WHAT HAPPENS TO YOUR RRSP WHEN YOU RETIRE?
I have had many clients turn 71 this year. And many will be turning 71 in the coming years.
So often we are enticed by financial institutions to put money into an RRSP so we can get a refund back from the government on our tax return. The problem is, we aren’t told what happens when we reach the age that the government forces us to start drawing money out of our RRSP savings (which is when we have to turn our RRSP into a RRIF, or Registered Retirement Income Fund). To me, it is not just an income fund for you, it is an income fund for the CRA since they are now going to be taxing the savings you have built up over your lifetime.
This information post isn’t about the benefits or pitfalls of an RRSP, as it is a great planning tool if used correctly, it is about what happens when you come to the government mandated withdrawal period.
We spend so many years saving into their RRSPs, they forget to plan for how they will withdraw the money. At the end of the year in which you turn 71 your RRSP matures, and you must move from the accumulation phase to the payout phase, if you haven’t already.
How do you do this?
If you were to simply take the money out of your RRSP, you would have to pay tax at your marginal (highest) tax rate on the full amount. Instead, most people transfer the assets into a Registered Retirement Income Fund (RRIF) or purchase an annuity, which are more tax efficient strategies.
CONVERTING TO A RRIF
Think of a RRIF as an RRSP in reverse. Instead of contributing to the fund, you withdraw from it, but your money remains tax-sheltered while it’s inside the RRIF. You can hold all the same investments as you did in your RRSP, or change the asset mix to match your post-retirement needs.
Just as RRSPs have rules about how much you can contribute, RRIFs have rules about how much you must take out. After the year the RRIF is established, a schedule of minimum mandatory withdrawals begins. Minimum withdrawals start out small and increase as you get older.
Although withdrawals are considered taxable income, there is no withholding tax deducted at source from these minimum withdrawals. You may take out more money from the RRIF at any point; however, withholding tax is paid at source on these amounts.
PURCHASING A REGISTERED ANNUITY
This is a product you purchase to provide a guaranteed income stream. Funds are managed by the company where you hold the annuity, and you receive a reliable monthly income, either for a fixed period of time or for your lifetime.
There are many different types of annuities, so it’s important to choose one with features that meet your goals. For example, a couple might choose a joint and last survivor annuity that would provide an income for both spouses for their lifetimes. A person with children might choose an option where a payment is made to their estate.
An annuity is a “set it and forget it” product, which many people enjoy. The only decision involved is the initial purchase and then the annuity is locked in.
STRUCTURING A PAYMENT PORTFOLIO
Planning RRSP withdrawals isn’t an all or nothing situation. For example, you could withdraw $10,000 in cash to take that dream trip when you retire. The rest you could divide between a RRIF to provide long-term growth and leave assets in your estate, and a life annuity for predictable, guaranteed monthly income for your remaining years.
Deciding how you will use your RRSPs is as important as figuring out how to invest them during your working years. Your financial advisor can guide you on the right structure to meet your income and legacy goals in a tax efficient manner.