Gresham’s Law

Gresham’s law is commonly stated as “bad money drives out good money.”

It seems to be a universal truth.  If you have $20 gold coins circulating along side $20 paper bills, you will find the gold coins disappear into a safety deposit box and the paper money is spent.  People believe good money is worth more.  Pretty simple really.

In retirement though, many people lose track of the idea and they sometimes preserve their bad money and spend their good money.  Even in the absence of gold there is still a distinction.  Good money is money that is worth full value.  100 cents per dollar.  Bad money is worth less, maybe much less.  In many cases, you will find that spending a RRIF quicker than mandated by the tax rules is a good idea.

By definition a RRIF is “bad money’ because before you can use the money, you must give up a share to the government.  Same in your estate.  It is reasonable to believe that a RRIF dollar in your estate is worth no more than 52 cents.  While living, it could be as little as 48 cents if OAS clawback is a problem and it may well be for a surviving spouse.

For the majority,  tax on RRIF income is 35% or less.  The dollars taxed at 35% are better than dollars taxed at 48% to the estate or 52% to a surviving spouse.  It would take a long time for the tax deferral advantage to make up the difference.

Consider the case where a couple has income of about $120,000 between them.  If one dies, then RRIF income to the survivor can easily cost 52%  when the OAS Clawback is included.  Income for the survivor will probably be about 25% less (assumes some pensions) than the total before and the tax bill will go up.

Your reasonable strategy then is to spend bad dollars before good dollars.  RRIF first, usually spread out to about age 80 to 85, then other investments, while being sensitive to tax, then the TFSA, and finally assets held inside life insurance plans.

Under this method the assets left in your estate will be worth closer to 100 cents per dollar and your spending while alive will be after a tax rate you can manage.  You will need to a long term income projection to get the time and the mix right.

An easy estate optimization plan.  Plus it will give you greater flexibility should you live a very long time.  The dollars left for you to use later are close to 100 cent dollars.  If you need to spend money at an advanced age taking $1,000 from a TFSA is about the same deal as taking $1,900 form a RRIF, so you don’t need so many dollars working for you.

Work it out, it can easily matter.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.

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