A Registered Retirement Savings Plan (RRSP) is a great way to invest for retirement and reduce income taxes. But, like most good things, it must come to an end. You are required by law to wind-down your RRSP by the end of the year in which you turn age 71. In reality, most people start drawing on their RRSPs for retirement income before then.
So, when that time comes, what are your options?
You have three basic choices: Convert your RRSP to a Registered Retirement Income Fund (RRIF), purchase an annuity or collapse the plan and take the cash. A RRIF and an annuity have a similar purpose – to create a steady stream of income from the wealth you’ve accumulated in your RRSP. Taking the money in a lump sum makes little sense because you’ll be taxed on the entire amount at once, usually at a high rate of tax. These days, most people choose RRIFs because of their flexibility. A RRIF is a mirror image of an RRSP –instead of being a vehicle to accumulate wealth, it is a way to distribute your retirement savings as periodic income.
A RRIF is an umbrella under which you can hold the same types of investments that are eligible for your RRSP. These include everything from Guaranteed Investment Certificates (GICs) to mutual funds and individual securities such as equities. RRIFs are available from most financial institutions and allow you to retain control of your investments. You can’t contribute any money to a RRIF, and you must withdraw a minimum amount from the plan each year, according to a formula based on your age. You can withdraw as much from your plan as you wish, in excess of the minimum. (There are annual maximum payment restrictions applicable to special types of RRIFs such as LIFs or LRIFs.) Your income payments will be a combination of principal and investment returns. Generally, you can choose the frequency of regular income payments.
Those who want maximum control can manage their money through a self-directed RRIF. The second most popular option for RRSPs is purchasing an annuity. This is a contract with a financial institution that provides regular income (usually monthly) in exchange for a fixed sum. The payments you receive are a combination of repayment of the principal of your investment plus the investment income it earns. The benefit of an annuity is that once it’s purchased, you aren’t faced with making constant decisions about managing your retirement wealth.
An annuity is similar to a mortgage –in reverse. When you take out a mortgage, a financial institution provides you with a lump sum that you repay, with interest, over a number of years. With an annuity, you provide a lump sum to an institution that pays you back, with a predetermined, fixed amount that includes income generated by your money. Annuities are not as flexible as RRIFs because you have less control. Your funds are invested for you, and the income level depends on the annuity premium and interest rates at the time of purchase. Other factors include your age, your health, your gender, and the type of annuity you choose.
There are many types of annuities. Among the most popular are “life annuities”, which provide a steady stream of income during your lifetime (or in some cases until the death of your spouse). Another is the “term to 90 annuity”, which provides income to age 90. Some individuals have transferred a portion of their RRSP assets to a RRIF and used the remaining assets to purchase a life annuity contract to provide income to pay for basic expenses such as food, clothing, utilities, property taxes, or rent.
Regardless of which option you choose, start preparing well in advance. Make sure your retirement plan doesn’t contain investments that are locked in past the deadline for winding down your RRSP; this can complicate the transfer of funds. Talk to us, if you are uncertain about choosing between RRIFs and annuities, it is best to ask for advice. Conversion of RSPs can only be done once and cannot be undone. A few moments in conversation today can give you peace of mind for years to come.
Written by Mohamad Sawwaf, CFP, CPCA
Financial Consultant and Division Director
IGM Financial Inc.
He can be reached at Mohamad.Sawwaf@investorsgroup.com.
Please note: this article is not a substitute for legal advice. This article only provides general information which you may find helpful. You may wish to consult with a qualified professional financial or legal advisor, as appropriate.