Tax planning and converting your RRSP

You must turn your RRSP into a RRIF or an annuity by the end of the year you turn 71. Otherwise you’ll receive all your RRSP money and have it count as income. This will likely push you up into the top tax bracket. At that point, you’ll pay the tax department a large part of the RRSP money you saved over your lifetime. Don’t fall into that default trap. Plan now.

tax planningYou must close your Registered Retirement Savings Plan, or RRSP, by December 31 of the year in which you turn 71. At that point, you’ll face three options. You can cash it in, buy an annuity, or open a Registered Retirement Income Fund, or RRIF.

It’s important to weigh the investment and tax implications of all three. If you’re turning 71 in 2016 we suggest that you lay the groundwork for converting your RRSP into retirement income as soon as possible.

Cashing in your RRSP may be very costly

One option is to cash in your RRSP. The trouble is you’ll likely pay the top tax rate on this ‘income’—giving the taxman much of the RRSP money you built up over a lifetime of saving. But cashing in your RRSP may make sense if you need cash, say, to make home improvements and you already have an adequate pension.

Shop around if you’re buying annuities

A second option is to buy annuities with cash from your RRSP. That is, you transfer cash tax-free to a life insurance company which guarantees you a series of future payments. The trouble now is low interest rates will reduce the payments. Also, the payments of most annuities are fixed. Over time, inflation erodes the value of these payments.

Then again, dependable income lets you plan your retirement. You can forget all about investments. We recommend annuities mainly to ‘top up’ your pension income if it’s insufficient to meet your living expenses.

If you plan to buy annuities, shop around. Some life insurance companies pay more than others. Also, make sure your annuity income from any one life insurer is at most $2,000 a month. That way, if the insurer fails, your income is fully covered by industry-funded Assuris. If you want over $2,000 a month, buy annuities from more than one life insurance company.

Plan ahead to time RRSP cash withdrawals

If you plan to cash in your RRSP or transfer cash to buy an annuity, you must plan ahead.

Make sure your RRSP holds short-term bonds. Avoid stocks and long-term bonds. Selling at the wrong time can cause unnecessary losses.

Also, if you’re withdrawing cash directly, rearrange and defer other income so you declare the RRSP proceeds in a year when you’d otherwise be in a low tax bracket. Even better, plan ahead and take the cash withdrawals from the RRSP over a few years, keeping other taxable income to a minimum. Just make sure you have maturities in each of those years to supply the cash.

Advantages of RRIFs over annuities

The third option is to convert your RRSP into a Registered Retirement Income Fund, or RRIF. A RRIF essentially continues your RRSP with one big difference—you withdraw money each year instead of contributing. As a result, unlike when buying annuities or taking cash, you need not have bonds mature before the conversion date.

Still, you should gradually arrange your portfolio so that some bonds or mortgages mature in each future year to fund your required withdrawals.

RRIFs have become popular. They offer some advantages over annuities and we usually recommend you convert at least part of your RRSP to a RRIF. You keep managing your money and build the RRIF so that the minimum withdrawals, based on the RRIF’s value, grow and offset inflation.

If you opt for a RRIF, invest defensively: you can’t replace losses in a RRIF. The only hope of recovery is through capital gains from your remaining portfolio, which provides an incentive to take even more risks.

Remember also that your minimum withdrawals will vary as the portfolio fluctuates, making planning more difficult. RRIFs remain a sound option, but mainly if you’re prepared and able to manage your own money.

 

The MoneyLetter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846