You know that saving for retirement is an important part of securing your financial future. Hopefully, you've been using tax advantaged accounts to help you build your retirement savings over time.
If you’ve been saving part of your income in your RRSP, by the time you retire you’ll likely have a comfortable nest egg. While there are tips to reduce your taxes when withdrawing your income, there is something else you’ll want to plan ahead for: converting an RRSP to RRIF.
What is a Registered Retirement Income Fund?
While you might like to keep your RRSP forever, the reality is that you can't. You must close out your RRSP by the end of the year of your 71st birthday. You have to convert that money into another form, such as a life annuity or the RRIF.
The Registered Retirement Income Fund, like the RRSP, in not an investment in itself but simply a tax shelter plan that you can benefit from in your retirement. Plus, unlike a life annuity, which someone else has control over in terms of investments, you direct your RRIF. This element of control is one of the reasons that the RRIF is one of the preferred methods of RRSP conversion.
However, there are some drawbacks to the RRIF. Unlike an RRSP, you cannot make new contributions to an RRIF. There is also a minimum amount that must be withdrawn from your RRIF each year. You have to withdraw some of the money each year.
This minimum withdrawal amount is calculated as a percentage of your plan’s total value at the beginning of the year. The percentage is based on age, from as low as 4.76% at 69 years old to as much as 20% at age 90. Keep in mind that though the percentage increases each year, and depending on the return of your investments, the total value of your RRIF may have decreased as you draw down from the plan. These factors may even out the actual dollar value of your yearly minimum withdrawal over time.
Realize that your RRIF withdrawal is still considered taxable income. This means that you will pay taxes on your withdrawal, even though it's mandatory, at your marginal rate. The good news is that the mandatory minimum withdrawal does not incur any withholding tax at the time it is withdrawn. This will allow you to benefit from the entire amount until tax time, at which point you may owe less than most withholding tax brackets, depending on your tax situation. If you plan to withdraw more than the minimum, taxes will be withheld on that additional amount, though.
What if you don't need the entire minimum amount you are required to withdraw? While you can’t avoid withdrawing it as income, you could move as much of the unneeded money as possible into your TFSA, up to your contribution limit. The TFSA may become a major part of retirement planning since there is no maximum age limit, and since the earnings grown tax-free. Consult a retirement planning expert to get an idea of how you can use your TFSA with your RRIF.
Another tax planning move you can make is to create a small RRIF account at age 65. When you do this, it's possible to make annual withdrawals of $2,000 and qualify for the pension credit earlier. You can keep making contributions to your RRSP, if you still have it, and you can move money from your RRSP to your RRIF as it suits you as long as you have your RRSP.
With a little planning, you can reduce the tax impact over the years, and make the best of your situation.