Does “Topping Income Up” to Next Tax Bracket Make Sense?

Sarah is 67 and earning all her income in the lowest tax bracket. She has not yet started withdrawing money from her significant RRSP, which holds $800,000. When should she start? How much should she take into income?

When a taxpayer is in a lower tax bracket today than he or she will be in in the future, it may make sense to “top income up to the next bracket.” This is common in determining the amount of income to be withdrawn by business owners and retirees. In these cases, discuss income composition with clients before year end. Next consider how much income is needed for the “top up”. Finally, consider the income mix to achieve the best effective and marginal tax rates.  

For example, when Sarah turns 72, she will be required to withdraw $44,000 or more from her RRIF (balance x 1/(90-72)). When added to her other income sources, she will be taxed at 22% federally rather than her current 15% (see table below). She can immediately save at least 7% each year on withdrawals from her RRSP to bring her income up to the top of the lowest bracket ($43,561 in 2013). If Sarah does not have a spouse to roll her RRSP over to, her RRSP/RRIF balance will be taxed at the highest rate in the year she passes away. Additional tax savings could be made by withdrawing more from her RRSP—up to the lower limit of the OAS clawback zone ($70,954 for 2013)—so they are taxed at 22% rather than 29% in the year of her death.

Here are the federal tax brackets and rates for 2013: