By Rob Cosman, Partner, Jones & Cosman Chartered Professional Accountants
By the last day of the year you turn 71, you must close your Registered Retirement Savings Plan and choose one of three options. You can cash out the account and pay income tax on the whole amount, or convert the investment to an annuity or a Registered Retirement Income Fund. The latter two options safeguard your investment from taxation until you receive distributions, but there are key differences between these two options, and you should consider them carefully before moving forward.
RRIFs Compared to Annuities
An RRIF is a collection of investments such as stocks or bonds. In contrast, an annuity is essentially an insurance policy that provides you with a set amount of money annually or monthly. For example, if you have $100,000 in an RRIF, that money is invested in stocks or bonds, and the value of your RRIF increases or falls as the value of the investments changes. However, if you buy an annuity worth $100,000, you receive a set amount of money each year or month, and that amount does not change. Typically, the amount you receive is based on your age when you purchase the annuity.
For example, as of 2014, an annuity purchased by a 65-year-old man is likely to pay out $600 a month for the remainder of his life. In most cases, the older you are, the higher the payments are likely to be. Additionally, women tend to receive lower annuity payments than men of the same age due to their comparatively longer life span.
Types of Annuities
The annuity described above is a single life annuity, meaning it pays benefits for a single person until his death. However, there are also other types of annuities. For example, joint and survivor annuities are designed for married couples, and these annuities pay out monthly payments until both partners die. In most cases, the amount of the monthly payment is reduced after the death of the first spouse. In some cases, you may also purchase this type of annuity with another person who is not necessarily your spouse.
There are a range of different features offered by various annuities. For example, some annuities guarantee to at least pay out the total amount of the principal balance. With this feature, if you bought an annuity worth $100,000 but have only received $50,000 in payments by the time of your death, your heirs would inherit the remaining balance of the annuity’s principal. Typically, the more features you choose, the more expensive the annuity.
Types of RRIFs
The two main types of RRIFs are self-directed and fully managed. If you want an advisor deciding how to allocate your investments, you may want a fully managed account. However, if you like picking and choosing investments, you may decide to opt for a self-directed account. Aside from these two options, you may want to consider the fees or penalties charged by the financial institution managing the account, as well as any extra costs or perks offered by the fund.
Comparing RRIFs and Annuities
Because RRIFs and annuities work with money in different ways, it can be hard to compare them, as you are not comparing apples with apples. However, as a baseline comparison, you may want to look at the monthly payment you would receive with an annuity and then calculate if an RRIF could yield the same or a larger monthly payment. However, when thinking about the monthly payment your RRIF could yield, you need to take into account how much the stocks in the RRIF are likely to grow. To account for volatility, many financial analysts suggest using a 2% projected growth rate with an RRIF.
Tolerance for Risk
As you are probably well-aware, the money in an RRIF may grow by more than 2%, and in some cases, you may want to hang onto your RRIF just because of the potential for growth. Unfortunately, with stocks, you can make a lot of forecasts, but there are no earnings guarantees. Conversely, with an annuity, you are guaranteed to receive a certain amount every month, and there is little to no risk. Ultimately, you need to be realistic about your own tolerance for risk and determine what types of investments appeal to you the most.
Keep in mind, however, you don’t have to convert your entire RRSP to an RRIF or an annuity. Instead, if you like, you may take a more balanced approach by putting some of your RRSP funds into an RRIF and using the rest to purchase an annuity.
The Canada Revenue Agency treats payments from annuities and RRIFs the same. In both cases, you report the payments as income on line 115 of your income tax return. However, as of 2016, if you are over the age of 65, you may claim a pension income amount worth $2,000.
About Rob Cosman
Rob Cosman, is a Chartered Professional Accountant who runs his own accounting and tax practice with his wife in Toronto, Ontario. Beginning in 2000, Rob’s career spanned over Halifax, Cayman Islands and Toronto. Rob held senior industry positions including CFO roles in public and private industries ranging from telecommunications, retail sales, and consumer packaged goods.
Rob has over 10 years of tax experience and is the author of numerous articles. He has the ability to take complex tax situations, explain them in common sense terms and guide clients to make the best decisions based on their individual situations.