The most effective way to generate retirement income from your RRSP depends on when you retire, the value of your RRSP and the amount of any other retirement income you receive.
It’s a good idea to estimate how much you will have in your RRSP well before you retire. Then you can calculate how much income your RRSP can produce based on various conversion options.
RRSPs defer income tax from your peak earning years to your retirement when your income and tax liabilities are lower. Once you have set up your RRSP, you have to identify the combination of options available to you that provide the income you want, while keeping your taxes low.
For example, you can generate income from your RRSP by setting up a registered retirement income fund or RRIF, purchasing an annuity, or withdrawing cash. In each case, the amount of income you receive is taxable.
While you can start converting an RRSP and withdrawing funds at any time, you must have completed the conversion by the end of the year in which you turn age 71.
How RRIFs Work
An RRIF can hold many of the same investments as an RRSP, but you cannot make deposits. Instead, you specify a minimum rate of withdrawal that provides a steady retirement income. You can choose an investment plan or hold your investments directly in the RRIF.
While less flexible than an RRSP, an RRIF still allows you to purchase an annuity from the balance in the account at any time.
Jeffrey Quenneville, a financial advisor with Raymond James, says that RRIFs are the most common option for RRSP conversions. “The investment vehicle of choice inside a RRIF in this low interest rate environment is currently a Guaranteed Minimum Withdrawal Benefit plan offered by insurance companies.
These products offer guaranteed income for life, growth potential to help keep up with inflation, control over how the assets are invested and a predictable, sustainable and potentially increasing income stream,” he says.
You can choose other plans, but you must withdraw a minimum amount each year.
Once you purchase an annuity with part of your RRSP, you have made a final decision on how to structure that portion of your retirement income.
Annuities provide a guaranteed income for life, no matter how long you might live. If you worry about running out of money in your retirement, you should consider using some of your retirement funds for an annuity that delivers a minimum income. You can purchase annuities with fixed terms, but they lack the guarantee of a lifetime income.
In the present low-interest-rate environment, annuities are comparatively expensive and deliver low payouts, but they are a secure instrument that requires no management.
Withdrawing Cash From RRSPs
Although you place money into an RRSP to reduce your taxes, and withdrawing it early seems to contradict that goal, there are circumstances when early withdrawals make sense.
For example, someone who has lost a job a few years before receiving a full pension may benefit from withdrawing some money from an RRSP rather than applying for an early pension or using up other savings.
Even if you take early retirement voluntarily, you may have some low-income years before a full pension kicks in. RRSP withdrawals can bridge these kinds of gaps and still keep total taxes paid at a low level.
The RRSP Balancing Act
When you develop your RRSP conversion strategy, it’s a good idea to balance the three kinds of income that RRSPs can generate and consider them during the period before and after age 65.
You may benefit from the retirement income tax credit and receive full pensions and social security after age 65, but there is no difference in tax treatment for cash withdrawals.
Your income from employment or a business also can play a major role in your tax liabilities. Examining different scenarios can help you decide on the best way to meet your retirement goals, while paying as little tax as possible.
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