Turning your RRSP into a RIF
If you’re turning 71 this year, you’ll be required by law to mature your RRSP. There are essentially four ways to wind down your RRSP, each with their own benefits and drawbacks. You can (a) take a lump sum withdrawal, (b) purchase an annuity, (c) convert your RRSP to a RRIF (Registered Retirement Income Fund), or (d) some combination of these options.
Lump Sum Withdrawal
You can withdraw all the funds in your RRSP and have the money taxed as ordinary income. Be aware that the financial institution has no choice but to withhold tax on the amount withdrawn, which you’ll report on your tax return as ordinary income. This amount is included in the calculation of your income tax owing and it is not eligible for the pension tax credit.
Depending on the size of your RRSP and other income sources you have from pensions, for example, this can be a terribly inefficient tax situation. You could see a lot of your RRSP disappear in taxes.
This is typically the least desirable option, but you should know that you are indeed able to access your RRSP funds immediately, if you really needed the lump sum amount.
Purchase an Annuity
You can also use your RRSP savings to purchase an annuity, which is an insurance contract that will provide you with a steady stream of income over the course of the contract’s life.
You’ll pay income tax on the periodic (often monthly) annuity payments as they are received and some of the income (up to $2000 annually) will qualify for the annual pension income tax credit, which helps reduce your taxes owing.
There are three broad types of annuities: Term Certain, Single Life, and Joint and Last Survivor.
Term certain annuities guarantee payments to you or your estate for a fixed period of time. Single life annuities are payable to you for as long as you live. Lastly, Joint and Last survivor annuities provide payments to you and your spouse for as long as the longest-living spouse survives.
Convert RRSP to RRIF
You can maintain your ability to manage your investments throughout retirement by converting your RRSP to a RRIF. You’ll only be taxed on the amount that you withdraw in a given year.
As with an annuity, a portion (up to $2000 per year) of the annual withdrawals may be exempt from income tax thanks to the pension income tax credit.
One potential drawback to a RRIF is that the law requires minimum annual withdrawals ranging from about 7.4% of the value of the account at age 71 to 20% at age 94. If your spouse is younger than you, look into the option of using the age of your spouse to calculate the minimum annual withdrawal if you want to reduce the amount you have to take out of your RRIF.
Combination of the Above
It might make sense for you to combine the above options. You could decide to purchase an annuity in an amount that will provide you with a guaranteed stream of income to cover your basic, essential needs.
Then, with the basics covered, converting the remainder to a RRIF will allow you to retain control of your investments. You could then devise a retirement investment strategy that produces income to meet your needs over and above the basics. This could reduce anxiety around wondering if you’ll be able to generate enough income throughout market cycles.
Please feel free to call us for a second opinion about your own retirement income strategy. There are many elements to consider and it is most satisfying to understand your options and be confident about your next steps.
Heather Holden, PhD, DIM
Wealth Advisor
ScotiaMcLeod
1100-650 West Georgia St.
Vancouver BC
