What you must do before Dec. 31
Registered Retirement Savings Plans do not last indefinitely. In fact, they must be closed down by the end of the year in which you turn 71. So if you are in that age group this year, you have until Dec. 31 to convert your RRSP into another type of tax-sheltered plan. If you don’t, the Canada Revenue Agency will collapse it automatically, and the proceeds will be taken into your income for the year.
If your RRSP is sizable, taking it all into income could push you into a much higher tax bracket for the year. You’ll then pay tax on the entire RRSP amount – as well as your other regular income – at that higher rate, and that could be over 50%. In addition, the higher income could 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 a certain income threshold. 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.
To avoid this fate if you turned 71 this year, you have until Dec. 31 to choose an RRSP maturity option. Here are the main choices:
Registered Retirement Income Fund
When you convert part or all of your RRSP into a Registered Retirement Income Fund (RRIF), investments in the RRIF continue to grow sheltered from tax as long as they are in the plan. Note that investments eligible for RRIFs are the same as those for RRSPs. With a RRIF, however, you must begin withdrawing a minimum amount from the plan every year starting the year after the plan is set up. Withdrawals from a RRIF are considered income for tax purposes, and are therefore taxable at your top marginal rate in the year of withdrawal. The annual minimum withdrawal is calculated by multiplying the market value of your RRSP account on December 31 of the previous year by a percentage pre-set by the government. Note also that while you must withdraw a minimum, 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 plans 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 subsequent years, the minimum withdrawal factor at age 71 has been reduced to 5.28%, climbing to 7.08% at age 81, and 18.79% at age 94. Note that for 2020 only, the RRIF withdrawal rate has been reduced by up to 25%.
Move extra funds into a Tax-Free Savings Account. If you don’t need your full RRIF withdrawal to live on, consider contributing any extra into a TFSA. Funds in the TFSA continue to growth tax-free, and withdrawals are also completely tax free. Be sure not to overcontribute in the year, or penalties may apply.
Life Income Funds for Locked-in RRSPs
If you have a locked-in RRSP or a Locked-in Retirement Account (LIRA), it must be transferred to a Life Income Fund (LIF) or a Restricted Life Income Fund (RLIF) when you turn 71. Like a RRIF, a minimum annual amount must be withdrawn. In addition, some provinces allow you to unlock your LIF with a one-time lump-sum withdrawal of as much as 50%. Consider this option by taking the minimum in cash (taxable) and transferring the rest to an RRIF (non-taxable) for use down the road.
An annuity provides a guaranteed income stream for life. 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, and are even lower now as central banks have slashed their benchmark rates to near zero in order to provide monetary support during the economic downturn caused by the Covid-19 pandemic. Annuity rates are therefore correspondingly low, making annuities a less desirable RRSP maturity option.
If you have a number of different retirement plans and accounts, it’s always a good idea to talk to your financial advisor before acting, in order to make the most tax-efficient choices for triggering your income streams.