The registered retirement income fund (RRIF) and annuity are two of the most popular vehicles that seniors use to generate retirement income from their registered investment accounts.
At age 71, the government requires that you close your registered retirement savings plan (RRSP) and do one or a combination of three things with it:
- De-register the RRSP and cash out your money. When you choose this option, you must include the amount cashed out in your income for the year and pay the associated taxes.
- Convert your RRSP to an RRIF and start withdrawing at least the mandatory minimum amount every year.
- Convert your RRSP to an annuity that pays you a regular income for life or for a specified period.
To determine which of these options works best for you, you will need to weigh several factors. Before we look at these factors, let’s look at RRIFs and annuities in more detail.
What is an RRIF?
An RRIF is a registered account used to generate regular income in retirement.
While you can convert your RRSP to an RRIF any time, by December 31st of the year you turn 71, you must have made the transition into an RRIF, an annuity, cash, or any combination of the three.
The RRIF is similar to the RRSP in that you can generally invest in the same type of assets, and your account enjoys tax-free growth until withdrawal.
Differences between an RRIF and an RRSP include:
1. You must withdraw a minimum amount from your RRIF every year. This amount is based on the market value of your RRIF account, and a prescribed percentage that is set by the government based on your age (or that of your spouse, depending on which of you is the younger). There is no maximum withdrawal.
The current minimum withdrawal rate is as follows:
|Age||RRIF factors (2015+)||Age||RRIF factors (2015+)|
|Under 71||1/(90 – age)||83||7.71%|
When you make a withdrawal from your RRIF, you are required to include the amount in your income for the year and pay tax on it.
Withdrawals exceeding the minimum are subject to a withholding tax that your financial institution will deduct, using the following rates:
|Excess RRIF||Withholding Tax (non-Quebec resident)||Withholding Tax (Quebec resident)*|
|Up to $5,000||10%||21%|
|$5,000 to $15,000||20%||26%|
What is an Annuity?
An annuity is one of the options retirees have for creating a pension-like regular income in retirement.
Annuities are provided by insurance companies, which pay you a guaranteed amount of money for life (life annuity) or for an agreed-upon length of time (term-certain annuities).
You need to complete Canada Revenue Agency Form T2033 to purchase an annuity, and you can choose to convert all or part of your RRSP.
Annuity payouts are made either monthly, quarterly, semi-annually, or annually. The amount of money you receive is based on your age at the time of purchase, the size of your premium, your health status, interest rates, and any additional features you choose.
You can purchase an annuity with money from any source.
If you buy an annuity with money from an RRSP or an RRIF, it is considered a registered annuity. If you buy the annuity using funds outside of a registered account, it is referred to as a non-registered annuity.
Income from a registered annuity is fully taxed in the year you receive it. Whereas, only the interest portion of payments from a non-registered annuity is taxable.
The two main types of annuities are:
Life annuity: This will pay you a guaranteed amount for life, with payments stopping when you die.
Term-certain annuity: This pays you a guaranteed income for a specific period of time, such as 20 years. If you die before the end of your term, payments continue to your beneficiary or estate. At the end of the term, your payments stop, even if you are still alive. Term certain annuities bought with registered funds must extend till age 90.
Your annuity payments are determined and locked in upfront at the time of purchase and no changes are allowed afterward. When you buy a life annuity, there are certain options (add-ons) you can choose based on your needs. They include:
A. Joint life: You can buy a joint-life annuity for a couple so that if one of you dies, the other continues to receive payments until he or she also dies.
B. Guarantee period: A guarantee period can be added to a life annuity to ensure that if the annuitant dies before a certain number of years (e.g., 20 years), the beneficiary (spouse) will receive payments for the rest of the guarantee period. If the beneficiary is someone other than the spouse, they are entitled to a commuted lump-sum value. If the guarantee period ends and the annuitant is still alive, annuity payments continue to them, however, they will stop when the annuitant dies and nothing goes to the estate or beneficiary.
C. Inflation indexing: Annuity payments can be indexed to rise with inflation or a fixed percentage in order to protect against the loss of purchasing power.
RRIF or Annuity: Which One Should You Choose?
Deciding between an RRIF and an annuity for your source of regular income in retirement is not an all-or-nothing situation. You can choose to do one or both to meet your income needs. That said, there are some scenarios where you may prefer an annuity over an RRIF, and vice-versa.
Why you may choose an RRIF over an Annuity
1. Greater flexibility
An RRIF provides more flexibility for drawing down your money:
- Withdrawal amount: While you must withdraw a minimum percentage every year from your RRIF, there is no maximum limit. That means you can take the minimum amount in some years, and more in others, based on your changing needs and to minimize the tax you pay. This ability to vary your income can also help you avoid a clawback of guaranteed income supplement payments, which decrease as your income increases. With an annuity, your income is fixed.
- Age: If you’re married, you can choose to base your withdrawal rate on the age of the younger spouse, thus creating an opportunity to further lower your mandated withdrawal amount and make your money last longer.
- Buy an annuity: You can always decide to use some or all of your RRIF assets to purchase an annuity later.
2. More control of investment plus tax-free growth
An RRIF gives you control over the assets you invest in, and you get to decide how much risk you would like to take on.
For example, you can determine what percentage of your assets goes to equities and what to bonds. Any growth in your account is also protected from taxes until you make a withdrawal.
With an annuity, you have no say in what the insurance company does with your premium.
3. More estate-planning options
You can leave your remaining RRIF assets to your spouse or common-law partner, who can simply roll over the assets to his or her own RRIF without incurring immediate taxation.
If designated a “successor annuitant,” your spouse can simply continue to receive your payments. The assets can be rolled over to the registered disability savings plan (RDSP) of a disabled child or grandchild who is financially dependent on you.
Leftover RRIF funds can be used to purchase an annuity for young children who are financially dependent on you and who are not disabled. This type of annuity pays them periodically until they turn 18.
Any taxes due on the annuity payments are paid by the child who is likely going to be in a much lower tax bracket. If the child is an adult, not disabled, but is financially dependent, they can receive the RRIF assets in cash and it is fully taxed at their marginal tax rate.
Alternatively, the funds can go directly to your estate.
With annuities, options for estate planning are limited and the few available features may lower your monthly income payouts.
4. More flexibility in a low interest-rate environment
Annuities are not very attractive when interest rates are low because the payouts are lower. Once the periodic payouts are determined at purchase, they can’t be altered, even if interest rates rise significantly later.
On the other hand, you have a choice about how to invest your RRIF funds. You can choose assets that provide greater returns based on current market conditions.
5. You have a short life expectancy
If your health is bad and you expect to have a shorter-than-average life, an RRIF may be better. You can choose to withdraw more than the minimum and you can easily leave any remaining balance to your spouse or estate.
With a life annuity, you will need to have the right policy to maximize your payouts, for example by purchasing what’s called an “impaired” annuity.
If you have proof that your health is poor and your life expectancy is expected to be significantly shorter, an impaired annuity can pay you higher annuity payments.
Why you may choose an Annuity over an RRIF
1. Peace of mind
An annuity guarantees the income you receive and is insurance against volatile markets, which can significantly affect your RRIF investment. If you choose a life annuity, it means you will receive a specified income for life, regardless of whether the financial markets experience a boom or bust.
If you have a low tolerance for risk, you may prefer the security that annuities provide.
2. You have limited sources of guaranteed income
When your sources of retirement income are diverse and you already have a source of guaranteed income (such as from a defined-benefit pension), the need for security in the form of an annuity diminishes.
However, if you have limited income sources in retirement, you may want to protect yourself from outliving your money by annuitizing your RRSP to create a stream of guaranteed income.
3. You can use any funds
The money you can invest in your RRIF is limited to what you have in registered accounts such as an RRSP. But you can use funds from any source – even an inheritance or other windfalls – to purchase an annuity. You do not need to have contributed to an RRSP to buy an annuity.
4. It’s simple
An annuity is simple to set up and you receive the same amount, month after month. It also removes the need for you to make investment management decisions or to follow the financial markets.
Both RRIF and annuities allow income-splitting between couples to minimize the family’s overall tax burden. You can always put excess funds taken from either plan into a TFSA if you have contribution room, so your money can continue to grow tax-free.
The withdrawn money could also be contributed to a spouse’s (spousal) RRSP if the spouse is not yet 71. Finally, you can claim payments from both sources as eligible pension income to take advantage of the $2,000 pension income tax credit.
When planning your retirement, you should be looking at the pros and cons of converting your RRSP to an RRIF, an annuity, or both. Since these options are not mutually exclusive, a balanced approach that combines them works for most people.
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