Registered retirement savings plans (RRSP) and registered retirement income funds (RRIF) are two of the retirement planning options available to Canadians. One lets you save for retirement (RRSP) and the other is used for withdrawing those savings when the time comes (RRIF).
Which of the two investment tools you should use depends on what stage of life you’re in and your age.
An RRSP is a financial tool that lets you invest part of your income and defer the taxes until you start withdrawing money when you retire. The interest or other income earned in an RRSP also doesn’t get taxed until you start withdrawing money.
It’s important to note that investing in an RRSP doesn’t mean you won’t pay tax on that money. It means you’re deferring the taxes until after you retire. At that point, many people have a lower income than when they were still working so the money withdrawn from an RRSP is likely to get taxed at a lower rate.
An RRIF is like an extension of your RRSP. After you retire, you can convert your RRSP into an RRIF and start withdrawing money from it. The funds that remain in the RRIF still earn interest or other income tax-free, the same as they do in an RRSP.
After retirement, you can choose to convert your RRSP into an RRIF and leave it as-is if you don’t need the extra income. But once you reach 71 years old, you have to start withdrawing a minimum amount each year.
The current withdrawal amounts start at 5.28% at age 71 and increase each subsequent year up to 20% at age 95. These were set in the 2015 budget and were a reduction from the previous amounts to help extend the lifespan of an RRSP. Withdrawal rates could change again, so it’s important to stay abreast of the current rates once you start withdrawing from your RRIF.
Most Canadians choose to convert their RRSP to an RRIF when they reach 71 because it lets the bulk of the investment continue to appreciate tax-free.
When you withdraw money from an RRSP before maturity, the institution holding the RRSP will withhold a certain amount of income tax. The withholding tax rate depends on the dollar amount:
For example, if you withdraw $10,000 from your RRSP, you’ll receive $8,000 and the other $2,000 will get submitted to the Canada Revenue Agency as taxes paid on that amount.
Depending on your annual income, these percentages may or may not cover all the taxes you need to pay. If you’re in a higher tax bracket than the percentage withheld from your withdrawal, you’ll have to pay more taxes when you file your return the following year. Or if you’re in a lower bracket, you could end up getting a tax refund.
There are a couple of exceptions to the early-withdrawal rules. The Canadian government offers two options for using the funds in your RRSP without paying tax on the money you withdraw — the Home Buyers Plan (HBP) and the Lifelong Learning Plan (LLP).
With the HBP, you can withdraw up to $35,000 from your RRSP to use for the purchase of a qualifying home. It’s more of a loan than a withdrawal, however, as you have to repay the money to your RRSP over the following 15 years.
The LLP lets you withdraw up to $10,000 from your RRSP in a calendar year to use for full-time training or education for you or your spouse. You can’t use the funds for your children, however.
Similar to the HBP, LLP withdrawals are really a loan. You need to repay the funds into your RRSP over the following 10 years.
In both cases, failing to repay the money as required causes it to be considered a true withdrawal and you’ll pay income tax on the money. In this case, taxes aren’t withheld at the source since you received the money on the basis that you would repay it. If you have to pay tax, it can result in a significant bill from the CRA.
An RRSP is a registered savings vehicle but you can hold all kinds of different investments in it, including:
An RRSP can be self-directed, meaning you make all the decisions about how the funds get invested. Or you can invest in something like a mutual fund or GIC that’s mostly hands-off.
You can also hold RRSPs with more than one institution and have different types of investments in each of them. There’s no restriction as long as you don’t exceed the maximum annual contribution.
Like with any type of investment, it can be a good idea to diversify your RRSP portfolio. Having some funds in “safe” investments like savings bonds or GICs and others in higher-yield but riskier investments is a good way to hedge against risk.
As you get older, you can gradually move more and more of it into the safer investments since you’ll have less time to recover from any losses.
An RRIF is similar to an RRSP in that it can be held in many different types of investments. By the time you convert your RRSP to an RRIF, you’ll likely want to hold it mostly in safer investments.
The biggest difference with an RRIF is the withdrawal requirements. You have to withdraw a certain percentage of the money in it every year, starting by December 31 of the year you turn 71.
The remaining funds will continue to appreciate tax-free but as the withdrawal percentages increase, the funds will grow more slowly.
An RIF is a retirement income fund. It’s similar to an RRIF in that it’s a fund set up to provide income when you retire.
The difference is the word “registered” which is more significant than it might seem. An RIF isn’t a “registered” fund, which means it’s not tax-deferred.
With an RIF, you won’t get the benefit of earning interest or other income tax-free. Any appreciation in the RIF gets taxed annually, not when you withdraw the money.
An RRIF is the easiest way to convert an RRSP into an income fund. The investments it holds can stay where they are and you can continue to be as active as you want in deciding how they’re invested.
It’s not the only option you have though. You can also take the money from your RRSP and buy an annuity.
While converting to an RRIF is the most popular option, it does have a couple of drawbacks. First, you have to take minimum annual withdrawals. Even if you have enough retirement income to live on without this money, you still have to withdraw it every year.
Second, with an RRIF, there’s a risk that you could outlive your money. If your RRIF grows at a lower rate than what you have to withdraw, you’re going to reduce the balance every year. If you live long enough, you could run out of money.
An annuity is like an insurance policy that pays you a certain amount every month (or year) for a stipulated amount of time. Instead of converting your RRSP into an RRIF, you would withdraw the funds and buy an annuity with them.
The advantage of an annuity is that you’re guaranteed a certain amount for the rest of your life. There’s no risk of outliving your money.
There are some things to consider, however. First, some annuities only pay until your death. If you invest $100,000 in the annuity and have only received $50,000 when you die, the rest doesn’t get paid out to your family.
Other annuity products guarantee to pay out at least the amount of your investment, so in a situation like that, the difference would go to your heirs. Other annuities are designed for married couples and will continue to pay the monthly amounts until both spouses’ deaths.
The more features an annuity offers, the more expensive it will be. Which means you’ll get less every month or year for the same investment.
It’s important to plan ahead so you know you’ll have the income when you reach retirement age. A financial planner can help you decide the best route to take. If you would to learn more about finances in Canada, check out our financial blog for unbiased advice!