Just when you think it’s time to take it easy, you turn 71 and then retirement really happens. That’s when investors must convert their Registered Retirement Savings Plan (RRSP) into cash, a life insurance annuity or roll the savings over into a Registered Retirement Income Fund (RRIF).
What’s it to be?
The recession and low interest rates have taken their toll on the newly retired and those soon to be retiring. Market volatility has greatly reduced the risk tolerance for many investors and lowered the value of their retirement savings and future income expectations. Under those circumstances, an annuity that can guarantee a fixed income for life starts looking good. An RRIF, on the other hand, is still an ongoing investment and subject to market forces — one more thing to worry about.
For most investors, cashing in an RRSP is not an option: about 50 per cent of the net value of the plan will disappear after income tax is paid. On a tax-deferred basis, investors can purchase an annuity that guarantees a fixed income for life or convert their RRSP into a RRIF and stay invested in the market. There is also a third possibility and that is, do both.
An RRSP/RRIF rollover keeps the investments intact after conversion and you can continue to manage the portfolio as before as a tax sheltered plan, only no new funds can be contributed. Funds are withdrawn and taxed as income each year based on a fixed percentage formula. It’s a rate that rises each year starting at about seven per cent of the RRIF’s value at age 71 and rising to 20 per cent for those in their 90s.
The ability to manage the RRIF and potentially grow its value over time is what makes it so attractive to many investors. It gives them a fighting chance against future inflation and rising interest rates that undermine the purchasing power of fixed income retirement plans. This makes an RRIF a much more “hands-on” retirement option and not for everyone as they enter their seventh decade.
The annuity option
The annuity option offers the purchaser a guaranteed fixed income free of investment uncertainty. Annuities using RRSP funds are bought from life insurance companies to provide a fixed annual income for life or a fixed term of years.
The income level depends on size of the contract purchased and a calculated rate of return determined by the insurance company based on prevailing interest rates at the time and their own actuarial assessment (sex, age and health) of the purchaser. That rate of return is locked in for the duration of the contract and is not renegotiable and the principal is non-refundable.
Annuities can be purchased that allow for spousal continuation, inflation indexing, and with a guaranteed number of payments so even if an annuitant dies, income will flow to a designated estate or beneficiary. All these features will affect the calculated rate of return payable by the insurance company and reduce the amount of income the annuity will be able to pay out.
The risk of an annuity is there’s no guarantee that your future costs and expenses will remain as fixed as the income you get from the annuity. Annuities can be attractive to investors who want to leave investment cares behind them. But even moderate inflation will seriously erode the purchase power over a 10-15 year time span.
Annuity or RRIF — Why not both?
There are risks in both types of retirement plans but the third option of a financial retirement plan that uses both an annuity and a RRIF might be worth considering. It would be a two-step process, which is converting totally to an RRIF at the age of 71 with the expectation that at some time in the near future, when the time seems right or insurance annuity rates seem especially attractive, that a portion of the fund’s assets can be used to purchase an annuity.
Age 71 brings with it the last and most important phase of your retirement planning. It’s worth a discussion with your financial advisor. They can explain the RRSP to RRIF conversion process and show you how you can customize your income strategies according to your personal needs and retirement goals.
Judy Poole is a financial advisor with Raymond James, and has spent the last 39 years involved in the financial industry. You can reach her at firstname.lastname@example.org. This article is provided as a general source of information and should not be considered personal investment advice. The views expressed are those of the author and not necessarily those of Raymond James Ltd. Securities offered through Raymond James Ltd., member – Canadian Investor Protection Fund. Financial planning and insurance offered through Raymond James Financial Planning Ltd., not a member – Canadian Investor Protection Fund.