Many Canadians associate celebrating their 71st birthday as the date when certain important financial retirement decisions should be made. While some retirement decisions are irreversible, most can be adjusted as you move along the retirement horizon. You just need to be prepared to invest a little time into understanding your needs ahead of time.
Retirement saving is a lifelong process and along the way you may have collected several different Registered Savings Plans (RSP). The RSP umbrella can include any of the following:
- Registered Retirement Savings Plan (RRSP)
- Registered Pension Plan (RPP)
- Locked-in Retirement Account (LIRA)
- Pooled Registered Pension Plan (PRPP)
- Individual Pension Plan (IPP)
- Specified Pension Plan (SPP)
Each plan is unique and has its own nuances. Your plan administrator or financial advisor should be able to explain the salient points of each plan to you. If you have multiple RSP accounts, it might make sense to investigate whether you can collapse your RSPs into a single plan. Doing this would make your account management easier and possibly save money as each plan will have yearly administration expenses.
As most Canadians have saved for retirement using the RRSP retirement vehicle, this article focuses on this event. Future articles will discuss the other non-RRSP plans.
There are only three permitted ways to draw from your RRSP: 1) through a Registered Retirement Income Fund (RRIF), 2) purchase an insurance annuity, 3) take the savings out of the plan and into income or iv) choose a combination of the above.
A majority of individuals choose option 1 and/or 2; the proportion of each is tied to your spending needs and your risk tolerance.
Option 1 – RRIF (Self or Professionally Managed)
No later than December 31 of the year you turn 71 (55 is the earliest you can draw on your savings through a RRIF), make your final contribution and then advise the registered plan administrator (Bank, Insurance or Trust Company) to convert your registered plans into a RRIF. The investments within the RRSP are not required to be liquidated or mature. The investments are transferred as-is; no tax implications occur. Furthermore, your investments continue to grow on a tax-deferred basis.
Your first withdrawal must be in the next calendar year following the conversion. If you converted your RRSP to a RRIF in 2019, you must begin withdrawing funds in 2020 (latest being December 31).
A RRIF is basically a registered plan, closed to new contributions with statutory minimum income distribution. The distribution amounts are a percent of your registered savings and are transferred periodically from your RRIF to your personal Bank account (often without withholdings). The minimum income is a function of your RRIF’s market value. As the market value of the RRIF changes, so can your distribution amount.
In the year prior to conversion, your administrator (Bank, Investment Management Firm or Insurance company) should reach out and ask for some basic information (if not already known). They will ask you to: i) confirm the age profile you want for your minimum distributions, ii) the amount of income to be withdrawn annually (there is a CRA mandated minimum), iii) how often you would like the income withdrawn (weekly, monthly or annually), iii) the account the income is to be deposited to, and iv) who you would like to name as the beneficiary of the RRIF (preferred to simply administration of your estate at death).
As you move towards your first RRIF income draw date, some individuals may wish to shift and move to different asset classes. This re-balancing can be done alone or with the help of a professional.
For this reason, it is important to advise that a RRIF can be self-managed or fully managed by an investment professional. Selecting who to manage your RRIF is important; a managed account will charge for this service and these expenses will decrease your income and capital. However, if you are not financially inclined and don’t want to spend your leisure time reviewing economic trends and selecting investments this may be an alternative. Furthermore, a professional RRIF manager will ensure that assets are liquidated in an efficient and timely manner to meet your income needs.
RRIFs are not without their issues. If your RRIF is not growing at a rate faster than the withdrawals, you will be drawing on your “capital” or “savings”. This is acceptable if you have accumulated significant registered savings and have additional non-registered investments. If you deplete your RRIF savings too early you may run-out of funds. This may force you to revisit your lifestyle and spending habits.
Another issue some RRIF annuitants struggle with is the mandated minimum withdrawal requirements. The RRIF administrator is required by the CRA to distribute funds at the legislated rate based on your age. For those with significant sheltered savings, the minimum income can be significant and may create an annual unwanted tax liability. Fortunately, there are three possible solutions to this issue:
- If the RRIF owner has a younger spouse/partner the minimum rate can be based on their age (designation needed at conversion from RRSP to RRIF);
- If you don’t need the full RRIF withdrawal, you can contribute the excess to a Tax Free Savings Account (“TSFA”);
- Beginning in 2020, you can elect to transfer 25% ($150,000, lifetime limit) to an Advanced Life Deferred Annuity (“ALDA”). This new type of annuity will allow you to defer some payments until you reach 85. The CRA is still working on the administration of this new annuity; more information to come.
Option 2 – Purchase an Insurance Annuity
An insurance annuity is a financial contract sold by an annuity provider (usually an Insurance company) that will pay a guaranteed regular income. It is purchased lump sum and paid for from the proceeds of your registered plan. Most retirement annuities pay a combination of investment return and return of capital.
There are three main type of annuities: Life, Term Certain and Variable. Each annuity provider may have different options, but they all behave similarly.
A life annuity is a contract that provides you with a guaranteed lifetime of income. Unless specified otherwise, the payments will stop when you die, and no money goes to your estate or named beneficiary. The income stream is tied to the interest rates at the time of purchase. Features can be added to the contract that will allow for joint and survivor options, guarantee option at death or cash-back to your estate.
No risk of outliving your income
Guaranteed income payments for as long as you live
May die before receiving all your money returned as income and capital
Adding option of survivorship or transfer will lower annuity income
Term Certain Annuity
A term certain annuity is a contract that provides you with a guarantee of income, but only for the contract specified period. The period can vary in length for 5-years to 20-years. If you die before the end of the term your beneficiary or estate can continue to receive the regular income payments (or receive a lump sum). The income stream amount is tied to the interest rates at the time of purchase. The payments include both income and return of capital.
Guaranteed income for a set period
Your estate or beneficiary will receive any remaining benefit at death
May live longer than the term of the annuity
In a variable annuity, the provider invests part of your funds in a product with variable returns (such as equities) and the remainder in a fixed income. Your income component is a combination of the variable return and a fixed portion along with a gradual return of your capital. The variable return will fluctuate based on the performance of the underlying investment. The payments can include both income and return of capital.
Fixed income plus potential for additional return based on equity returns
Variable return could exceed capital depletion; extending life of annuity
Consideration before buying an annuity
An annuity can be purchased at any time from the proceeds of your registered savings. In fact, you can buy annuities outside of your registered savings too. Some people will draw on their RRIF for a certain period of time and decide that they want the security of a known and “locked-in” income stream without any interest or stock-market volatility. Once an annuity is purchased is very difficult to undo the investment without penalties.
Each annuity seller will offer different income streams even if the contract terms are the same. This is because the provider bases the income flows to you based on:
- Your health, age and lifestyle as reflected in their in-force actuarial tables and their view of mortality for your age group;
- Their internal operating and administrative costs to serve and administer the annuity;
- The returns they expect to generate based on their ability to source investments; and
- The commission rates they offer to sales agents and re-sellers.
Before selecting an annuity, make sure that you understand the fees and commissions the provider will levy against your investment along and have a clear understanding of any penalties or hidden charges.
For more personalized advice and information, contact Vulcan Investments at 647 808 5512 for a free assessment of your RSP.