Many retirees remain unsure about the process of converting an RRSP to a RRIF and the timing of when it can be done.
Investments within an RRSP (Registered Retirement Savings Plan) or RRIF (Registered Retirement Income Fund) remain fully tax-exempt, as long as the funds remain in the account. As soon as funds are withdrawn, they immediately become taxable at the holder’s marginal tax rate.
Anyone may withdraw funds from an RRSP at any age. However, should they do so before it is converted to a RRIF, the withdrawal will be subject to a standard tax-withholding which is reconciled when the income tax return is filed. With the sole exception of a permitted “borrowing” of up to $25,000 from an RRSP for the down-payment on a first home, most RRSP holders are generally well-advised to avoid any withdrawals until after retirement when they will either need, or be required by CRA, to withdraw funds.
Once an RRSP holder reaches age 55, they may convert it to a RRIF and commence regular withdrawals. Once the conversion takes place however, it cannot be undone. The taxpayer must, from that point on, withdraw a minimum annual amount from the RRIF. At age 55, the mandatory minimum withdrawal is set at a low 2.86% of the RRIF value. Each year the required minimum withdrawal percentage rises, eventually peaking at 20% of account value once the RRIF holder turns 94.
While the conversion to a RRIF may take place any time after age 55, it must occur no later than the calendar year in which the account holder reaches age 71. Conversion to a RRIF simply involves signing a document, provided by the account administrator, changing the designation from an RRSP. This name change does not affect investments held.
After converting the RRSP to a RRIF in the year one reaches 71, draws may commence immediately, at a minimum 7.38% of value. Or, if the account holder prefers, he may delay the first draw until the following calendar year, when he turns 72 and can no longer delay withdrawals. At that time, the minimum draw required will be 7.48%.
While at least the minimum annual withdrawal must be met once an RRSP is converted to a RRIF, there is no upper limit to the amount which may be withdrawn. Of course, the more withdrawn, the higher the resulting tax bill.
The principle applied by the government is simple. They allow us to receive a generous tax deduction when we contribute to an RRSP; and they exempt earnings or capital gains in the account from income tax. However, by the year we turn 72, CRA wants to start retrieving taxes on at least the mandatory minimums.
When the annual minimum percentages were set by the government, retirement lifespans were significantly shorter. The specified percentages did not pose a significant risk of the account holder exhausting the RRIF during retirement. Today, a retiree may spend as many years in retirement as in the workforce; the mandatory percentages now pose a serious risk that the RRIF holder may exhaust his funds prematurely. Many groups continue to urge the government to either moderate the minimum draw percentages, or raise the mandatory initial withdrawal age above 72 — preferably both.
Assuming sufficient other retirement income, a general strategy to consider to obtain the greatest value from investments would be to allow the RRSP account to grow and compound, tax-free, for the longest-possible time before commencing draws — and then at only the prescribed minimum percetages.
For further clarification of the rules relating to RRSPs or RRIFs, consult your accountant, your account provider, or call the 1-800 number for the Canada Revenue Agency.
A retired corporate executive, enjoying post-retirement as an independent Financial Consultant (www.dolezalconsultants.ca), Peter Dolezal is the author of three books, including his most recent, The SMART CANADIAN WEALTH-BUILDER.
Contact Panorama Rec Centre to register for Peter’s Elder College Spring session – Financial & Investment Planning for Retirees and Near-Retirees (Wednesdays, March 18 to April 15).