RRSP Withdrawal Options at Retirement

With February being the busiest month of RRSP season, I am often asked during annual reviews “what is the best way to get the money out of my RRSP?”

Canada Revenue Agency (CRA) allows RRSP holders to defer withdrawals until the end of the year they turn 71. At this point in time, the RRSP must be turned into a pension (either an Annuity or RRIF) or it will be redeemed in full on December 31st of that year.

There are only three methods of withdrawing funds from your RRSP:

#1 – Cash Withdrawals

CRA allows individuals to take lump sum cash withdrawals from their RRSP at any time. 100% of all withdrawals are fully taxable, and CRA demands the financial institution put a “Withholding Tax” on all such transactions. If the amount is $5,000 or less the Withholding Tax is 10% if less than $15,000 but greater than $5,000 it jumps to 20% and finally, all amounts over $15,000 have a flat 30% on the full withdrawal.

Advantage – you can time the cash withdrawal to coincide with a year when you are in a lower tax bracket because of unemployment, or taking a sabbatical, return to school, medical leave, etc.

Disadvantage – cash withdrawals are not eligible for the Pension Tax Credit which starts at age 65.

Note: If going this route, the entire account must be closed by the end of the year you turn 71, and large amounts over $15,000 may create an extra tax liability. Be aware that this could also affect your Guaranteed Income Supplement or OAS Clawback taxes for that specific year.

#2 – Purchase a Life Annuity

An Annuity is a financial product purchased from a Canadian Life Insurance company that pays a lifetime stream of income. The RRSP is converted into an annuity and the income received is a blend of capital and interest, which is paid for the life of the annuitant. Payments end upon death of the annuitant unless the annuity is purchased as “Joint Life” with a spouse or has a minimum payment period attached. Thus a 20 Year Guarantee associated with Life Annuity would guarantee that at least 20 years would be paid out of the annuity should the annuitant die before the end of the guarantee period.

Advantages – it is the only pension vehicle that guarantees a predictable & stable lifetime income.

Disadvantages – annuity rates are based on current interest rates and at present, we have the lowest prime interest rate in our lifetime. Annuities are difficult to “unwind”, thus if one is chosen, either they can not be reversed or they can only be canceled with large penalties.

#3 – Transfer into a Registered Retirement Income Fund (RRIF)

A RRIF is simply an extension of an RRSP and it is the vehicle that pays out a periodic stream of income. The minimum annual percentage that must be withdrawn each year is based on a CRA formula and increases as we age. Thus, a RRIF which must have a minimum withdrawl of 5.28% at age 71 will increase to 7.08% by age 81.

The RRIF is invested in the same manner as the RRSP and can be as conservative or aggressive as one wishes.

Advantages – With proper investment planning the returns earned can exceed what an annuity would have paid, thus preserving the account for later years.

You are allowed to take out more than the CRA Minimum, a big advantage over an annuity, where to do so would be impossible.

At death, the remainder of the unused balance is paid either to the spouse, children, or estate.

Disadvantages – With poor investment planning a RRIF can be depleted far too quickly with multiple negative annual returns.

Large, multiple early withdrawals can also deplete the RRIF; meaning the individual could outlive their money by their early 80’s.

Note: Funds that are transferred from a Registered Pension Plan are held in a Locked-in RRSP (LIRA) and can only be turned into an Annuity or Life Income Fund (LIF). LIFs have firm minimum & maximum withdrawal limits and are extremely inflexible when compared to a RRIF.

There is very little ability to withdraw lump sums from a LIRA or LIF unless the account is considered “Small Balance” or the individual has a reduced life expectancy.