Surveys show that as many as 60 per cent of Canadians have set up an RRSP, even if only a quarter of us manage to make a contribution in the average year.
That's millions of plans that, at some point in the future, will need to make an abrupt transition from accumulating money for retirement to paying out money in retirement.
Canadians face three broad choices when they mature their RRSPs. Whatever choice they make, they must act by the end of the year in which they turn 71.
- Convert their RRSP to a Registered Retirement Income Fund. This is the most common choice at maturity. In fact, converting an RRSP to a RRIF can seem like little more than a name change, in that the RRIF can hold most of the same investments the RRSP did. You can even hang on to your old financial adviser. The difference is that once the RRIF is in place, deposits stop and minimum withdrawals start. Those minimum annual withdrawals start at low levels and go steadily up with age. (RetirementAdvisor.ca has a good RRIF calculator that allows you to see a RRIF payout schedule.)
- Use the proceeds of the RRSP to buy an annuity. Annuities come in various varieties — single life, joint and last survivor, indexed, term certain etc. The more bells and whistles the annuity has, the more it will cost, meaning that the monthly payout will be less. Life annuities guarantee their payouts for the life of the holder, so are attractive for people worried they might run out of money, but in the current low-interest-rate environment, their payouts aren't what they used to be in the "good old days" when interest rates were in double-digits. Quotes provided by insurance companies show that $100,000 of RRSP money can buy a non-indexed annuity for a 65-year old man with about $600 a month for the rest of his life. Payouts for women are lower as they tend to live longer.
- Collapse your RRSP and pay tax on the whole amount. This is the least attractive option on several counts. For one thing, people with a good chunk of change in the plans could wind up losing more than 40 per cent of it to taxes. They'd also have no retirement income and wouldn't qualify for the annual $2,000 pension income tax credit.
It's also possible to choose a mix of options — a RRIF and an annuity, or a RRIF then an annuity.
We asked a couple of retirement experts for tips on the whole RRSP maturing process.
Tina Di Vito, director of the BMO Retirement Institute:
Converting to a RRIF offers more flexibility. If people aren't sure whether a RRIF or annuity is best, Di Vito points out that you can roll an RRSP into a RRIF and you aren't locking yourself in. You can always annuitize later, at age 75, for example. "But if you go from an RRSP to an annuity, the decision is irreversible."
RRIF withdrawals can be made in kind. "You don't have to sell investments and pull out cash," Di Vito says. You can ask your financial institution to transfer an investment from your RRIF to a non-registered account. You'd still have to pay tax on the value of the withdrawal — all RRIF withdrawals are taxable — but an in-kind transfer could spare you from having to sell an equity investment when the market is tumbling.
Consider moving some RRSP assets into a RRIF at age 65, whether you need the income or not. "RRIF withdrawals at age 65 and later qualify as pension income, so they qualify for the pension income tax credit," Di Vito says. That's a federal tax credit on the first $2,000 of qualifying pension income each year. ("Qualifying" pension income does not include CPP or OAS payments.) Di Vito says if someone moved $14,000 from an RRSP to a RRIF, they could withdraw $2,000 each year from age 65 to age 71 — enough to qualify for the maximum tax credit and effectively shelter the income from tax. Both spouses are able to claim this tax credit, so people should try to arrange at least $2,000 in qualifying pension income for each spouse.
Di Vito says there's an important caveat to this strategy. If you are drawing a pension from a company pension plan, you may have already used up that tax credit. But she notes that only a third of Canadians have company pension plans.
Warren MacKenzie, CEO of Weigh House Investor Services:
Consider an annuity for 20 per cent of the total RRSP. "It puts it in the hands of professional managers and gets rid of the emotion," MacKenzie says, noting that a life annuity provides worry-free income for the rest of the annuitant's life. Annuitizing a portion of one's RRSP is also something to consider when longevity runs in your family. "If you did that, you'd have the freedom to take more risk and have a higher equity content in what remains."
Don't confuse cash flow with income. "You don't need to be in income-producing stocks or bonds to get the cash you need," he says. "I've seen people twist themselves out of shape, changing all of their [RRSP} investments when they should still be in a balanced portfolio." He says people can easily sell positions to give them the cash necessary for the withdrawal.
If you don't need the money, base the RRIF drawdown on the age of the younger spouse. RRIF rules require minimum annual withdrawals that steadily rise with age. But MacKenzie notes that you can use your spouse's age to arrive at the minimum withdrawal amount, rather than your own.
Have a financial plan that shows if your RRIF withdrawals will eventually trigger a clawback of OAS. About five per cent of pensioners are hit by the Old Age Security clawback. Once net income reaches $66,733, OAS payments are reduced by 15 per cent of the excess. If you're facing such a clawback, MacKenzie says you should "consider taking payments earlier [than age 65] so as to reduce the amount that needs to be taken later."