What you need to know about RRIFs

Most Canadians know the ins and outs of a Registered Retirement Savings Plan (RRSP), but fewer can tell you what happens to an RRSP when you turn 71.

That’s because most of us are more interested in what the government gives us in the spring in the form of a tax refund for an RRSP contribution. That’s an easier focus than what it’s going to take away decades later in taxes.

But all good things come to an end and the tax avoided in an RRSP starts coming due a few years into retirement when you are forced to cash in it in.

What is a RRIF?

By the end of the year in which you turn 71, you must convert your RRSP into a Registered Retirement Income Fund (RRIF), a vehicle that allows Ottawa to get those tax refunds back. Unlike an RRSP which is a savings plan, a RRIF is an income plan. It is a structured way to cash out your RRSP.  It is the most popular and simple way Canadians turn their RRSPs into income streams.

How does a RRIF work?

In March, 2020 Finance Minister Bill Morneau said the federal government would reduce the minimum withdrawal rate for registered retirement income funds (RRIFs) by 25% for the year. The measure was part of the government’s COVID-19 relief package.

For example, if you were 71 as of Jan. 1, 2020, you would only need to withdraw 3.96 per cent of the opening balance, rather than 5.28 per cent, the normal rate. The lower minimum withdrawal also applies to Life Income Funds (LIFs) and other locked-in RRIFs. If the amount withdrawn was more than the temporarily-lowered minimum amount in 2020, unfortunately, you can’t recontribute any excess back to your RRIF.

The minimum withdrawals  for RRIFs were relaxed in the 2015 federal budget. The changes recognized that we’re living longer and rates of return on investments are much lower than they were. You want to have enough money to live on, but not to outlive your savings. The changes reduced the required amount of withdrawals each year.

Although the required withdrawal amounts changed, the basic rules stayed the same. You can take the money out of your RRSP as a lump sum, you can keep the same investments and sell them bit by bit, or you can convert your RRSP into an annuity that pays a monthly amount for life. Each has a tax liability.

If you choose the second or third option, there are strict requirements about how much you have to take out of your RRIF each year.

Suppose a retiree has converted his or her RRSP to a RRIF and is 71 this year. The minimum withdrawal in 2020 is 3.96% for this year only.  (You can always withdraw more, but not less.) If you have $100,000 in the RRSP, in the first year $3,960 comes out, leaving a balance of $96,040 at the end of the year.

In Year 2, the withdrawal rate goes up to 5.40% of the balance, so $5,186 comes out, leaving  balance of $90,854. And so on.

What can I hold in a RRIF?

There are no restrictions on the type of investment you can hold in a RRIF. You can keep the RRSP holdings as is and sell the appropriate amounts. You can hold any combination of stocks, bonds, GICs, mutual funds or Exchange Traded Funds (ETFs).

But as  interest rates fall, retirees are looking for ways to improve their  income streams. A decade ago if you had $1 million and put it into GICs, you might have seen a 4% to 5% yield, or $40,000 to $50,000 a year. GICs are currently yielding about 1.3%  or $13,000, so the income has declined considerably.

The question is how to find the right mix for their circumstances.  For many that involves a combination of fixed income investments and some high quality, dividend paying stocks.  Stocks adds some risk, but the alternative is the risk of not meeting your needs for cash flow. As always, there is no one size that fits all and it is something to discuss with an advisor.

Here are some RRIF resources:

Getsmarteraboutmoney.ca: A site sponsored by the Ontario Securities Commission
Reirehappy.ca –  A primer by long time financial blogger Jim Yih.
7 myths about RRSPs  – An article from my Toronto Star days