Collapsing RRSPs – Part One
Collapsing a RRSP
Part One
One of the most important decisions to be made in retirement is when to collapse your Registered Retirement Savings Plan. We shall examine the advantages and disadvantages of transferring funds in a RRSP to an annuity as compared to a RRIF. An RRSP must be terminated by December 31 of the year individuals turn 71and they can choose from the following options:
• withdraw the funds as a lump sum amount
• use the proceeds to purchase an annuity
• transfer the funds to a registered retirement income fund (RRIF)
Given the current level of interest rates, transferring funds to a RRIF is normally the best option. If one chooses to take a lump sum payment, the withdrawal will be taxable. If the funds are used to purchase an annuity, the value of the annuity payments is dependent upon interest rates at the date the annuity is purchased. Since interest rates are at very low levels, purchasing an annuity at this time will lock in the low rates and corresponding low monthly payments throughout one’s retirement. Most RRSPs are collapsed and the proceeds transferred to a registered retirement income fund.
If individuals do not collapse their RRSP by December 31 in the year they turn 71; the tax rules require the fair market value of the RRSP must be included in the individual’s income in the next calendar year. Arrangements can be made atmost financial institutions to automatically transfer the proceeds of an RRSP directly into a RRIF unless specific instructions to the contrary are received. This option will ensure the entire amount of the RRSP is not brought into income if an individual does not give the financial institution holding the RRSP the appropriate direction. This is especially important for seniors who make their own investment decisions but lack a level of sophistication. Although individuals must collapse their RRSP before they reach age 72, there is no minimum age for collapsing a RRSP or establishing a registered retirement income fund.
Registered Retirement Income Funds
A RRIF is an extension of an RRSP, except the individual is not allowed to make contributions. Funds must be withdrawn from the RRIF each year, except in the year the RRSP is converted to a RRIF. A RRIF may be self-directed and is eligible to hold investments similar to an RRSP. The rules require a minimum amount be withdrawn each year. The minimum amount that can be withdrawn from a RRIF increases each year until the individual reaches the age of 94. Once age 95 is reached, individuals must withdraw at least 20% of the funds remaining in the RRIF on an annual basis.
In 2015, the rules changed for withdrawing money from a RRIF. The following chart outlines the minimum withdrawals that must be taken each year.
Minimum amount (as of January 1, 2015)*
Age
71
5.28%
72
5.40%
73
5.53%
74
5.67%
75
5.82%
76
5.98%
77
6.17%
78
6.36%
79
6.58%
80
6.82%
81
7.08%
82
7.38%
83
7.71%
84
8.08%
85
8.51%
86
8.99%
87
9.55%
88
10.21%
89
10.99%
90
11.92%
91
13.06%
92
14.49%
93
16.34%
94
18.79%
95+
20.00%
Formula before Age 71 – If an individual starts to withdraw funds prior to age 71, the minimum annual withdrawal is calculated using the following formula:
70 and under
Calculated as 1/(90 – age)
For example, at age 65:
1/(90 – 65) = 4.00%
Using Spouse’s Age – Individuals are allowed to use either their age or that of their spouse in determining the minimum withdrawal requirements. The advantage of using the age of the younger spouse is to extend the period the funds remain in the registered retirement income fund. This increases the time the investments can grow tax-free and defers the date of the first minimum withdrawal requirement.
Additional Factors to Consider – The following points are relevant if an individual is considering a registered retirement income fund:
• an individual can have more than one RRIF
• although there is a formula for minimum annual RRIF withdrawals, lump-sum withdrawals in excess of the minimum are permitted
• the RRIF payments can be structured to include an inflationary index
• monies within the RRIF that have not yet been withdrawn, continue to grow tax-free
• there is a penalty provision that requires if an asset is removed from the RRIF at less than fair market value, an amount equal to twice the difference in value will be included in the taxpayer’s income
• the RRIF can be self-directed. Therefore, the individual can make the investment decisions within the RRIF. One issue that should be addressed is the ability of individuals to make sound investment decisions as they age. It may be appropriate to have professional assistance on the various investment decisions related to the RRIF
Registered Retirement Income Funds and Death – If an individual is married or has a common-law partner, there are a number of options available to the owner of a RRIF upon death. If the spouse is named as a “successor annuitant,” the spouse will continue to receive the monthly RRIF payments. If the spouse is not named as a survivor annuitant, but rather the RRIF goes to the estate and the surviving spouse is the beneficiary, the surviving spouse will receive the funds remaining in the RRIF at the date of death. These funds can be transferred tax free to the spouse’s registered retirement income fund. The RRIF can also be transferred to the spouse’s RRSP, but only if the spouse is under the age of 72, as RRSPs must be collapsed before December 31 of the year an individual turns 71.
If there is no spouse, the beneficiary of a RRIF can be a dependent child or grandchild. The funds will be taxable to the child. In order to reduce the tax liability, the child has the option of purchasing an annuity that must expire at age 18. If the child or grandchild is dependent upon the deceased because of a mental or physical infirmity, the dependant may purchase an annuity to eliminate the tax, but the annuity need not end at age 18. These amounts received would be taxable to the dependants, rather than the deceased.
If anyone else besides the spouse, child or grandchild is named as a beneficiary, the funds remaining within the RRIF would be taxable in the deceased’s estate and the tax paid in the individual’s final tax return. Once the income tax is paid, the remaining funds will be paid to the beneficiaries as provided by the deceased’s will.
Next Update – The next article will discuss the pros and cons of transferring RRSP funds to an annuity or taking a lump sum withdrawal.
