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How to convert your retirement accounts to a RRIF or LIF
As you approach retirement, you’re likely thinking about what steps you can take to help turn years of savings into a reliable income stream. You may need to start withdrawing funds soon, but how do you get started?
Like many Canadians, you may be relying on funds from more than one account to provide you with income when you retire. You could have savings built up in a workplace pension, a Registered Retirement Savings Plan (RRSP), a Locked-in Retirement Account (LIRA) or a mix of all the above.
As you get closer to retirement, you need to consider your game plan for your savings and how you can start using them to fund your retirement years. You may consider transferring the money you’ve stashed away in your retirement accounts to a registered income savings vehicle, such as a Registered Retirement Income Fund (RRIF) or a Life Income Fund (LIF).
Here’s a look at how to convert your retirement accounts, and a breakdown of the potential tax implications.
The registered account rundown: What’s the difference between an RRSP, a spousal RRSP and a LIRA?
Three registered savings accounts that must be converted before the end of the year you turn 71 years old include RRSPs, spousal RRSPs and LIRAs. (There are other locked in accounts that you need to convert, but LIRAs are the most common). Each of these accounts has its own rules and transfer options, so it’s important to know the differences and what your choices are.
Registered Retirement Savings Plan (RRSP)
An RRSP is intended to be a long-term investment account that you can use to save for retirement. Contributing to an RRSP can reduce your taxable income, and the earnings and growth in the account are sheltered from tax until withdrawn. You can make withdrawals from your RRSP before retirement, but this will be included in your taxable income and will reduce your total contribution room – with some exceptions, such as the Home Buyers’ Plan (HBP) or the Lifelong Learning Plan (LLP).
Spousal RRSP
A spousal RRSP helps couples with different income levels save for retirement, while also lowering their overall household tax bill. The advantage of the spousal RRSP is that it allows the higher-income partner to contribute to the lower-earning partner’s spousal RRSP, and to claim the tax deduction on the contributing partner’s tax return. A spouse can contribute to both an individual RRSP and a spousal RRSP, so long as the total contributions don’t exceed the contributing partner’s total available contribution room.
As with an individual RRSP, you can withdraw funds from the account before you retire, but only the annuitant – the owner of the RRSP – can make these transactions. Additionally, withdrawals are taxed as income in the hands of the annuitant, but because they are the lower-income partner, they will likely pay tax at a lower marginal tax rate. Keep in mind there are attribution rules for withdrawals that may impact your tax bill if you are a contributing spouse.
Locked-in Retirement Account (LIRA)
A LIRA is a retirement account that holds funds transferred from a pension plan sponsored by a former employer. As with an RRSP, investments in a LIRA grow tax-deferred until withdrawn. However, you can’t make additional contributions to your LIRA, as you can with an RRSP. Additionally, the funds are “locked in,” meaning you can’t make withdrawals until you meet specific conditions allowing them to be unlocked, such as age, financial hardship or critical illness.
Deciding when to convert retirement accounts
The most common retirement income vehicles are the Registered Retirement Income Fund (RRIF) and the Life Income Fund (LIF), which are designed to help provide you with a steady stream of retirement income.
Before you convert your retirement accounts, there are a few questions you need to consider. When do you need the money? What strategy offers the best tax advantages? What potential income sources will you have in the future?
While it’s always a good idea to plan for your retirement ahead of time, you’re required to transfer your funds from your RRSP or LIRA by December 31 of the year you turn 71. This will avoid the account being automatically liquidated by the Canadian Revenue Agency (CRA) and the entire balance being added to your taxable income for that year.
Converting an RRSP to a RRIF
With your RRSP, converting the account to a RRIF is often the preferred option. The benefit of a RRIF is that you can keep your money invested and sheltered from tax until you take it out. That means your savings have the potential to continue growing throughout retirement. The only catch is that you must make minimum withdrawals each year, beginning the year after you convert the account. The amount you’re required to take out is calculated as a percentage of your plan’s total value at the end of the preceding year and is also based on your age. For example, the annual withdrawal percentage at age 55 is 2.86%, while the minimum withdrawal amount at age 72 is 5.40%.
Timing the conversion matters. The longer you wait to convert your account, the larger your mandatory withdrawals will be. It’s important to weigh the impact of larger withdrawals, as that could affect income-tested benefits, such as Old Age Security (OAS), which may be reduced if your income exceeds certain thresholds.
Converting a spousal RRSP to a spousal RRIF
Like an individual RRSP, a spousal RRSP must also be converted to a RRIF, specifically a spousal RRIF. Minimum annual withdrawals apply, as with individual RRIFs. The main benefit of a spousal RRIF is that when the account holder (the lower-income partner) withdraws funds from the spousal RRIF, the income is attributed to the account holder, not the higher-income partner. This helps lower the overall household tax bill. Be mindful of the rules with a spousal RRIF. For instance, let’s say you’re the account holder and you withdraw the minimum annual amount. This income is reported on your tax return. But if you take out more than the minimum and your spouse contributed to the plan in the last three years, that additional withdrawal will be attributed and taxed to your spouse instead.
Converting a LIRA to a LIF
Upon retirement, your LIRA is typically converted to a LIF to provide you with retirement income. In a LIF, your money continues to grow in retirement and is sheltered from tax until it’s withdrawn. However, unlike a RRIF, there are annual maximum withdrawal limits that are set by provincial regulations. The maximum amount is determined by your age and the balance within the account. There are certain unlocking provisions depending on the province you live in.
The bottom line
Whether you’re approaching 71 this year or just exploring your options for down the road, it’s important to be prepared ahead of the December 31 deadline. Knowing how to transfer your retirement funds, and to what type of account, is a critical first step in the process.
When you’re ready to convert your accounts, your financial advisor can help you navigate the process, so you can enjoy a smooth transition into the next chapter in your life.
