Nov. 20, 2020
If the requirement to withdraw an annual minimum amount from your Registered Retirement Income Fund (RRIF) was eliminated, it would cost the government approximately $1 billion dollars annually, according to a cost estimate released this week by the Office of the Parliamentary Budget Officer. The estimate was done at the request of Conservative MP Kelly McCauley (Edmonton South) and is based on the assumption that RRIF holders would withdraw less, thereby reducing government revenues since RRIF withdrawals are considered taxable income.
While it’s unlikely the current government will eliminate the RRIF minimum withdrawal requirement completely, it did lower the amount that needs to be withdrawn for 2020 by 25 per cent. Let’s review the RRIF rules, how withdrawals work and give some tips for those RRSP holders who turned 71 in 2020 and need to act by Dec. 31 if they want to convert their RRSP to a RRIF.
What is a RRIF?
If you have an RRSP and you turned 71 in the year, you effectively have three choices. The first is to simply cash in your RRSP and include the entire fair market value of the plan in your income. This rarely makes sense, unless the amount in your RRSP is relatively small and your tax rate is zero (or close to zero) in the year of collapse. (You could always put the funds back into a TFSA.) The second option is buy a registered annuity from a life insurance company, which can provide a steady, guaranteed flow of retirement income. The third, and, by far the most popular option, is to convert your RRSP to a RRIF.
With a RRIF, you can keep the same investments as an RRSP and enjoy continued tax deferral on the funds, with the exception that you must withdraw at least a required minimum amount annually, starting in the year after you set it up. The required minimum amount is based on a percentage factor, often referred to as the “RRIF factor,” multiplied by the fair market value of your RRIF assets on Jan. 1 each year. For example, if you have $100,000 in your RRIF and you were 71 at the beginning of the year (i.e. Jan. 1), normally you must withdraw 5.28 per cent or $5,280 in the year. The RRIF factor increases each year until age 95, when the percentage is capped at 20 per cent.
As stated above, for 2020, the government passed legislation as part of its COVID-19 response plan that decreased the required minimum withdrawals from RRIFs by 25 per cent. 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 lower minimum withdrawal factors also apply to Life Income Funds (LIFs) and other locked-in RRIFs. If you have already withdrawn more than the temporarily-lowered minimum amount in 2020, unfortunately, you can’t recontribute any excess back to your RRIF.
For those who regularly take out their RRIF minimums in December, now is a good time to double-check with your RRIF provider if you want to take advantage of the lower withdrawal amount for 2020. Note that this lowered RRIF minimum only applies for this year, so the regular RRIF withdrawal factors will apply again starting in 2021.
Of course, you always have the option to withdraw unlimited amounts from your RRIF, unless it is a locked-in plan that was created by a transfer of funds from a registered pension plan. Locked-in retirement funds include a life income fund (LIF), locked-in retirement income fund (LRIF), and a prescribed RIF (PRIF). The maximum amount that you can withdraw from a locked-in fund depends on the specific legislation, but, should you meet the specific conditions under the applicable pension legislation, you may be eligible to withdraw additional funds from a locked-in plan in cases of shortened life expectancy, financial hardship, or where there is a small plan balance.
Converting to a RRIF
If you’re planning to convert your RRSP to a RRIF by the end of 2020 and you have unused RRSP contribution room carried forward from prior years, you only have until Dec. 31 to make a final RRSP contribution before converting to a RRIF — you don’t get the normal sixty days after year-end (i.e. March 1) this time around.
If you’re at your RRSP maximum contribution limit, but you have “earned income” in 2020, perhaps from a part-time job or rental income, that will generate RRSP contribution room for 2021, you may wish to consider making a one-time, deliberate overcontribution to your RRSP in December before conversion. While you will pay a penalty tax of one per cent on the overcontribution (above the $2,000 permitted overcontribution limit) for December 2020, new RRSP room will open up on Jan. 1, 2021 so the penalty tax will cease in January 2021. You can then choose to deduct the overcontributed amount on your 2021 (or a future year’s) return. Note that this may not be necessary if you have a younger spouse or partner, since you can still use your contribution room after 2020 to make contributions to a spousal RRSP until the end of the year your spouse or partner turns 71.
And, while we’re on the topic of a younger spouse/partner, if you’re married or living common-law and you do have a younger spouse or partner, consider using the younger spouse’s/partner’s age to calculate the minimum RRIF payment when establishing your RRIF. This allows you to take the lowest possible minimum payment from your RRIF on an annual basis.
Finally, if you have multiple RRSPs, consider consolidating them all into one RRIF to simplify management of your retirement income and have only one minimum amount to calculate and track each year.
Pension credit and pension splitting
One of the advantages of converting an RRSP to a RRIF is that, once you are at least 65, RRIF withdrawals qualify for the 15 per cent federal non-refundable pension income credit on the first $2,000 and also qualify for a provincial/territorial credit. In addition, if you’re over 65, you can split up to 50 per cent of your RRIF income with your spouse/partner. Doing this could lower your household’s overall tax bill, potentially preserve tax credits such as the income-tested age credit, and avoid the potential OAS recovery tax. It may also permit you to double up on the pension income credit, if your spouse/partner doesn’t have their own pension income.
Jamie Golombek, CPA, CA, CFP, CLU, TEP is the Managing Director, Tax & Estate Planning with CIBC Private Wealth Management in Toronto.