Are you close to turning 71 years of age, but still don’t know what would be the best conversion option for your RRSP? We’ll look at the options available to you.
A quick recap on RRSP – Registered Retirement Savings Plan – An RRSP is a retirement savings plan that is established by you, registered with the government, and for which the contributions are made by you or your spouse or your common-law partner.
The Canadian government requires RRSP account holders to convert their RRSP no later than December 31st of the year that you turn 71 years old. However, it is not mandatory for you to wait until the end of the year that you turn 71 years of age to convert your RRSP. You may convert your RRSP at any point prior to age 71. The optimal time to convert is a difficult question to answer that depends on many factors including your other savings accounts, pensions, your income tax bracket and personal financial goals.
The most well-known option that many RRSP account holders choose is RRIF. Little do they know, there are other options including cashing out the RRSP (withdrawal without conversion) and buying annuities.
RRIF or Registered Retirement Income Funds is the most well-known option for retirees to convert their RRSPs. If the RRSP is a tool used to save money for your retirement, the RRIF is the tool to unlock those savings and turn them into your retirement income. A RRIF is like an RRSP, but you cannot contribute to a RRIF after converting from your RRSP. Additionally, a minimum annual withdraw is imposed each year for any RRIF account holders by federal regulation. All withdrawals from RRIF will be taxed as these amounts are added to your annual taxable income.
While a RRIF seems to be less flexible compared to an RRSP, it still allows account holders to have many of the same investments as their RRSP and the conversion is not required until age 71.
Cashing out your RRSP is not a common option that retirees choose. Whether or not it’s a sound strategy depends on different circumstances and your financial goals. Cashing out RRSP works best if you have little taxable income—relative to what you typically earn—as you will then be in a relatively lower tax bracket. It is often better to withdraw some money from your RRSP than to apply for a pension benefit early or use other savings if, for instance, you lost your job a few years before becoming eligible to receive a full pension.
For those who decide to retire early, withdrawing RRSP early could help to fill in the gap of lower-income years before receiving pension benefits while keeping the total amount of taxes paid over the course of your retirement at a low level.
Keep in mind that cashing out your RRSP also means the withdrawn amount from your RRSP will be added to your taxable income of the year withdrawal was made. A withholding tax of up to 30% will be applied when you withdraw from the RRSP, but the total tax owed is based on your marginal tax rate (tax bracket) and is determined when you file income taxes for the year.
If the withdrawn money is used to invest in a non-registered account, any earnings made inside that investment will also be taxed.
Another option for converting your RRSP is to purchase an annuity. You have the options to either purchase an annuity that will provide you with a fixed income for life or until the age of 90.
Recently with the low-interest rate situation, annuities tend to deliver low payouts and are relatively expensive, but they require no management and are a secured instrument.
There are two options for annuities:
Life annuity: provides you with a guaranteed fixed income for the rest of your life regardless of the market, interest rate, inflation, and the economy. Your cash flow will stay steady and stable for your lifetime.
Fixed term annuity: you may choose to receive a level payment each year from the year of the annuity purchase to age 90. If you choose this option and pass away before 90, the remaining payments will be paid to your beneficiary or your estate.
Overall, the individual and any advisor must take into consideration his/her financial goals, desired income level and planned retirement age before converting an RRSP. Talk to your financial advisor to discuss the advantages and disadvantages of these options to find the best solution for your retirement years.