You’ve been accumulating money for your retirement in an RRSP for a long time now. But one day you will have to convert that RRSP to a registered retirement income fund (RRIF). What are the factors to keep in mind?
A RRIF is essentially a continuation of the RRSP. It’s designed to convert the money accumulated in an RRSP into retirement income. Once they’re in a RRIF, your savings can continue to grow tax-free. However, unlike with your RRSP, you will be required to withdraw a portion of this money every year, and you will no longer be able to contribute to your RRSP.
You are required by law to wind down your RRSP, at the latest, by December 31 of the year you turn 71. If you fail to do so, the government will close the RRSP itself and all your registered savings will be subject to income tax.
“If you work during the year you turn 71, don’t forget that you are allowed to contribute one last time to your RRSP for the current fiscal year,” says Guy Côté, Portfolio Manager and Senior Vice-President, Wealth Management, at National Bank Financial.
The maximum RRSP contribution is 18% of your previous year’s income. The amount you invest allows you to reduce your taxable income, and therefore pay less tax.
Not many people are aware of this, but nothing prevents you from converting your RRSP to a RRIF before you turn 71. And there’s no minimum age for making the switch. But the goal should be to move into a RRIF when you can derive the maximum benefit from it. Since withdrawals are taxable, it’s in your best interests to make the jump when your income tax rate is at its lowest.
For example, if you retire at age 60, you could delay drawing your Old Age Security pension and your Canada Pension Plan or Quebec Pension Plan payments until 65 or 70. Your taxable income would therefore be lower and you would pay less tax on withdrawals from your RIFF for several years.
To determine the best tax strategy for your situation, it’s wise to consult with your advisor or a financial planner. He or she will be able to lay out various scenarios based on your age and your projected retirement date.
Because the purpose of the RRIF is to provide a retirement pension, you have no choice but to withdraw funds from it. You can choose the frequency (monthly, quarterly, semi-annually or annually), but you must withdraw a minimum amount each year.
This amount depends on your age and the total amount invested in your RIFF. For instance, at 71 years of age you must withdraw 5.28% of your savings every year. At 80, that rises to 6.82%. As you grow older, the percentage increases, until it reaches 20% at age 95.
What about before 71? The minimum withdrawal is determined by dividing the number 1 by [90 minus your age]. Therefore, at age 60, you must withdraw at least 3.33% of your RIFF annually. To find out what percentage applies to your age, consult the Canada Revenue Agency chart.
Don’t need all of the annual minimum withdrawal amount from your RRIF to get by? If you have a spouse who is younger than you are, you can request that the calculation of withdrawals be based on his or her age rather than yours. The amount to be withdrawn each year will therefore be smaller.
This lets you kill two birds with one stone: pay less tax, since your annual taxable income will be lower, and extend the life of your RIFF. This choice, which must be made when you open your RRIF, is irrevocable, even if you get divorced or your spouse dies.
If you don’t use all the money you withdraw, you can put any surplus into a tax-free savings account (TFSA). That way, you will avoid having to pay tax on the interest earned.
Of course, this strategy is possible only if you have unused contribution room in your TFSA. The maximum amount an individual can have in a TFSA in 2020 is $69,500. This amount rises each year.
As long as they stay in your RIFF, your investments and the income they generate are not taxable. They become taxable only when they are withdrawn.
If the minimum amount isn’t enough to meet your needs, you can always withdraw more money – there is no limit. In this case, however, taxes will be held at source on the amount above the mandatory minimum.
What are the tax implications if there’s money remaining in your RIFF at the time of your death? There’s good news here: It can be transferred to your spouse without being taxed. On the other hand, if you have no spouse, the entire amount remaining will be added to the estate’s taxable income. If it’s a large sum of money, the tax rate will be high. And a large portion of your savings will go to the government instead of to your heirs.
To get the best results, a lot of careful thought should go into retirement tax planning. An advisor or financial planner can help you determine the strategy that works best for you. Who knows, you might even discover that you can retire earlier than you thought!
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