Just turned 71? Time running out to convert RRSP to RRIF

Your investments needn't change, as long as you meet the annual withdrawal requirement.

Matthew Elder 4 December, 2014 | 6:00PM

Much attention is given to the March 1 deadline for making a contribution to a registered retirement savings plan. But too often overlooked is the timeline for closing an RRSP and transferring the money held within it to a registered retirement income fund (RRIF) or registered annuity.

An RRSP must be collapsed no later than the end of the year in which the planholder turns age 71. A plan that is left intact into the following year will automatically be deregistered, and tax paid must be in full that year on the value of the entire RRSP. By contrast, income paid out by a RRIF or annuity is taxed only in the year you receive it.

Acting just short of a deadline rarely is a good idea when it comes to properly assessing circumstances and making sensible decisions. But unless you are contemplating using your RRSP savings to buy a registered annuity (and receive guaranteed income from it for life or until a specified age), you don't have to make any major decisions because your investments can remain the same. Only the account type needs to be changed, from RRSP to RRIF.

Since income from an annuity is based on an interest rate available at the time it is purchased, in most cases an annuity doesn't make sense, due to the low rates currently available. (An exception might be someone whose circumstances make it wise to lock into a guaranteed and regular income stream, which an annuity provides.) As a result, most people opt for a RRIF, which allows you to invest in the same fashion as your RRSP. Normally, the investments held within an RRSP can be transferred intact to a RRIF.

"It's a seamless process, particularly if you stay with the same institution," says Howard Kabot, vice-president, financial planning at RBC Wealth Management Services. "There's basically one form to fill out. Whatever you had in your RRSP flows into your RRIF. There's normally no need to change your portfolio content or strategy."

You do, however, have to ensure you have enough investment liquidity in your RRIF portfolio to meet the minimum withdrawal requirements, Kabot says. Because it is designed to provide retirement income from your RRSP savings, a certain percentage of assets in a RRIF must be withdrawn each year.

For example, if you convert your RRSP to a RRIF during the calendar year in which you turn age 71, your first minimum withdrawal requirement will occur the following year. That minimum withdrawal would be 7.38% of the value of your RRIF assets as of Jan. 1 of the new year. If the RRIF's value at that time was, say, $800,000, you'd have to withdraw just over $59,000 from your RRIF that year.

The older you are, the higher the minimum withdrawal requirement. At age 75, it's 7.85%; at age 80, 8.75%; 85, 10.33%; and so on, until age 94 or older, at which point you must withdraw at least 20% of the remaining assets each year. (Note that different minimum withdrawal rates apply to RRIFs started before 1993.)

When you set up a RRIF, you can opt to base the minimum payment on the age of your spouse (married or common-law). You must make this decision before you make your initial withdrawal.

Remember, you must pay tax on RRIF withdrawals at your marginal tax rate. This is because RRSPs and RRIFs (as well as annuities) provide a tax deferral over time. You make your RRSP contribution and claim a deduction for that amount. Interest, dividends and capital gains earned on the money invested escape tax while they are held within the account, but become fully taxable when they are withdrawn from the RRSP as cash or through a RRIF or annuity.

The financial institution where the RRIF account is held is not required to withhold tax at source on the amount of a minimum withdrawal. If the amount does not exceed the minimum withdrawal amount, you won't have to pay tax on the withdrawal until the time comes to file your income-tax return for that year. However, tax must be withheld on amounts in excess of the minimum withdrawal, at the same rates that apply to amounts taken from an RRSP. These rates are: Amounts up to $5,000 (10%), $5,001-$15,000 (20%) and amounts in excess of $15,000 (also 20%). For Quebec residents, those rates are, for federal purposes, 5%, 10% and 15% respectively, plus a flat 16% provincial withholding regardless of the amount.

If you don't need all or some of the money withdrawn from your RRIF to help fund your retirement lifestyle, you can either reinvest the after-tax proceeds in a non-registered account or, better still, in a tax-free savings account (TFSA) and thus allow those retirement savings to continue to enjoy a tax break. Because a TFSA is funded by after-tax dollars and income and capital gains earned within the account is tax-free, there is no tax payable on money removed from that account. The current annual maximum contribution to a TFSA is $5,500.

Rather than as cash, you are allowed to make withdrawals in kind, transferring securities intact from your RRIF to a non-registered account or a TFSA, says RBC's Kabot. You will have to pay tax on the amount of the deemed disposition, based on the value of the securities on the day they are withdrawn.

If the amount of these securities exceeds your minimum annual withdrawal amount, you will have to ensure there is enough cash in your RRIF account for the financial institution to use as a tax withholding. Note that a withdrawal in kind intended for a TFSA must first be transferred to a non-registered account and then to the TFSA.

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Matthew Elder

Matthew Elder