Three basic RRSP maturity options
Unlike a Tax-Free Savings Account (TFSA), a Registered Retirement Savings Plan (RRSP) does not last forever. In fact, it has a specific date by which you must collapse the plan and choose one of three main options for what to do with the proceeds. Here’s a look at how this works.
The rules say that you have until Dec. 31 of the year in which you turn 71 to collapse your plan. If you don’t, the Canada Revenue Agency will basically do it for you and deem the entire amount as part of your income for the year. If your RRSP is a large one (and if you’ve been contributing for 30 or 40 years, it should be), you would be propelled immediately into the top marginal tax rate for your province, typically 50% or more across Canada. The entire proceeds will then be subject to that 50% income tax, and you’ll very quickly learn the true meaning of the political slogan, “Tax the rich!” Ironically, you may not feel particularly rich either before the fact or after.
There’s yet another drawback to taking (or being forced to take) your entire RRSP proceeds into income. The higher income for that year could significantly reduce or make you ineligible for various income-tested government benefits and tax credits. Old Age Security payments, for example, are clawed back in part or entirely above an income of $126,058 in the year. In addition, once you collapse your RRSP and bring the proceeds into regular income, you will no longer have the advantages of tax deferral that you enjoyed in your RRSP. While taking your entire RRSP proceeds into income may be considered a maturity option, it’s not a good one. Instead, if you turned age 71 at any time this year, it would be prudent to choose one of these RRSP maturity options before Dec. 31.
1. Registered Retirement Income Fund
A Registered Retirement Income Fund (RRIF) is a tax-deferred plan that is registered with the government like an RRSP. The difference is that you must begin withdrawing a minimum amount from the RRIF every year starting the year after the plan is set up. Withdrawals from a RRIF are included in income for the year and are taxable at your top marginal rate.
When you transfer part or all of the property (typically various allowable investments) from your RRSP into a RRIF, the property in the RRIF continues to grow sheltered from tax in the plan. Qualified investments for RRIFs are the same as those for RRSPs. The annual minimum withdrawal is calculated by multiplying the market value of your RRSP account on Dec. 31 of the previous year by a percentage pre-set by the government. There is no annual maximum withdrawal amount.
Minimum RRIF withdrawal amounts are calculated by RRIF withdrawal factors set on a sliding scale by the Canada Revenue Agency. The withdrawal factors increase as you age. For RRIFs established before 2015, you must withdraw 7.38% of the value of the RRIF if you are 71, increasing to 8.99% by age 81 and 20% by age 94.
For RRIFs established in 2015 and later (including 2019), the minimum withdrawal factor at age 71 is 5.28%, climbing to 7.08% at age 81, and 18.79% at age 94. So, for example, for a RRIF valued at $1 million that is set up at age 71, you must withdraw a minimum $52,800 in the year.
Note that funds from locked-in RRSPs cannot be withdrawn as a lump sum or transferred to a regular RRIF. In most provinces locked-in RRSP must be transferred to another locked-in plan (in Ontario, a Life Income Fund, or LIF) or used to purchase an annuity at age 71.
If an RRSP is collapsed and the proceeds are used to purchase an annuity contract, the proceeds of the RRSP are not included in income for the year. When you purchase an annuity, you essentially buy a contract under which the issuing company (usually an insurance company) invests the lump sum you provide and guarantees a regular payout over the life of the annuity contract.
There are several types of annuities. For example, a “Term Certain Annuity” guarantees a monthly income for as long as you want, up to age 90. If you die before all payments are received, the balance will go to your estate. Another option is a “Life Annuity,” which guarantees a monthly income for as long as you live. However, payments stop when you die, and no money will go to your estate.
Because annuities are ultra-conservative products, they are typically tied to the level of prevailing interest rates. And those rates have been ultra-low since 2008. Annuity rates have thus also been correspondingly low, making annuities a less desirable RRSP maturity option than RRIFs for the past few years. However, this may change as rates rise.
Annuities are complex products, and it is important that you understand how interest rates and other factors affect how much income you will receive. It may not be advisable to convert all of your RRSP into an annuity – this will depend on your investment objectives and risk tolerance. I recommend seeking the advice of your financial planner and/or a licensed insurance agent to discuss annuity options and how they might best fit into your overall retirement plan.
3. Mix and match
RRSP maturity options are not an all-or-nothing choice. In fact, you can choose some combination of an active RRIF portfolio and an annuity so that your retirement assets continue provide a measure of growth, inflation protection, as well as a stream of guaranteed income.
Another option may be to invest a portion of your portfolio in an insurance product that offers a guaranteed income withdrawal feature. This is similar to an annuity in that it guarantees a specific regular payment made monthly, quarterly, or annually until you pass away. But unlike an annuity, you can cash in the policy and take the “cash surrender value” if your situation changes dramatically and you need the cash. (But I do not recommend taking the cash out of this type of policy except as a last resort.)
When considering converting an RRSP at maturity, it’s important first to make sure you have the minimum income you need to live on. Annuities or an insurance product with guaranteed income withdrawal are two options, but these can be complicated, so I’d recommend talking to a financial planner with insurance expertise first. Then diversify the balance of your holdings into a RRIF portfolio that will continue to generate capital appreciation along with an income stream (e.g., from dividends).