Question. I’ve been fairly diligent about saving, and have contributed to my RRSP every year. I’m not ready to retire just yet, but I do plan to retire within the next few years. I guess after all these years of saving, I hadn’t really thought much about it, but now I’m wondering, what happens to my RRSP after I retire?
Answer. First and foremost, congratulations for being a disciplined and diligent investor all these years. As we know, many Canadians have no RRSP or meaningful form of retirement savings at all, so you’re ahead of the pack there.
However, even those who are diligent about saving and adhere to a plan for contribution, seldom have a plan for withdrawal. As we know, all funds inside an RRSP must eventually be withdrawn at some point.
Every dollar withdrawn from your RRSP is subject to full inclusion and taxable as regular income in the year you withdraw it.
With that in mind, let’s take a look at the options for dealing with your RRSP when you retire.
Options for RRSP Maturity
First, a bit of terminology. A matured RRSP is one that is no longer in the accumulation phase, but rather, is in the payout phase. That is, a matured RRSP is in the stage of producing retirement income for the plan beneficiary (owner).
There are 3 options available for maturity:
1. RRIF – Registered Retirement Income Fund
This is by far the most popular option, as it allows a continued tax deferral, as well as continued control over your investments. The transfer of funds from an RRSP to RRIF is not in itself a taxable event. However, once the RRIF is established, there are mandatory minimum withdrawals. There is no mandatory withdrawal in the year the RRIF is established, but withdrawals are mandatory beginning in the year following. Note that, similar to RRSPs, RRIFs also have the same rate of withholding tax. However, only the withdrawal amount in excess of the minimum is subject to withholding tax, as there is no withholding tax applied to the RRIF minimum.
An annuity is an insurance product that is designed to provide you with a regular income stream. You can think of it like buying a pension, since an annuity will provide you with a stable, reliable, and predictable income stream. However, you must relinquish control of your capital, and of the investment decision process, which is a drawback for many investors. There are many different types of annuities, and one key fact in this case is that the annuity must be a registered annuity, since it is purchased with registered funds from your RRSP. That means every dollar you receive from the annuity payments is taxable as regular income.
This option just means, quite simply, that you withdraw the assets from your RRSP. Of course, the reason most people do not elect this option is because the amount you withdraw from the RRSP must then be included on your income tax return, and you must pay the resulting income tax. This is typically the least tax-efficient option, and hence the least attractive.
Remember that you don’t have to wait until retirement to withdraw from your RRSP. In fact, you can take money out of your RRSP at any time. However, an RRSP must mature by December 31st of the year in which you turn age 71.
Furthermore, the options described above are not an “all or nothing” type decision. The CRA requires your RRSP to be converted into any one, or any combination, of the maturity options described above.
For example, if you have $200,000 in your RRSP, you could decide to take $25,000 as cash, use $75,000 to purchase a registered annuity, and transfer $100,000 to a RRIF.
How To Decide – What’s the Best Option for You?
As with many decisions in personal finance, there is no universal best option. Rather, the most appropriate RRSP maturity option(s) will depend on your own unique personal circumstances.
Start by asking yourself this question: Assuming everything else in your life generally goes as planned, what’s the purpose of this money? How do you plan to spend the money in your RRSP?
Some of the most common goals include:
- Regular monthly withdrawals to supplement overall retirement income, and enjoy an overall higher standard of living and more comfortable lifestyle in retirement.
- Dream vacation – Round the world cruise, sail the Caribbean, etc.
- Home renovation project – A new kitchen, new master bedroom with ensuite, new basement and garage, etc.
- Big ticket purchases – New car, recreational vehicle (RV), boat.
- Retirement property – Cottage by the lake, or a condo in the south to escape the Canadian winters.
- No spending, but rather, intend to leave the money in the RRSP as an inheritance to children or grandchildren.
Of course, this list is by no means exhaustive. But thinking about the intended use of the RRSP money is a great way to help decide the best option for maturity. When making your decision, some general criteria to consider include:
- Desire to minimize tax – the RRIF and annuity options allow for deferred and/or gradual taxation of withdrawals, whereas the cash option involves a larger immediate tax consequence.
- Income needs – some of the items mentioned above, such as dream vacations or big ticket purchases, should only be considered to the extent that all other needs have been met.
- Estate planning – if you plan to leave the assets as an inheritance to a child or grandchild, the RRSP is actually a really inefficient way to do this. In most cases, a far more powerful solution involves the use of a life insurance policy. Speak to us if you’d like to know more about how this works.
- Income flexibility vs. income guarantee – if you want a guarantee, an annuity is typically the way to go. However, if you want flexibility and control, a RRIF is generally the better choice.
Every dollar withdrawn from your RRSP, RRIF, or registered annuity, is subject to full inclusion and taxable as regular income. When combined with other sources of taxable income, such as an employer pension, CPP, and OAS, this creates a heightened need for tax planning.
Indeed, it’s important to keep tax efficiency as a key priority when planning your RRSP withdrawals. A plan for eventual withdrawal from your RRSP – that is, an RRSP exit strategy – is just as important as a plan for contribution.
Interested in learning more? Contact us today to find out about the exciting solutions we have to offer.