of value out of my LIF? If markets are not as strong in 2020, I may not
have this same opportunity and would fall back to the first rule of
the calculated percentage which will come to 6.63% in 2021 when I will be 57. The forgone
opportunity to withdraw 27% from my LIF cannot be rolled over to the
following year and would be lost forever.
But taking out this unplanned
maximum would push my 2020 income significantly higher than expected, increasing my income tax burden. I also had not saved enough cash within my LIF to pay the withholding tax and would need to sell some stock in the account to generate it. Additionally, I would
need to scale back the larger withdrawal that I had planned for
within my RRIF, where I did have the extra cash to cover the withholding
tax. My overall goal is to drastically reduce the value of my
registered accounts by the time I am age 71, so that I will not be
subjected to as much claw-back of Old Age Security (OAS) payments, which are indexed for inflation. For the past few years, I have
concentrated on my RRIF but now came an opportunity to deal with my
LIF.
After some thought, I decided that I could not pass up this opportunity. Instead, I would withdraw the allowed maximum
from my LIF and take the one-time hit to my net income level. As
has been my strategy for the past few years, I would take a portion of this withdrawal as
stock-in-kind to move to my non-registered account where it will
continue to generate dividend income at a better tax rate. The rest of the withdrawal would be taken in cash and paid up front as withholding tax. Rather than paying the minimum required withholding tax, I would pay enough to cover my projected overall tax burden generated not just from this LIF but from all of my registered and non-registered accounts. I am able to obtain a fairly close estimate of this future 2020 tax burden by entering anticipated income figures into my 2019 tax software.
To generate the cash to cover the withholding tax, I put in a "limit-sell" for some shares of one of my stocks and was able to sell at a decent price while locking in some tax-free capital gain. By voluntarily paying extra withholding tax as part of my LIF withdrawal, I avoid the need for the government to put me on a mandated tax installment payment plan in future years. CRA installment payments are required when insufficient tax is deducted at source. The requirement for installment payments is as follows:
No tax is deducted for any of the dividend payments that my husband Rich and I receive and split as income
from our jointly held non-registered account. The minimum withholding tax charged
on my registered account withdrawals would not be enough to put me under the "net tax owed" threshold to avoid the requirement for installment payments. Rather than needing to adhere to a fixed schedule (usually quarterly) for paying taxes throughout the year and having to make sure that I have the funds available for each period, I would rather be in control of when I pay and prefer to do it in one or two lump sums. This way I can sell stock at an opportune time in order to fund the payment(s) and I can pay amounts closer to what I actually owe, as opposed to the CRA estimates that are based on previous years' net taxes owed.
My initial motivation for paying more withholding tax up front was a means to help the economy during the COVID crisis by paying my income tax debt to the government ahead of the regular due date. Now with the possibility of being imposed installment payments, I would not be paying that far in advance anyway.
Taking advantage of the second rule of LIF
Withdrawal limits was probably a good decision since it may be a while
before these conditions present themselves again. A similar situation happened for Rich, but
since the size of his LIF is much smaller, withdrawing the maximum
would not have the same effect on his annual income as it did for me,
and he actually had enough cash saved up to cover the withholding tax.
So this was an easy decision for him to take advantage of this year's
extraordinary maximum withdrawal allowance. This large withdrawal followed by the initial market crash incurred after the start of the pandemic caused the value of his LIF to drop below the "Small Amount Rule" which allowed him to collapse his LIF all together and move the money into his RRIF. I discussed this in a previous blog entry.
I was not aware of this. I can't believe it. Thank you.
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