If you’re turning 71 this year, there’s something that MUST be on your ‘to do’ list

For every Canadian turning 71-years old a decision needs to be made by year-end about what to do with the Registered Retirement Savings Plan. Once you turn 72 you are not permitted to have an RRSP. It must be converted into one of three vehicles: Cash, a Registered Retirement Income Fund, or an Annuity. And it’s not an easy decision to make.

Let’s start by reviewing the Cash option. Any time you withdraw funds from your RRSP – no matter what age you are – it will be considered taxable income, taxed at your highest marginal rate for that calendar year. If you withdraw ALL of your RRSP balance at age 71, it will ALL be taxed as income, and this could eliminate about half of it when your tax bill comes due. If you like to defer your taxes as long as possible, the Cash Out option is not a very good one. There are better options that could spread the tax bill over the rest of your life.

The RRIF is the most popular choice. It is available as a means to move the RRSP over to another registered (tax-deferred) plan. In the calendar year in which you turn 72 you must start to withdraw a minimum amount as taxable income each year (as a percentage of the January 1 balance). The percentage of the balance you must withdraw starts at 7.38% (for a 72-year old) and increases from there until you are forced to withdraw 20% at age 94. A little known fact is that you can use your younger spouse’s age to determine this minimum withdrawal rate, which can be a real plus if your spouse is several years younger than you are.

Unlike the other two options, the RRIF permits you to hold the same investments as the RRSP. So, if you have stocks, index funds, mutual funds or GICs in your RRSP, you can transfer them all over ‘in kind’ to the RRIF without cashing them out and continue to hold them in the RRIF. Many Canadians slowly sell-off their investments as they age in order to convert what might be an aggressive portfolio to a more conservative portfolio – according to their risk profiles and timelines.

A couple of other points about the RRIF:

a) While there is a required minimum withdrawal percentage, there is no maximum withdrawal percentage unless the plan is officially ‘locked-in’ because proceeds came from a prior pension plan. This means you could effectively run out of money fairly quickly if, for instance you decided to withdraw 25% of your RRIF balance in the first few years of retirement.

b) Just because you must withdraw a certain minimum percentage of your RRIF as income each year does not mean you have to spend it! In fact, you don’t even need to sell the stocks, index funds, mutual funds or GICs held in your RRIF – you just need to ‘recognize the appropriate amount as taxable income and withdraw it from your RRIF’. This means you could transfer it ‘in kind’ to a non-registered plan and never actually dispose of the investments held. This is an important point for those with significant assets and/or pensions in retirement, or for those who don’t want to cash out a sound investment at a bad time.

The estate planning benefits of the RRIF may also be preferred compared to the other options. With a RRIF, the balance will automatically pass to your surviving spouse with no tax hit. Upon the second spouse passing (unless there are minors or children with disabilities in the family), all of the RRIF will be considered taxable income and taxed at the deceased’s marginal rate on the final tax return. This means a significant amount of wealth can be passed on to the next generation (albeit after taxes are accounted for), and this is an important consideration for many Canadians.

Next time I will describe the third option, the Annuity. While many frown upon the Annuity because, with a standard Annuity, nothing is left when you pass away, more and more experts are recommending this as a prudent choice for a growing number of seniors. It’s important to weigh the pros and cons of each choice, and to seek the counsel of an unbiased professional when the time comes.

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