What to consider when converting your RSP

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Scott Boyd

July 08, 2019

Saving strategies

If you currently have an RSP, you probably already know that when you turn 71, you can no longer make contributions to your RSP. In fact, by December 31 of the year you turn 71, you must actually convert the money in your RSP into some form of income.

Financial institutions are required to convert your RSP to a Retirement Income Fund (RIF) if you do not provide specific instructions prior to the deadline. However, it’s probably better for you to take action yourself so that you can go with the RSP conversion option that best suits your needs.

Options for converting your RSP

At this point, you may well be asking what options are available to your when it comes time to convert your RSP? Well, one option is to simply collapse the RSP and take immediate possession of the money in the account. Be aware, however, that you’ll be required to pay income tax on the entire amount of your RSP. Depending on where you live in Canada, and the value of your RSP, this could result in roughly half of the money in your RSP going to taxes.

Secondly, you can use the funds in your RSP to purchase an annuity. An annuity takes the form of a contract you set up with a life insurance company. In exchange for depositing your money, the company provides you with a guaranteed income, for a predetermined period of time.

The amount you’ll receive is based on several factors including the initial amount you deposit, interest rates, and how long you wish to receive income from the annuity. If you are entering into an annuity designed to pay you for the rest of your life, your current age and your expected remaining years are all used to determine your payout amount.

The primary drawback with annuities is that once in place, you cannot change the payout structure. While a guaranteed payment may be comforting for some retirees, you can not increase payment amounts later to address increases in inflation and the cost of living. Nor can you withdraw a lump sum of money in the event of an unexpected expense or other emergency.

The third option and by far the most popular with Canadians, is to convert your RSP to a RIF.

RSP? RIF? What’s the difference?

To put it simply, an RSP is for building your savings, while a RIF is used to generate income. A RIF offers several benefits thanks to the flexibility provided by the RIF structure. For example, one of the primary advantages of a RIF over an annuity is that with a RIF, you must withdraw a minimum amount from the RIF each year, but you can withdraw more than the minimum if necessary. This can provide a little extra security to help you deal with unexpected costs.

You can also invest the holdings in your RIF in mutual funds and other types of investments so that your savings can continue to earn for you. While held within the RIF, your earnings remain sheltered from taxes as you are only required to pay income taxes once you withdraw money from the RIF.

RIF Minimum Withdrawals

The minimum amount that you must withdraw from your RIF is mandated by the Canada Revenue Agency and is calculated as a percentage of the value of your RIF. The percentage is determined by your age – or your spouse’s age – and the percentage amount increases each year. You can find the current annual RIF minimum withdrawal percentages on the Oaken website.

Keep in mind also that all withdrawals from your RIF are taxable as income. For this reason, and especially if you have other sources of retirement income such as a company pension and even government pensions including the Canada Pension and Old Age Supplement, you should speak with a tax planning specialist to help you minimize your tax obligations.

If you’re in a position where you don’t require all of your mandated RIF withdrawals each year, don’t forget that you can put surplus funds in a Tax-Free Savings Account (TFSA). This way, you can continue to earn interest on these extra funds tax-free.

It’s also worth noting that depending on your age and other retirement income sources, you might also be eligible for the Pension Income Tax Credit. This provision allows you to withdraw $2,000 per year of income from your RIF with no taxes deducted.

Converting to a RIF before you turn 71

While you are required to convert an RSP to a RIF or other form of income option when you turn 71, you don’t have to wait until you reach 71 before converting your RSP. If you wish to retire early, for instance, you can convert your RSP to a RIF at any time.

In fact, if you do move your RSP to a RIF before you turn 71 and later determine that you don’t actually need the money, you can convert your RIF back to an RSP. For example, if you retire and then decide to go back to work, it might make sense from a taxation point of view, to stop taking the forced RIF withdrawals and allow your savings to continue to grow tax-free inside an RSP. Be sure to speak with a tax-planning specialist if you have questions on any of these matters.