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Market-timing your RRIF withdrawals can make sense

Looking for extra money? So was a 33-year-old man who was charged last September in New York City with attempted grand larceny. According to the New York Post, the man was arrested after allegedly attempting to deposit two bogus computer-printed cheques into his bank account -- totalling $11-billion (U.S.).

Turns out this guy had pulled off a smaller scam the week before by successfully depositing cheques for $350 and $1,300. I guess he felt he was due for a raise.

The moral of the story? If you're looking for extra dough, skip the forgery. Consider timing your registered retirement income fund withdrawals instead.

The issues

You can have a registered retirement savings plan around only until the end of the year you turn 69. Most people convert their RRSPs into RRIFs by the end of that year. Your RRIF has a required minimum withdrawal each year, starting in the year you turn 70. The usual advice? Make your required withdrawals as late as possible -- Dec. 31 of that year.

But your RRIF will fluctuate in value throughout the year if you hold equities in the plan. Does it make sense -- is it possible -- to take advantage of these fluctuations by making withdrawals at the right times in the year?

The numbers

You might be cringing at the thought of market-timing RRIF withdrawals. But this involves less risk than regular market timing because you're not changing investments. You're simply choosing when to pay tax on the withdrawals.

Consider a study done last year by T. Rowe Price in the United States. The firm compared two investors, each 72, with $100,000 (U.S.) in an Individual Retirement Account. (An IRA is very much like a RRIF in how withdrawals work, so the study is relevant.)

Each invested in the S&P 500-stock index over the period 1994 to 2003. One investor made his withdrawals on Jan. 1 each year, while the other made his withdrawals on Dec. 31.

As the market boomed in the mid- and late-1990s, the late withdrawer gained ground over the early withdrawer, with his plan reaching a peak of $285,000 in 1999, about $12,000 ahead of the early withdrawer. That lead shrunk to just $3,000 when the market reversed itself, but the late withdrawer still came out ahead with a plan worth $179,350 at the end of 2003.

A real investor, of course, might have changed strategies throughout the year. If the late withdrawer had sensed the market drop coming and switched to earlier withdrawals in the down years, timing the market perfectly, his plan would have been worth $187,278 instead.

If you're like me, you'd never time the market perfectly. What if our investors had completely mistimed the market, making early withdrawals when the market was rising, and late withdrawals when it was declining? He would have ended up with $170,412 -- not so significantly less than perfectly timing the market that you might not try the idea.

The strategies

Here are some other RRIF strategies to consider.

If market timing is not your thing, make your withdrawals as late in the year as possible. In seven out of 10 years, you'll end up ahead.

Hold a diversified portfolio to smooth out the bumps of the equity markets.

Hold cash in your RRIF at all times equal to three years of withdrawals. This way, you'll avoid having to sell at the wrong times to make your required withdrawals.

Vary your RRIF withdrawals with your tax bracket. If you have a year of low income, consider making slightly greater withdrawals in that year.

Tim Cestnick, FCA, CPA, CFP, TEP, is a tax specialist and author of Winning the Tax Game 2005 and The Tax Freedom Zone.

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