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 turns71. 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 commonoptions Canadians choose to convert RRSP savings to tax-deferred income.
“There are generally five types of RRIF, including self-directed, fullymanaged, guaranteed interest, mutual fund, and segregated fund,” says TomHamza, president of Investor Education Fund, a Toronto-based not-for profitorganization founded by the Ontario Securities Commission. “The choice dependson the level of flexibility you are looking for.”
Investments in a RRIF continue to accumulate earnings. “Restrictions applyto withdrawals, not to returns,” says Mr. Hamza. But once set up, nocontributions can be made to a RRIF, nor can it be terminated except by theholder’s death.
While 71 is the maximum age, conversion to a RRIF can begin at any timedepending on the income needs of the holder.
A formula based on age and the value of the RRIF at Dec. 31 of the previousyear is used to determine the minimum annual RRIF withdrawal. Minimumwithdrawal amounts increase with age.
For example, at age 71 the minimum withdrawal amount is 7.38%. If the valueof a RRIF is $100,000 on Dec. 31, the holder must withdraw $7,380 over thecourse 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 appliesto amounts above the minimum.
Under certain circumstances, the tax burden can be reduced. Delayingopening a RRIF until you are 65 or older offers the option of income splittingwith 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“While the full minimum amount must be withdrawn from the RRIF, up to halfcan be given to a spouse and is attributed to her taxable earnings,” says DavidAblett, director of tax and retirement planning with Investors Group inWinnipeg. For example, if $20,000 is withdrawn from a RRIF, up to $10,000 canbe allocated to a spouse for tax purposes. Federal and provincial pensionincome tax
credits may also be available.
Electing to use a spouse’s age to calculate the minimum withdrawal isanother option. This lowers the amount taken out of the account and may alsoreduce taxable income.
Whether a RRIF is opened at 60 or 71, the most important aspect isstructuring a portfolio correctly prior to conversion, says Robin Muir, acertified financial planner and managing partner of Hatch & Muir LLP in Victoria.
A portfolio should have between 20% to 30% in cash, GICs or short termbonds 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 sothat equities can be sold by choice rather than by necessity to replenish thecash flow pool for annual withdrawals.
After death, what happens to an RRIF depends on whether or not abeneficiary has been named. Naming a beneficiary ensures that the RRIF isexcluded from the calculation of probate fees on an estate.
If a spouse is named, they can automatically start receiving payments fromthe RRIF. A financially dependent child or grandchild can purchase a termannuity or transfer it to their RRSP.
“When seeking RRIF advice, be sure to get it from someone who understandsdrawing down wealth not just accumulating it,” Mr. Muir says, “so you don’t runout of money before you run out of life.”