Introduction
If an RRSP account was one of the savings vehicles you have taken advantage of to accumulate your retirement nest egg, you should understand how RRIFs work. RRSPs are designed to accumulate savings throughout your working life, and RRIFs are designed to pay income throughout your retirement years.
RRIF Basics
RRIFs don’t have a minimum age requirement, but most people set up RRIFs as they near retirement. Earnings in a RRIF are tax-free, and all RRIF withdrawals are subject to income tax.
You must close your RRSP by the end of the year in which you turn 71, at which point most people convert the balance of their RRSP to a RRIF. You could withdraw the total amount of your RRSP and never set up a RRIF, but this would cause the full amount to be taxed in the year it was withdrawn (not an attractive option for most). Another option is to buy an annuity which we will cover in a future article.
RRIFs are not investments in and of themselves but a tax-sheltered umbrella, much like RRSPs and TFSAs. The underlying investments include stocks, bonds, mutual funds, ETFs, and GICs.
With a RRIF, you must withdraw at least a “minimum withdrawal amount” each calendar year. The “minimum withdrawal amount” is calculated using your age and a percentage of your plan’s total value at the start of the year. Currently, the annual withdrawal percentage at age 55 is 2.86%, while the annual withdrawal percentage at 95 is 20%. Converting to a RRIF earlier may be advantageous if someone is considering retiring early. Just because you withdraw money from your RRIF doesn’t mean you have to spend it. The funds could be moved into another investment vehicle, such as a TFSA.
Withholding Tax
It’s important to note that your “minimum withdrawal amount” is not subject to withholding tax, but it must be included as income for the year it was withdrawn when you are filing your taxes. Over and above the annual minimum withdrawal, the financial institution holding your RRIF must collect withholding tax when you make an RRIF withdrawal.
If you withdraw more than the “minimum withdrawal amount” from your RRIF, you will be subject to withholding tax, taken at source. Below are the withholding tax rates for anyone living outside of Quebec.
Withdrawal Amount Withholding Tax (%)
- 10%: Up to $5,000
- 20%: $5,001 to $15,000
- 30%: Over $15,000
Even though your financial institution has collected withholding tax on your behalf, you must still claim the amount withdrawn as income at tax time. Depending on your overall situation and marginal tax rate, you may be required to pay even more tax or receive some, or all, of it back as a refund. It all depends on your overall income situation.
RRIF Versus LIF
RRIFs and Life Income Funds (LIFs) have many similarities. Both are designed to pay out income, can be invested in various investments, and amounts withdrawn are taxable. One significant difference is that LIFs have a maximum annual amount that can be withdrawn. The maximum is because LIFs manage funds that originated as part of a pension plan and are governed by pension legislation.
Additional Considerations
If your spouse is younger than you, you can base your annual minimum withdrawals on their age. You could reduce the income you must withdraw each year, resulting in potential tax savings.
If you are married, consider naming your spouse as your-successor annuitant’ for your RRIF. This way, your RRIF would be transferred into their name upon your passing, and payments could continue, avoiding any estate taxes or complications.
Income from your RRIF could impact other benefits (e.g., Old Age Security). Pulling too much income from your RRIF may negatively impact your OAS benefits.
RRIF Summary
Before turning 71, you can transfer all or a portion of your RRSP account to a RRIF. You would typically set up a RRIF when it is time to withdraw income regularly, which is often, but not always, retirement. Earnings in a RRIF are tax-free, and amounts paid out of a RRIF are taxable on receipt.
How you manage your RRIF will depend on your marital status, age at retirement, and other retirement income sources – such as an employer pension, government benefits, or an anticipated inheritance. All these factors should be considered.
