RRSPs versus RRIFs. RRSP is registered retirement savings plan and RRIF is registered retirement income fund.
Should you convert your RRSP to a RRIF? If so, when should you do it?
It’s not an easy decision folks. There’s a lot of misinformation out there. This is something we do all the time and something we advise people on all the time.
If this is on your mind, please go to speaktorob.com – we’ll set up a free, no obligation consultation.
Registered Retirement Savings Plan
The big difference between the RRIF and the RRSP is that the RRSP is a savings plan. The RRIF is an income fund.
Savings versus income. Savings is when you are taking money from your hard-earned salary or income and you’re putting it into a savings plan for retirement. Generally, the concept from the government was that when you’re ready to draw down on that income, they will convert it to an income fund, a RRIF (Registered Retirement Income Fund).
All right, so RRSP is the product that you contribute to and when you do this contribution, you do get that tax deduction from your income. This has been covered in another of my videos, but the key with the RRSP is when you contribute, you’re reducing your taxable income by the amount in which you contributed. Your effective tax savings become your marginal tax rate.
If you are in the top tax bracket in Canada, most provinces are around the 50% mark. You are getting 50 cents back on every dollar that you contribute to your RRSP. Conversely, when you are drawing on that RRIF, the amount withdrawn is now being added to your income.
This RRIF income, is being added to all your other income: your pension income, your OAS (old age security), your investment income and whatever other income you might have. Your RRIF income gets added to that income as well and conversely, you’re now paying tax on the applicable marginal tax rate.
The ideal scenario is when you are working, you are a high-income earner (in a high tax bracket) and when you’re retired, you’re a low-income earner (in a low tax bracket) and you get to take advantage of the arbitrage; the difference in tax rate between the two. But even if you’re not, even if you’re going to be a high-income earner in retirement, for a lot of people the RRSP still makes a ton of sense because you get the tax-free compound growth of having the money invested in an RRSP account.
Let’s look specifically at that decision of when you should be converting your RRSP to a RRIF.
First, there is no minimum age to convert an RRSP to a RRIF. You must, however, convert it in the year you turn 71 years old – before the end of the year that you turn 71. Converting it does not mean you need to draw all the income out of the account. In fact, that’d be a terrible strategy for most people. You will have a minimum required withdrawal amount every year starting the year you turn 72.
Let’s say you do know that now it’s time to draw the income. You’re drawing the income a couple of different ways. You could leave it as an RRSP and draw the income or you can convert to a RRIF and draw the income.
Now if you leave it in an RRSP, you are going to pay a de-registration fee every time you de-register the RRSP. If you’re drawing income, you’re paying to de-register and plus you’re going to pay the withholding tax on the amount that’s being withdrawn.
Now, with respect to the actual withdrawal itself, essentially the tax rate is the same, except you’re paying the tax up-front. With a RRIF, that situation is different because of your minimum withdrawal amounts. In either scenario, the funds withdrawn will be added to your taxable income for the year and taxed at your marginal tax rates.
On a RRIF, you are getting a percentage that you must take out every single year. You’re 71 and you convert your account to a RRIF in December of the following year and after that you must withdraw from your RRIF.
The withdrawal rates vary based on your age. It’s 5% approximately when you start, and it goes all the way up to 20% or higher even – by the time you’re in your nineties. That is an amount that you must take out from your RRIF, the mandatory minimum but not the maximum.
Now if you’re doing the minimum withdrawal amount from the RRIF, there is no withholding tax that gets applied to that and there is no de-registration fee. If you’re in a situation where you’re actually going to draw on the income, you should certainly consider converting it to a RRIF.
If you’re in a situation where you do not need the money, you’ve built up wealth somewhere else and you’re deferring your RRSP withdrawals, you absolutely want to review your overall plan, cash flow needs and tax rates before making the decision to convert your RRIF earlier than necessary.
If you need the income, you could consider converting your RRSP to a RRIF earlier. The RRIF income after age 65 does also qualify for income splitting. We did another video on income splitting and this is a neat concept.
If the incomes aren’t the same, if you are married or if you have a spouse (married or common law) and the incomes are not the same, you can actually income split your RRIF income, which is really neat because that allows you to kind of stabilize your incomes, reduce your taxes and basically, be much more tax efficient in your later years.
Now the key to all this, is retirement cashflow. We’ve talked a lot about deciding whether you do need the cash or not.
The key is figuring out what your cashflow is and that’s not a simple analysis. It’s one that we help our clients with. You need to know how much you need to spend on, and then where do you actually get that money from?
Perhaps you should derive this from your RRIF, maybe you take it from your non-registered or maybe you take it from a corporate account. The answer is, I don’t know. It depends on your situation. This can be very complicated and there are often no cookie cutter answers. We look at your personal cashflow, we look at how to structure your retirement income and then we structure the retirement plan. Afterwards, we build a portfolio and then we draw down the income for you.
People have different objectives in retirement. Some folks tell me they want to spend all their money before they’re 80, or all their money before they’re 90 and some people have a very strong need to leave a legacy or to leave money for kids.
If you’re debating to convert the RRSP to a RRIF, just remember that it’s not an easy question. Generally, if you’re not pulling the income, you keep it. If you’re pulling the income, then you convert.
You can also take advantage of the pension tax credit. Depending on where you are, it’s a few thousand dollars that you could take advantage of. That’s something you could do as well. There’s a lot of moving pieces to this.
Hopefully we helped you out a little bit and if not, don’t hesitate to give us a call at www.speaktorob.com.
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