Updated: Jan 13
A reader was asking some questions yesterday that made me think I need to revisit how I’m explaining some registered investment accounts. They were asking about RRSPs and RRIFs, the basic differences, why we needed to create different accounts, and why we had to convert to RRIFs from RRSPs? With the RRSP contribution deadline approaching at end of Feb, it seemed like a good time to recap and try to explain these retirement savings and income accounts in a different way (hopefully simpler?).
Firstly, RRSPs and RRIFs are CRA (Canadian Revenue Agency) registered retirement accounts. This means they are registered with the CRA, and subject to CRA rules specific and unique to these accounts. The fundamental difference between an RRSP and a RRIF is that an RRSP is designed for individuals to save money into and grow tax-free, while a RRIF is designed to force you to withdraw (some) money and pay tax. An RRSP is a tax-deferred, tax-favored account used during your accumulation years. A RRIF is a forced-withdrawal, income-taxable account used during your decumulation years. With an RRSP, you can contribute your annual RRSP room plus any unused RRSP room into the account at any time. With a RRIF, you can only contribute money into it from an RRSP. You must move all your personal RRSP money into a personal RRIF by the end of the year you turn 71. I look at it this way, RRIFs are basically accounts where the CRA says (at age 71), “enough is enough, it’s time to get the tax back from the RRSP savings we allowed you to accumulate tax-free over the years”. Once a RRIF is established, you must start withdrawing the money from it according to the CRA schedules set up based on your age. This starts at 5.4% per year at age 71, and increases incrementally every year. Alternatively, you can set RRIFs up and withdraw earlier, starting at age 55 or any time after, and the CRA withdrawal percentages (called elections) are graduated and lower than 5.4% based on your age.
So the next question. When I retire, can I keep my money in my RRSP and withdraw it? Absolutely, … providing you are younger than 71. Many people choose this course in retirement or semi-retirement to have more control over their withdrawal amounts and the timing of their withdrawals. Some people continue working part time and still want to still contribute to their RRSP to reduce their income tax bill, whilst also using it to supplement their annual income. You can take a lump sum withdrawal from your RRSP any time in the year, or establish an annual amount and set it up for monthly payments with your institution. You’ll need to talk to your institution as there are a few ways to skin this cat.
Can I set up a RRIF before the age of 71? Yes you can, but not before you are age 55. Well, then why would I want to ever switch my RRSP to a RRIF before the age 71 deadline set by the CRA? There are a few reasons that you may want to set up a RRIF. The first one is that if you transfer an RRSP to a RRIF, and you are age 65, you can claim a pension credit of $2000/year against your income. Many will transfer a portion of their RRSP into a RRIF account at age 65 just to claim this credit every year, while still keeping a portion in their RRSP where they have more control with the withdrawal rates. There are other ways to get the pension credit even earlier, e.g. you are withdrawing money from qualifying pension accounts. However, many people do not have qualifying accounts to get the pension credit earlier, so using the RRIF option at age 65 is their only option. A second reason to convert to a RRIF at age 65, is because your RRIF not only qualifies for the pension credit at this age, but it will also qualify for income-splitting with your spouse. The third reason to convert to a RRIF is that you are fully committed to never working again and want to start recieving the full payments/withdrawals/tax from all your RRSP savings per the CRA age schedule, because it fits with your overall retirement withdrawal plans. Once you have transferred money from your RRSPs to your RRIFs you cannot move it backwards into an RRSP, and you must follow either the minimum or maximum CRA withdrawal schedules tiered to your age. Can you take out more then the minimums or maximums from your RRIF once these elections are set up? Again, yes you can. You can take out lump sums to meet your income plans or needs throughout the year as required, the same as an RRSP, and will pay withholding tax under the same rules.
To recap, RRSPs shelter your investments from tax, RRIFs shelter the investments from tax, but also force you to take some income and pay the associated taxes. You must be 55 in order to transfer RRSP money to a RRIF. And, as mentioned before, by the end of the year you turn 71, you must move all your RRSP money into a RRIF. If you set up your RRIF to the minimum withdrawals (elections), there are no taxes applied at source to these amounts. If you take money at the maximum withdrawals, you will pay tax at source on the payments, based on the annual amounts coming out. Also, if you further decide to withdraw money in lump sums from your RRIF you will be subject to withholding taxes based on the CRA thresholds. This withholding tax is set at 10% for lump sum withdrawal amounts up to $5k, 20% for amounts from $5k to $15k, and 30% for amounts greater than $15k.
You can withdraw money from an RRSP any time, provided it is not locked-in as in a group RRSP designed to act as a pension. However, when you do take money out, the withdrawals will be subject to withholding taxes under the taxation same rules as RRIFs. The resulting net withdrawals will also be added to any other income you are making and taxed at your marginal tax rate at year end. This adjustment will be made when your tax return is done, and if you are in higher tax brackets, this could result in more tax taken during tax return time. Let’s say you take out $5,000 from your RRSP, but are in a 33% plus tax bracket based on your annual income. You will have withholding tax of 20% ($1000) on the $5,000 gross withdrawal, netting you $4000. The $4000 will be added to your income and taxed the remaining 13% during tax filing time.
The gist of this is you have to decide what best suits you and you retirement plans. RRSPs and RRIFs follow some of the same, and some very different, withdrawal rules. RRSPs are meant to shelter your savings and growth from tax, RRIFs are meant to force you to take some income, and only tax-shelters what you leave in them. RRSPs let you contribute to them to reduce your tax bill, RRIFs allow you to transfer money in only from an RRSP and force you to pay some tax by making you take some income. You can take money out of both as lumps sums. RRSPs do not have the forced minimum or maximum elections (withdrawal percentages). All income is taxed from both RRSPs and RRIFs in your hands. Though RRIFs will allow you to split income at age 65, giving you a tax advantage you will lose if you wait to set them up til 71. Some tax will be by withholding tax at source, and you may pay more at tax time depending on your income levels and marginal tax rates in that year. One other important consideration, is RRIFs allow you to set the withdrawal rates to the younger spouse’s age. But you only get one chance to do this when you set them up, so need to review if this is right for you before you set these accounts up.
Personally, we set up all our RRSPs as RRIFs when we retired (I was age 58, my wife 55), and set the withdrawal rates to my younger wife’s age. I felt this was best and easiest thing to do as we were never going back to work, and I didnt want to worry about it again later. At my younger spouse’s age, the dividends from these accounts will cover the forced election withdrawal amounts for 10 years of our retirement. This gives us a bit more flexibility with our income plans, and a bit more insulation from volatile markets, as we are not forced to sell shares to generate income when we don’t want to. I can and will take lump sums from the RRIFs to meet our income and withdrawal goals, but do not need to if the market is not favourable.
Even if you are using an Advisor, it is good to know the inner workings of these registered programs. It allows you to pre-plan your retirement and further motivates you to save into RRSPs during your accumulation years.