Now that the RRSP contribution deadline has passed, maybe its time to think about when it makes sense to start cashing in those RRSPs, especially for seniors that are no longer making contributions.
A basic rule of thumb is that you will save money on taxes by making withdrawals from your RRSP or RRIF in those years when your income places you in a lower tax bracket. Normally, that means that you would wait until you retire to start taking money out of your RRSP. Indeed, the rules require you to start making regular withdrawals from your RRIF the year after you establish it, and you must transfer your RRSP into a RRIF, or cash it in, the year you turn 71.
Even if you are making regular withdrawals from your RRSP/RRIF, you may end up paying more tax than you need to when you eventually die. You will be deemed to have cashed in your entire RRSP or RRIF at the date of death and will have to pay taxes on this amount in the year of death. If you have a significant amount in your RRIF at that time, you will end up paying taxes at the highest marginal tax rate.
Withdrawals from Tax Free Savings Accounts (TFSA) on the other hand, are not taxed at all, and growth within them is tax free as well. In addition, such withdrawals do not cause clawback of Old Age Security or other benefits. This makes them more attractive for seniors or others receiving benefits tied to taxable income.
So, how can you arrange to transfer money from an RRSP or RRIF to a TFSA? The answer is, withdraw the money from the RRSP or RRIF, pay the taxes on it, and contribute it to the TFSA. Unfortunately, you will have to pay taxes on the withdrawals from the RRSP/RRIF, there is no way to avoid this. However, if you are in a lower tax bracket, you will end up saving money over letting the RRSP/RRIF be taxed in your estate.
You will only be able to transfer $5,000 per year to your TFSA, starting in 2009, however, the eventual tax savings may still make it worth your while. Assuming you are in the 22% tax bracket, you would pay $1,100 in taxes to transfer $5,000 to your TFSA. If you wait, and that $5,000 is taxed in your estate, you would pay $2,200 or double, because it would be taxed at 44%. A hidden benefit not included in this calculation is that all growth in the TFSA is tax free, while that growth in the RRSP/RRIF ends up being taxed in the estate.
Before you decide to follow this strategy, talk to your accountant in order to make sure you avoid clawback of OAS or other benefits, and to make sure this is the correct course of action for you.