Registered Retirement Income Fund
Markus Muhs - Nov 20, 2019
It's November, and if you turned 71 this year or are turning 71 before year-end and haven't already converted your RRSP to a RRIF, the clock is ticking on you to a December 31st deadline (most institutions will require this to be done sooner).
Updated November 2019
Most of us save money in our RRSPs all our lives without really understanding what a RRIF is and how it works until the time comes to make the conversion. I've found there are a lot of misconceptions from how they're invested to how they do their payouts to "what really is the point of putting money in an RRSP if I'm going to pay tax on it eventually anyway?"
To explain an RRSP to RRIF conversion I think back to how RRSPs were explained to me the first time: The RRSP is a house, the house has a door, RRSP contributions go in through the door, and once inside they are invested and they stay in there and grow until eventually withdrawn.
The RRIF conversion figuratively bars the door shut (no more contributions) and sets a requirement that a certain minimum of the invested capital has to go out the chimney of the house each year.
There really are no restrictions to how money can be invested in a RRIF. Effectively there's no difference from how they were invested inside the RRSP other than that investment decisions need to take into account a shorter time horizon and the liquidity needed to make those annual minimum payments (AMP). In other words, unless you choose to sell all the investments in your RRSP and purchase an annuity (which is one alternative to a RRIF, when you turn 71), you don't stop investing with a RRIF. You just invest slightly differently, with an income goal in mind instead of a wealth accumulation goal.
A note on the RRIF conversion deadline that people are often confused about: it's not your 71st birthday; it's the end of the calendar year in which you turn 71. Once you convert your RRSP to a RRIF, the key things that change are:
- You can no longer contribute to it. If you're under 71 though nothing's stopping you from opening a new RRSP and contributing there. You can potentially also still contribute to a younger spouse's Spousal RSP.
- You can take out as much money as you want, but will face the tax bill for doing so. Initially there's a minimum withholding tax on anything in excess of your calculated Annual Minimum Payment (AMP), which in the year of conversion is anything (your AMP is $0). You can choose to have more withheld too. Your actual tax bill will be based on your overall income for the year.
Annual Minimum Payment Table
The CRA wants to eventually earn their tax revenue on that money you squirreled away over the years. How much do they require you to take out each year? For reference I have created the below table, which also illustrates a couple of withdrawal scenarios. More on that later.
AMP% is the Annual Minimum Percentage that you have to withdraw in a given year from an established RRIF, based on your age on January 1st of that year.
For example, if you wait to convert your RRSP to a RRIF before Dec 31st of the year in which you turn 71, then your minimum for the following year is calculated on Jan 1st (age 71) at 5.28% times the value of your RRIF on that day. You are then given a deadline of Dec 31st of that year to withdraw the required minimum.
Some people withdraw this amount right away at the beginning of the year (the TFSA provides a nice new home for part of it, if it's not all for spending), others defer withdrawal to as late as possible in the year and others choose to have this amount paid out monthly, like a pension. The choice is really up to the RRIF holder and can be changed at any time.
Key to the decision of when to convert your RRSP to a RRIF, and how much to withdraw above and beyond your minimums, is your total taxable income situation in retirement. It's rather short-sighted to simply say "I'm going to defer taxation on this money as long as possible and wait until the age 71 deadline to convert."
If you're already retired at age 60, no longer earning an employment income, with no plans to return to the workforce, why not convert to a RRIF right away? Your income will not be any lower in the future, in fact it will be higher once your Canada Pension Plan and Old Age Security kick in. Waiting until 71, your RRSP will grow more, so the higher AMP percentages are applied to a bigger pie, yielding a higher taxable annual income from the RRIF. Not only might there be more tax due, but a higher overall income can cut into OAS eligibility or other income-tested retirement benefits.
The last two columns in my table illustrate two hypothetical RRIF withdrawal scenarios. In both cases the RRSP/RRIF is worth $300,000 at age 60 and the investments within are growing at 5% annually until age 95. One scenario has the RRIF starting at age 60, while the other scenario allows it to grow 11 more years (to a total of $513K, if compounding at 5% annually) before starting minimum RRIF payments at age 71. The full math, if you're interested, can be found on this Excel sheet.
Summing up the incomes in each column does yield more gross income when RRIFing at age 71 (just over $1 million vs. just over $800k), as one would expect when giving capital a longer time to compound, however what is not taken into consideration here are taxes and potential reinvestment of RRIF withdrawals (moving the money over to your TFSAs for example, a popular strategy with my clients).
Another benefit of converting your RRSP to RRIF at age 65-70 is the pension tax credit you can claim on RRIF income of $2000 or more (only if you are 65 or older). That is, if you have no other pension income at that time, and whether or not it's a net tax benefit to you can only be determined on a full assessment of your overall situation. It's just another side-effect and another reason to consider not waiting until age 71.
Another important consideration is the impact of the RRIF on your estate. A surviving spouse can face significantly higher annual taxation when no longer able to split this income. Upon the death of the surviving spouse the entire balance remaining in RRIF(s) is taxed all at once, leading to a considerable terminal tax bill.
In the two scenarios above, the RRIF holders are left with $108K to $166K remaining in their RRIFs at 95. Of course, most of us don't actually live until age 95. In the above scenarios the RRIF balances at age 90 are $200K and $308K respectively. Should the RRIF holder and spouse die before that time, a good chunk of their RRIF(s) are subject to our ever-higher marginal tax rates. In Alberta that's as high as 48% fed+province.
Simply following the annual minimum payment schedule, instead of a proper retirement income plan, can lead to significantly more taxes paid over your lifetime. Remember that all of that money has to come out of your RRIF at some point at some tax rate.
If you're retiring at 60, take more RRIF income from 60 to 65, when your CPP/OAS income isn't as high. Take more than the minimum throughout your retirement so that by the time you are in your 80s and closer to your expiry date you don't have such a large future tax liability kicking around.
Maximize your TFSA contributions throughout retirement, so long as you have money in your RRIF. The TFSA is a wonderful program, allowing you to permanently shelter wealth, minimizing your tax in later years as well as on your estate.
A proper financial plan should, over the long-term, end up having shifted as much of your net worth out of RRIFs and into TFSAs as possible (provided you're not spending it all). Properly executed, the tax savings can amount to tens of thousands of dollars or more, depending on your particular situation. In other words, the cost of financial planning advice can pay for itself multiple times, if followed.
I offer retirement income planning as well as other financial planning services complimentary to my wealth management clients and on a fee for service basis to anyone else. If you have any questions at all about RRIFs, retirement planning, or would like to book a no-obligation consultation please don't hesitate to contact me.