Should I Take Maximum LIF Payments?
Markus Muhs - Aug 13, 2020
Many of us end up having at least a small LIRA or LIF kicking around in our portfolio due to a pension at a former job. How do they work?
Some years ago I wrote a blog post that I’ve been updating regularly on RRIFs. The need for that blog post was obvious: too many people save in their RRSPs all their lives without the slightest inclination of what a RRIF is, how it works, essentially what happens to their RRSP when they retire. There are important considerations to be made around when to convert your RRSP to a RRIF, and I also posted the annual minimum payment table on there. I suggest reading that post before reading this one, as a primer to RRIFs.
A LIF works very much like a RRIF, only it is the “locked in” version. With an RRSP or RRIF you can withdraw as much as you want whenever you want (minus tax, of course). A Locked in RSP (LRSP or more commonly LIRA, which is what I'll refer to them from this point on) gets converted into a Life Income Fund (LIF, less commonly referred to as LRIF), and just as with an RRSP, the deadline for converting it is the end of the year in which you turn 71.
If you have a LIRA or a LIF it came to be in the first place because you had a pension plan with a former employer and commuted it into a LIRA. Pension plans are mandated to provide a lifetime income and thus when you transfer your pension out (when you leave the job or retire) you transfer it into a LIRA, which is similar to an RRSP in most ways only that you can’t contribute to it and can’t withdraw from it, except under special circumstances. The LIRA issuer (ie: CGWM, your bank, your brokerage, etc) has to hold you to the original provincial or federal legislation of your original pension, limiting your ability to withdraw from it. An example of the special withdrawal provisions for Alberta-legislated LIRAs can be found here.
Whereas an RRSP can be converted to a RRIF at any time (there actually isn’t a minimum age), LIRAs have minimum ages of 50 or 55, depending on which legislation they fall under. When you convert your RRSP to a RRIF, you’re required to take a minimum percentage of the balance out each following year, based on your age, but you can withdraw any amount higher than this too, or all of it if you want. With a LIF you have both a minimum withdrawal requirement, like a RRIF, and there’s a maximum withdrawal, also based on your age. The table below lists the minimums for RRIFs and LIFs, along with the maximums for most LIFs (Federal, Quebec, Nova Scotia, and Manitoba-legislated LIFs have slightly lower maximums).
The maximum withdrawal holds the LIF somewhat to the original pension legislation, in keeping you from just withdrawing it all in one shot, or withdrawing at an unsustainable rate that will have you run out of money too early, but it’s important to understand that maximum withdrawals aren’t sustainable into your 90s, as the minimum withdrawals are, or as your original pension might have been (if it was a defined benefit pension).
The impetus for writing this post was a response I offered to a reader question in Global's Money123 newsletter. In this case, a person was wondering why her LIF payments were going down year by year while she was doing maximum LIF payments. I already knew why, but to do the math I created this Excel file to estimate what minimum and maximum LIF payments would be in a given scenario. You can play around with this sheet too by changing the variables in the blue highlighted boxes. I created several tabs with different start ages, in 5 year increments, but you can also on any one of them put your actual starting balance into the appropriate row of the "End of Year" columns and it calculates the rest for you.
What I found was that in the scenario of someone starting their LIF payments at age 65 was that when doing maximum LIF payments, at a theoretical 5% investment growth rate, payments are reasonably steady all the way to age 89 and then money runs out. When doing LIF minimums, the money lasts quite a bit longer, well into your 90s, and payments actually increase gradually each year at a rate that might keep up with inflation. Obviously, taking maximum LIF payments makes a drastic difference in terms of the LIF’s sustainability; you can’t just take maximum payments and expect you’re all set for life. You will run out of money if you live to 90 and beyond.
My base scenario of course presumes 5% growth, which isn’t any kind of guarantee and might even be challenging to achieve over retirement, as you try to balance risk and return. Too much risk leads to sequence of return risk, which can severely impair a retirement plan, if the markets provide disproportionately bad returns at the beginning of retirement—even if they average out to 5% long-term—and force you to withdraw more principal in early retirement. Too little risk will also force you to draw down your principal faster and will lead to a steady decline in those LIF payments. At a 2% rate of return, which already is a stretch to achieve these days if you're unwilling to take any market risk, those LIF payments go down pretty quickly when doing max payments.
While LIF maximums are good in principle, in that they keep you from running out of money too early, they do cause for some inflexibility in retirement planning in scenarios where we want to draw down the LIF faster. I’ll expand on this in the below example.
Lending us a bit more flexibility is the 50% unlocking provision available now among many types of LIFs. Though the process differs from one pension legislation to another, when converting your LIRA to a LIF you have a one-time chance to unlock half your money. This isn’t meant to be an invite to raid half your LIF assets and withdraw all that formerly locked in money (too often that’s what people do) but it really improves your overall retirement income flexibility when you shift those assets over into your RRIF, where you have more freedom as to how much to withdraw, and when.
As an example, let’s take a scenario where someone chooses to retire at 60, defers their CPP and OAS as long as possible (for a higher payout; this isn’t recommended for everyone, but for more info on when to start CPP check out this post), and wants to spend more money in their first 15 years of retirement (very normal). If they have $500K locked up in a LIF, they can draw regular LIF payments of between $17K (at the minimum) and $34K (at the maximum, in orange above). If doing maximum payments, that LIF will keep paying something in the low $30K range until age 89 (again assuming 5% investment growth), which doesn’t fit their goals of spending more earlier on and having a lower taxable income once they begin CPP and OAS at 70. To allow for a higher income in the early years, they can unlock $250K when they convert the LIRA to a LIF, do max LIF payments on the remaining locked in portion ($17ish thousand until age 89) and draw down the unlocked $250K more quickly over ages 60 to 70.
LIFs certainly make retirement planning more interesting. Typically, whenever possible, I recommend a client take advantage of the 50% unlocking provision, simply to add greater optionality down the road, even if the above scenario doesn’t apply to them (you can still, if you choose, stick to the LIF maximums). Whenever starting RRIF and LIF incomes, if doing so before the deadline of age 71, it’s also worth considering depleting LIF assets faster, if it means leaving more in your non locked in RRIF, again just to provide better optionality.
In any case, the scenarios I mention above are fairly particular and only apply to certain people in certain situations, and not to everyone. If you’d like to discuss your own retirement income plan, I’d be happy to schedule a free 30 minute Zoom meeting with you to answer any pressing questions you might have. There are a lot of variables that go into a personalized retirement income plan, part of comprehensive financial planning, and I'd love to show you how I can help.
Investment Advisor & Portfolio Manager
MoneyWeHave: My Pension Deferral Dilemma
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Title image courtesy of Pixabay. Tables are my own.