Retirement planning shouldn’t be a guessing game, right?
By turning your RRSP into RRIF and using annuities you can create a stable and tax-efficient income. This could save you thousands in taxes through income splitting.
If you are 65 or older, you can split up to 50% of your RRIF Income, with your spouse to reduce the total taxes. On top of that, you can use this income to claim pension income tax credit, which applies to the first $2000 of eligible pension income. By doing so, you can be eligible for a pension tax credit of $2000 for each of you and your spouse.
It is mandatory that you must convert your RRSP into a RRIF (Registered Retirement Income Fund) or an annuity by December 31st of the year you turn 71.
There’s a formula to calculate the minimum amount that you should withdraw from RRIF. You calculate this by multiplying the fair market value of the amount that you have in the RRIF account by a prescribed factor.
For example, if you’re 65 years old, it would be 1/(90 – 65), or 1/25, which equals 4%. So, if your RRIF is valued at $500,000, on January 1st, the required withdrawal would be $20,000.
If you are 71 or above and you don’t need the money to cover your regular expenses, you can use the age of a younger spouse to calculate the minimum withdrawal requirements.
Benefits of a RRIF:
Flexibility: A RRIF offers flexibility, allowing you to withdraw lump sums to cover major expenses like buying a car or going on vacation.
Investment Control: With a RRIF, you maintain control over your investments, similar to how you did with your RRSP.
Drawbacks of RRIFs:
Minimum Withdrawals: You must make minimum withdrawals every year when you turn or older.
Potential to Run Out of Money: There’s a risk of depleting your RRIF due to poor investment performance.
Tax Implications: Upon the death of both you and your spouse, the market value of the RRIF is taxed at your marginal rate, which could result in a significant tax bill.
Now let`s talk about the Annuities
Annuities: An annuity provides a guaranteed income stream in exchange for a lump sum payment to an insurance company.
Types of Annuities: There are two basic structures:
Life Annuity: Pays income for the lifetime of the annuitant.
Term Certain Annuity: Pays income for a fixed period, such as 5 or 10 years.
Life annuities can be structured in several ways, including a straight life annuity, which provides income only while the annuitant is alive, and joint-and-last-survivor annuities, which continue payments until the second spouse passes away.
Tax Considerations: Annuities purchased with registered funds generate fully taxable income. If purchased with non-registered funds, part of the payment may be considered a return of capital, which isn’t taxed, while the interest portion is taxed as regular income.
Combining RRIF and annuity income can be an effective strategy to ensure a stable retirement income.
Benefits of Annuities:
Lifetime Income: You won’t outlive your money; you receive payments for as long as you live.
Low Maintenance: Once set up, an annuity requires no ongoing management.
Drawbacks of annuities:
Lack of Flexibility: Unlike RRIFs, annuities don’t allow for lump-sum withdrawals for unexpected expenses.
Interest Rate Sensitivity: Annuities are affected by prevailing interest rates; lower rates generally mean lower payments.
Due to this if you have a higher risk appetite, you won’t be able to achieve higher investment returns from Annuities.
Annuities could be a good fit for you if you are a risk averse investor, you need longevity protection for you or your spouse, and you are comfortable with fees and cost involved with annuities.
Most often It’s advised to have a combination of both RRIF and annuity payment to fund the retirement income.
The easier method to decide between RRIF & Annuity is, first, you should calculate how much your annual expenses we’ll be during retirement.
Then see how much of those expenses would be covered by your pension plans such as CPP, OAS, or other available sources.
To cover the remaining amount of expenses, you could consider Annuity as an option.
Though annuities are suitable for only a few people but we cant ignore the benefits they provide.
Now lets look at the example of
Dr. John, residing in Alberta, recently turned 65 and has $1 million in his RRSP. His spouse, aged 63, also has her own RRSP.
To begin his retirement income strategy, Dr. John decides to start withdrawing from his RRSP early. He opens a RRIF at his financial institution and transfers $12,000 from his RRSP to the new RRIF, leaving a balance of $988,000 in the RRSP.
Dr. John withdraws $2,000 annually from his new RRIF, which qualifies for the maximum pension income that’s eligible for the pension income tax credit. At tax time, he claims the pension income tax credit, saving $300 in federal income taxes and $200 in provincial taxes as a resident of Alberta.
When Dr. John’s spouse reaches age 65, she opens her own RRIF and starts withdrawing funds eligible for the tax credit. Together, they save $1,000 per year in taxes.
By the time Dr. John reaches 71, he has fully withdrawn the $12,000 initially transferred to the RRIF. At the end of the year in which he turns 71, he converts the remaining RRSP balance into a RRIF. From age 72 onwards, any withdrawals from this RRIF also qualify for the pension income tax credit.
Lets see another example for the use of Annuity.
Dr. Mark Lewis, a 68-year-old retired cardiologist, chose to purchase a $1 million life annuity to secure a stable, guaranteed income of $60,000 per year for life. He preferred this over other investments due to his desire for predictable income and risk aversion. The annuity simplifies his finances, removes market volatility concerns, and ensures he won’t outlive his savings. With his remaining assets, he still maintains flexibility and liquidity for other needs. This strategy provides Dr. Lewis with peace of mind and financial security in retirement.
Disclaimer : This is for information purpose only. Please talk to your tax/financial advisor before making any decision.