Determining risk tolerance, risk capacity, and time horizon are critical to selecting appropriate investments and creating a viable retirement plan. However, the Registered Disability Savings Plan (RDSP) has some unique characteristics that differ from other registered accounts. While the math of compound growth remains the same regardless of account type, the risks can be higher in an RDSP. Between mandatory payouts beginning by age 60, the restrictive 10-year clawback period, and the financial vulnerably of living with a disability, market volatility can be a major threat to the financial security of a beneficiary.
Withdrawals must start by age 60
Unlike a Tax Free Savings Account (TFSA) that can be withdrawn whenever the account holder wants, or a Registered Retirement Savings Plan (RRSP) which must be converted into a Registered Retirement Income Fund (RRIF) by age 71 and begin mandatory withdrawals by age 72, an RDSP must start paying out Lifetime Disability Assistance Payments (LDAPs) by age 60. Traditional financial advice advocates transitioning into lower risk assets or “de-risking” as the age of mandatory payments from a retirement account nears. Because of the earlier start date of the RDSP, account holders may have to consider the transition from higher risk assets into lower risk assets earlier than in a Registered Retirement Savings Plan (RRSP) or Registered Retirement Income Fund (RRIF). Failing to appropriately measure risk could result in the beneficiary beginning their mandatory lifetime payments during a market bottom, forcing the sale of assets at low valuations and ultimately exhausting the portfolio much faster than anticipated. This is also known as sequence of returns risk.
Being disabled is expensive
Studies show that living with a disability is significantly more expensive than living without one. From food, transportation and housing costs, to specialized equipment and therapy; The added costs are a financial burden to disabled individuals and their families. Unfortunately this “disability penalty” increases the likelihood that a beneficiary may need to access funds from their RDSP before the age of 60 in case of an emergency. While the RDSP is obviously intended for long-term savings, an emergency withdrawal comes with repercussions that do not exist in other registered accounts.
The 3-for-1 clawback trap and market volatility
When withdrawing via Disability Assistance Payments, account holders must be cognizant of the 10-year proportional repayment rule as the account may be forced to pay back government grants and bonds. This can make liquidity and stability more ideal inside an RDSP compared to other registered account types. Because the risks in an RDSP are higher than in a typical retirement account, account holders may have to consider allocating a portion of non-equity assets within the plan to hedge against emergencies, which would prevent having to sell stocks at a loss and satisfy the 3 to 1 grant and bond repayment. An emergency withdrawal during a market downturn could be devastating to the long term financial health of the beneficiary. Note that the clawback risk applies specifically to withdrawals made before age 60.
Example – If the stock market dips, a portfolio invested in 100% equities would probably lose value. If an emergency necessitates a withdrawal during that downturn, the government does not wait for the market to recover to claim its proportional repayment. The result is that the account holder would be forced to sell a higher number of shares to cover both the emergency cash withdrawal and the government clawback. And if/when the overall market does eventually recover, the account holder does not get to appreciate the full recovery because those investments have been sold.