After years spent paying into a registered retirement savings plan (RRSP), investors eventually have to use the funds as post-retirement income.
RRSPs must be collapsed by Dec. 31 of the year in which the holder turns 71. If RRSP savings are not put into a tax-deferred income plan by that time, the entire value of the RRSP becomes taxable income.
A registered retirement income fund, or RRIF, is one of the most common options Canadians choose to convert RRSP savings to tax-deferred income.
“There are generally five types of RRIF, including self-directed, fully managed, guaranteed interest, mutual fund, and segregated fund,” says Tom Hamza, president of Investor Education Fund, a Toronto-based not-for profit organization founded by the Ontario Securities Commission. “The choice depends on the level of flexibility you are looking for.”
Investments in a RRIF continue to accumulate earnings. “Restrictions apply to withdrawals, not to returns,” says Mr. Hamza. But once set up, no contributions can be made to a RRIF, nor can it be terminated except by the holder’s death.
While 71 is the maximum age, conversion to a RRIF can begin at any time depending on the income needs of the holder.
A formula based on age and the value of the RRIF at Dec. 31 of the previous year is used to determine the minimum annual RRIF withdrawal. Minimum withdrawal amounts increase with age.
For example, at age 71 the minimum withdrawal amount is 7.38%. If the value of a RRIF is $100,000 on Dec. 31, the holder must withdraw $7,380 over the course of the following year. If the holder is 83, the minimum amount is 9.58% or $9,580; at 90 it is 13.62%.
There is no upper limit on the amount that can be taken out of an RRIF. However, while all withdrawals are taxable at year end, withholding tax applies to amounts above the minimum.
Under certain circumstances, the tax burden can be reduced. Delaying opening a RRIF until you are 65 or older offers the option of income splitting with a younger spouse. Income splitting can also help to reduce OAS clawbacks.
“While the full minimum amount must be withdrawn from the RRIF, up to half can be given to a spouse and is attributed to her taxable earnings,” says David Ablett, director of tax and retirement planning with Investors Group in Winnipeg. For example, if $20,000 is withdrawn from a RRIF, up to $10,000 can be allocated to a spouse for tax purposes. Federal and provincial pension income tax credits may also be available.
Electing to use a spouse’s age to calculate the minimum withdrawal is another option. This lowers the amount taken out of the account and may also reduce taxable income.
Whether a RRIF is opened at 60 or 71, the most important aspect is structuring a portfolio correctly prior to conversion, says Robin Muir, a certified financial planner and managing partner of Hatch & Muir LLP in Victoria.
A portfolio should have between 20% to 30% in cash, GICs or short term bonds that can be drawn from, while leaving growth investments intact, he says. This should be phased-in before converting to a RRIF, allowing a cushion so that equities can be sold by choice rather than by necessity to replenish the cash flow pool for annual withdrawals.
After death, what happens to an RRIF depends on whether or not a beneficiary has been named. Naming a beneficiary ensures that the RRIF is excluded from the calculation of probate fees on an estate.
If a spouse is named, they can automatically start receiving payments from the RRIF. A financially dependent child or grandchild can purchase a term annuity or transfer it to their RRSP.“When seeking RRIF advice, be sure to get it from someone who understands drawing down wealth not just accumulating it,” Mr. Muir says, “so you don’t run out of money before you run out of life.”
Kathryn Boothby, Postmedia News | Feb 11, 2013