Chapter 1
Preparing for retirement: your RRSP and you
Gael Melville, Vancouver, and Jennifer Chandrawinata, Toronto
If you’re thinking of retiring soon, you’ll need to consider what sources of income you can draw on in your retirement years. Depending on where you have worked during your career or if you owned your own business, you may have a company or public sector pension plan, or you may need to rely principally on your own savings and investments.
If the bulk of your retirement income will come from a registered retirement savings plan (RRSP), one of the most important financial decisions you will make will be what to do with your RRSP when it’s time to start drawing a retirement income. The decisions you make regarding your RRSP could go a long way to determining whether your years of savings will provide the income you need for a comfortable retirement.
Let’s take a look at some of the main questions you may be asking yourself at this important time.1
When do I have to withdraw money from my RRSP?
You may withdraw money from your RRSP at any time after you open it, even before you retire. However, any money you withdraw will generally be included in your income in the year of withdrawal and so will be subject to tax at your current marginal tax rate.2 Therefore, when planning for retirement, most people choose not to withdraw their money from their RRSP all at once.
Your RRSP will have a maturity date provided under the terms of the plan. This is the date by which you must close your RRSP account and withdraw all the money from it, or select a maturity option to begin receiving retirement income.
Your RRSP must mature by the end of the calendar year in which you turn 71. Therefore, if you turn 71 in 2024, your RRSP must mature by December 31, 2024 and you will be unable to make any further contributions to your RRSP after that date.3
However, you do not have to wait until your plan matures to obtain retirement income from your RRSP. Should you wish to begin receiving a retirement income earlier, you can do so subject to any other restrictions you may have agreed to when you originally set up your RRSP.
My RRSP is maturing: what are my options?
There are a number of maturity options available to enable your RRSP to provide a retirement income from your plan assets. You can select one or a combination of these available maturity options. Each one will provide you with retirement income in varying amounts over different periods. Each option is discussed below:
Withdraw the value of your RRSP as a lump sum
- Allows you access to the entire RRSP amount, net of withholding tax at source.
- The entire amount would need to be included in your income and you would have to pay income taxes on the amount, which can be significant.
Purchase a fixed-term annuity
- These provide benefits up to age 90. However, if your spouse or common-law partner is younger than you, you can elect to have the benefits provided until your spouse or partner turns 90.
- Fixed-term annuities may provide fixed or fluctuating income.
Purchase a life annuity
- These provide benefits during your life, or during the lives of you and your spouse or partner.
- Life annuities may have a guaranteed payout option and may provide fixed or fluctuating income.
Roll your RRSP into a registered retirement income fund (RRIF)
- A RRIF is essentially a continuation of your RRSP, except that you must withdraw a minimum amount from it each year. There is no maximum annual withdrawal limit.
- A RRIF will provide retirement income from the investment of the funds accumulated in a matured RRSP.
Which RRSP maturity option is right for me?
Deciding which maturity option or options are best for you can be difficult, so you may wish to speak with your financial and tax advisors to better understand your options and the factors you should consider. In some cases, you can change (transfer) from one maturity option to another at a later date, but in others you cannot, so it’s important to understand the benefits and limitations of each maturity option.
Annuities
Annuities provide you with a predictable and guaranteed income stream. You must receive a payment of income at least annually, and you must include the full amount of the annuity payments received in the year in income for tax purposes. Since the income amount is guaranteed, you cannot select how the amount is invested. The annuity provider would decide that as part of their own investment strategy.
If you do not have a company pension plan or other income source that provides predictable and guaranteed payments, an annuity may be an appropriate maturity option to consider.
Annuities typically cease making payments when the annuitant dies. The company making the annuity payments, usually a life insurance company, assumes any financial risk associated with the annuitant living longer than expected. If the annuitant dies prematurely, the annuitant generally loses the right to receive future annuity payments. Options exist to continue payments for the life of the surviving spouse or common-law partner or for a minimum guaranteed period, but these options come at a cost that reduces the amount of each annuity payment you will receive.
You may be concerned about outliving your retirement savings, especially if longevity runs in your family. In that case, a newer type of annuity known as an advanced life deferred annuity (ALDA) may be an attractive option to offset this so-called longevity risk. You can use funds from your RRSP or RRIF to purchase an ALDA.
An ALDA is a life annuity, but you can defer the start of the annuity payments until any time up to the end of the year in which you turn 85. If you purchase an ALDA, the value of the product is excluded when calculating the minimum amount you are required to withdraw from your RRIF in any year after the year you purchase the ALDA.
Individuals are subject to both a lifetime ALDA limit in relation to a particular qualifying plan equal to 25% of the sum of the value of all property (other than most annuities) held in the qualifying plan at the end of the previous year, and any amounts from the qualifying plan used to purchase ALDAs in previous years. In addition, an individual is also subject to a comprehensive lifetime ALDA dollar limit for all qualifying plans ($170,000 for 2024). If you exceed your ALDA limit, you may be subject to a 1% per-month penalty tax on the excess.
RRIFs
If you have some other sources of guaranteed retirement income, or you are comfortable taking on the investment risk yourself, a RRIF may be an appropriate maturity option for you, either on its own or in combination with an annuity.
RRIFs allow you to continue to invest your retirement savings on a tax-deferred basis in the same types of investments that were available to you in your RRSP. Selecting a RRIF may increase your investment risk relative to selecting an annuity with a guaranteed and predictable income stream, but a RRIF also offers the potential to continue growing your assets, increasing your retirement income in the future.
You must make a minimum withdrawal from your RRIF each year, but you can also make additional withdrawals of any amount during the year should you require additional income. All payments out of a RRIF must be included in your income for tax purposes. The minimum amount you must withdraw from your RRIF is determined as a percentage, known as a factor, of the value of your RRIF at the start of each year. The RRIF factor increases each year in relation to the annuitant’s age, reaching a maximum of 20% for an annuitant aged 95 or older.
When you die, the general rule is that you are considered for tax purposes to have received the value of the property in your RRIF immediately before your death. As a result, the value would be included in your tax return for the year of death. However, there are several exceptions that allow the tax to be deferred until a later time — for example, where your spouse or common-law partner is named on the RRIF documentation as a “successor annuitant” or if your spouse or common law partner chooses to transfer the amount to their own RRIF.
What else do I need to know about RRIFs when I’m selecting a maturity option?
If you are considering transferring property from your maturing RRSP to a RRIF, there are a few other features you should be aware of.
The minimum withdrawal calculation for a RRIF is based on a formula that is dependent on your age at the start of each year. At the time when you set up your RRIF, you can make a one-time election to use the age of your spouse or common-law partner (if the spouse or partner is younger than you) in determining the required minimum withdrawal each year. This will lower the minimum withdrawal you need to make from the RRIF, resulting in further tax deferral on income earned on the money left in the plan. Of course, you still have the option of making additional withdrawals at any time.
The following example illustrates the benefit of making the election to use the age of the younger spouse or partner to compute the required minimum withdrawals from a RRIF. Suppose you turn 71 in 2024 and invest $200,000 in a RRIF in that year, earning a 4% return in 2024 and in each following year. Suppose also that your spouse or partner is 68 in 2024, and you make the election to use their age in calculating your minimum withdrawal amounts. At the beginning of 2034, you will have over $9,000 more remaining in your RRIF than you would have had if you had used your own age to calculate the minimum withdrawal amounts.
RRIF tax withholdings
If you withdraw only the minimum amount required from your RRIF each year, no tax is withheld on the amounts you receive. Since the withdrawals must be included in your income for the year for tax purposes, this may result in you owing tax when you complete your tax return, or may require you to make additional instalment payments yourself.
If you withdraw more than the minimum amount required, tax will be withheld at source from the excess amount at the rates below.4 Therefore, the amount you receive will be net of the withholding tax.
Note that if you elect to withdraw the excess amount for a year via a series of instalments instead of in one lump sum, the applicable withholding tax percentage will be based on the total amount of the instalments, rather than on the gross amount of each individual instalment.
If you discover, when you prepare your tax return, that not enough tax was withheld from the RRIF payments you received, you will have to pay the additional tax. Alternatively, if too much tax was withheld from the payments, the excess will be refunded to you.
When planning for withdrawals, it is important to make certain you have sufficient cash available within the RRIF to fund the withdrawals. Should you choose to withdraw assets in kind from your RRIF instead of withdrawing cash, the fair market value of the withdrawn assets will need to be included in your income for the year, and you must still have sufficient cash in the plan to pay the required withholding tax.
When you file your annual income tax return, you may end up paying no tax or a small amount of tax on the annual amount withdrawn from your RRIF if you are entitled to claim various non-refundable tax credits, such as the age amount and pension income amount, or if you are able to split pension income with your spouse or partner. You could even find that the minimum withdrawal requirement is more than what you need to fund your retirement living costs. In this case, you may wish to consider depositing the extra amounts withdrawn into your tax-free savings account (TFSA), assuming you have contribution room available. This will allow you to continue to grow your investments tax-free.
What happens if I don’t select a maturity option by the end of the year I turn 71?
At the beginning of the year you turn 72, if you have not selected a retirement income option, then your RRSP will mature and the plan will terminate. At that time, the entire value of your RRSP will become payable to you, will be included in your income for that year, and will be subject to tax at your marginal tax rate. Having said that, your financial institution may have an automatic rollover clause in the RRSP contract that would automatically move your RRSP to a RRIF. Speak with your financial advisor or your financial institution to confirm the terms of your RRSP contract.
If your RRSP has significant assets, having the entire value of your RRSP included in your income for the year is not usually desirable, because of the high tax cost associated with being in a higher income bracket. Therefore, you should be careful to review your RRSP options sufficiently early to allow time for any planning you wish to perform and for your financial institution to process the maturity option or options you select.
What are my options for my locked-in RRSP?
Under federal and most provincial pension legislation, the proceeds of locked-in RRSPs or locked-in retirement accounts (LIRAs) must generally be used to purchase a life annuity at retirement or must be converted to a life income fund (LIF), a locked-in retirement income fund (LRIF) or a prescribed retirement income fund (PRIF). Because these proceeds originate from a pension plan that is intended to provide retirement income for your life, you generally cannot use them to acquire a term annuity and you cannot withdraw all the funds in cash.
LIFs, LRIFs and PRIFs are all forms of RRIFs, so there’s a minimum annual withdrawal amount. But unlike RRIFs, there are also maximum annual withdrawal limits for LIFs and LRIFs, and in some provinces LIFs must be converted to life annuities by the time you turn 80.
Tax-deferred transfers are generally permitted between all these plans, so you might transfer assets from a LIF back to a LIRA (if you’re under 71) if you change your mind about receiving an early pension. Another option is to transfer funds from a LIF to an LRIF to avoid annuitization when you turn 80.
Tax tips
- If you’re going to be 71 at the end of 2024, make your annual RRSP contribution on or before 31 December 2024.
- If you’re over 71 and your spouse or partner is younger than you — and you have earned income or RRSP deduction room — consider making contributions to your spouse’s or partner’s RRSP until your spouse or partner turns 71.
- If you have sufficient earned income in the year you turn 71, consider making a contribution for the next year (in addition to one for the current year) just before the year-end. Although you must collapse your RRSP before the end of the year in which you turn 71, you’re still able to deduct excess RRSP contributions in later years. You will be subject to a 1% penalty tax for each month of the overcontribution (one month if the overcontribution is made in December of the year you turn 71), but this may be more than offset by the tax savings from the contribution. Consult with your tax advisor to make sure this possible planning option is right for you.
- Investigate and arrange for one or more of the maturity options that are available if your RRSP is maturing in the near future.
- If the minimum RRIF amount is withdrawn in a year, no tax is required to be withheld at source. Consider the effect of this on your income tax instalment planning.
- Consider receiving RRIF payments once a year in December to maximize the income earned in the plan.
Chapter 2
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