Getting Money Out of RRSPs Everything you need to know about RRIFs

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1 Special Report Getting Money Out of RRSPs Everything you need to know about RRIFs By Jim Yih This special report is brought to you by What s inside? RRSP maturity options What is a RRIF? Taking Income from your RRIF Investing your RRIF The Retirement Risk Zone Taxation of RRIFs Important RRIF tips 1

2 Everything You Need To Know About RRIFs Copyright 2012 Jim Yih All rights reserved. Printed in Canada. No part of this work covered by copyrights herein may be reproduced or used in any form or by any means graphic, electronic or mechanical without the expressed prior written permission of the publisher. For information address: Think Box Consulting, Street, Edmonton, Alberta Canada. T6G 1W3 Care has been taken to trace ownership of copyright material contained in this text. The publisher will gladly receive any information that will enable any reference or credit line to be rectified in subsequent editions. This publication is specifically designed to provide accurate and authoritative information in regard to the subject material covered. It is sold with the understanding that the author, publisher, and Think Box Consulting Inc. are not engaged in rendering legal, accounting, investment planning or other professional advice. The reader should seek the services of a qualified professional for such advice. The author, publisher, and Think Box Consulting Inc. cannot be held responsible for any loss incurred as a result of specific investment planning decisions made by the reader. Printed in Canada 2

3 Professional Speaker About Jim A familiar face to many, Jim Yih is one of Canada s leading experts on wealth, retirement and money. Since 1990, Jim has dedicated his career to educating people in the area of retirement planning, personal finance, investing and wealth management. He has worked in the financial services industry in numerous roles as a manager, analyst, researcher, financial advisor, educator and consultant. Jim is a regular contributor for the media. When the media needs someone to comment on the world of personal finance, they can depend on Jim to provide some interesting sound bytes given his extensive resume in the financial industry. Jim has entertained, educated and inspired audiences all across the country. In every presentation, his goal is simple: To say something that makes people better, smarter, happier and wealthier. He believes that education can only exist if there is a connection between himself and his audience. He is passionate about combining stories, humor, creativity and inspiring messages to create the connection. Jim has worked with organizations like The Canadian Association of Financial Insurance Advisors (CAIFA), Million Dollar Round Table (MDRT), MAFAC, CLU/CHFC Chapters, Manulife Financial, Great- West Life, Sun Life, Fidelity Speakers Bureau, Public and Catholic School Boards, CIBC, Retirement Life Challenge, Indigo/Chapters Bookstores just to name a few. Syndicated Columnist Jim is an active writer with almost 1000 articles written through his nationally syndicated column. Jim s analysis and research has been used by The Globe and Mail, National Post, Edmonton Journal, Vancouver Sun, Victoria Times, Calgary Herald, Ottawa Citizen, Montreal Gazette, Yahoo.ca, Canadian Business Online, CHQT Radio, COOL 880 Radio, CTV News, Global TV, Help TV and Investopedia.com. Helping People Take Away The Stress Of Money Today, Jim devotes his career to developing ideas, tools and strategies to help corporations, organizations and people create more success, wealth and happiness through his company The Think Box. Although Jim s expertise is rooted in the wealth and financial industry, he firmly believes that money is not everything. To be happy, you need to find balance between life and wealth. You need to remove the clutter and stress to live happier. Jim devotes much of his career to helping others find wealth, happiness, simplicity and balance in life. 3

4 RRSP Maturity Options Today, most people will convert the RRSP into a RRIF, but this is not the only option you have available to you. In fact you, have three alternatives: 1. Cash in the RRSP. While this may be an option, it is not usually a good one. Cashing in the RRSP means that the full value of your RRSP is added to your income and taxed accordingly. Unless you have a very small RRSP, this can mean a significant part of your wealth will go to the government. 2. Registered Retirement Income Fund (RRIF). Most Canadians select RRIFs as their retirement income option because they offer lots of flexibility. 3. Life Annuity. Think about a pension plan and that will help you to understand what an annuity is. Just like a pension plan, an annuity is simply a tool that provides you with a fixed stream of income that is guaranteed for the rest of your life. Regardless of markets, interest rates, inflation or the economy, your income remains stable and fixed for your lifetime. You can select a Fixed Term Annuity where it does not pay you an income for a lifetime. Instead, you choose a fixed term like 5, 10, 20 years, etc. The only stipulation is the term cannot extend past the age of 90. When should you take money out of RRSPs? If you think about it, the whole point of RRSPs is to have money when you retire. Thus, RRSPs should be used when you need to supplement your lifestyle in retirement. RRSPs remain one of the best vehicles to save for retirement. That being said, many people contribute to RRSPs because of the tax benefits. That s precisely why they created RRSP season, which is the 60 days into the following year when most RRSP contributions are made so people can still get a tax deduction for the previous year. If tax is one of your key motivators, then remember the ideal way to use the RRSP is be in a higher marginal tax rate at the time of contribution than at the time of withdrawal. In retirement, you should take money out of the RRSP/RRIF if you need the money or if there is a tax benefit to withdraw the funds. For example, even if you did not need the money, would you take it out and pay 25% tax if you knew in the future, you would have to pay 32%? When phrased that way, most people would take the money out early. 4

5 How do you know which option is best for you? The easiest answer is good planning. Different people will have unique circumstances and needs. Remember that it is not an all or nothing situation where picking one of the options means you cannot choose other options. Sometimes a combination may be the ideal solution. Here are some important issues for consideration when comparing RRIFs to annuities: Flexibility of income or investment choice - If you are looking for flexibility to set up the income the way you want, with the option of making changes in the future, the RRIF winds hands down. Control - Some people want control, while other just want to be able to set something up and let it run on autopilot. Annuities have the distinct advantage of being easy to set up and understand. RRIFs require more decisions and more management. Estate preservation - Generally, the best alternative to provide an estate benefit is usually through the RRIF. You can provide an estate with life annuities if it is set up with proper guarantee periods, but these options can reduce your level of income. Spousal protection - Providing survivorship options for your spouse can be facilitated under any route you choose (RRIFs or annuities). However, in the case of annuities, you must make sure they are set up properly. Income At the end of the day, it is important to run the numbers to see how much income you will get from each vehicle. 5

6 What is a RRIF? I often describe a RRSP as a bucket of money. When you put money into that bucket, you get a tax deduction. When you take money out of the bucket, you pay tax. As long as the money stays in the bucket, there is no tax. With the money that is in the bucket, you can invest in lots of different things like GICs, mutual funds, stocks, etc. A RRIF is really that same bucket of money but with a different label on the bucket. Instead of a Savings Plan, the bucket becomes an income fund. In essence, the RRIF is a bucket of money with a hole in it. The hole represents the need to draw income. The RRIF is where the RRSP money goes when you need to take a regular income. How much income can you take from the RRIF? With the RRIF, you can take out as much as you want as long as you meet something called the minimum income requirement. There is no maximum, just a minimum. In other words, the hole in the bucket can be as big as you want but it must be at least a certain size. Up to age 71, the minimum income formula is: RRIF balance on December 31 of the previous year x 1 (90 Age) After age 71, the minimum income no longer follows this formula. Instead it follows a pre- determined rate as illustrated in the table to the left. As you can see, the older you get, the more income you will be required to take out in income. 6

7 RRIFs are Flexible It seems like decades ago when it came time to collapse their registered retirement savings plans that most investors opted for annuities. Now, the registered retirement income funds (RRIFs) are the vehicle of choice. The reason that RRIFs are so popular can be summarized in one simple word - flexibility. You can customize a RRIF to pretty much any of your personal income needs. You can choose the frequency of income from monthly to quarterly, to annual income. You can keep payments the same or you can choose to manually withdrawal funds at any time. You can set your income level to any amount as long as you meet the government imposed minimum income levels. There are no maximum income amounts with RRIFs. Finally, you can make changes to these options at any given time. One of the common changes that takes place is the transferring of funds from one institution to another. If you do not like the performance or service offered by your current advisor or financial issuer, you can take the steps to move it. Be Aware of Minimum Income Payout If you decide that you want to move from one institution to another, you will want to find out if the minimum income has been paid out. Let s walk through an example. Let s assume Charlie has a $100,000 RRIF at XYZ Financial Company and he is just not happy. Let s assume he is 67 years old and XYZ Financial Company must pay out a minimum income of $ It does not matter how or when, but it must get paid out to Charlie before December 31 of this year. Let s further assume Charlie has decided to take monthly income, which means that he will get $ per month. Now we are in October and Charlie wants to move the money to another company. What happens in this transition? Charlie has received nine payments of $ totaling $ Before the transfer is made, XYZ Financial Company must pay the remaining minimum of $ to Charlie in a lump sum. If Charlie does not take this payout into account, he may set up income from the new RRIF and wind up with more income this year than he might want and that also means potentially paying more taxes. 7

8 RRIF Investment Flexibility Flexibility can also be found in choosing the vehicles to invest in. There are four main types of RRIFs: 1. GIC RRIFs. If you are looking for a safe, conservative investment, you will want to consider a GIC RRIF. You can get this at any financial institution be it a bank, trust company or life insurance company. The biggest decision when it comes to a GIC RRIF is to determine how long of a term to choose - one, two, three, four or five year? The most important thing when investing in a GIC RRIF is to shop for the best rates together with flexibility. 2. Mutual Fund RRIFs. These RRIFs are very popular today because of the low interest rates on GIC RRIFs. Mutual fund RRIFs provide a lot of investment choices and flexibility. You can invest in conservative funds like money market funds all the way up to aggressive funds like equity funds. Generally speaking you should err on the side of being conservative in a mutual fund RRIF. Ensure that you are properly diversified and not subject to extreme ups and downs in the market place. 3. Segregated Fund RRIFs. Similar to mutual fund RRIFs, segregated funds provide lots of flexibility and investment choice. The advantage to segregated funds is that they provide some death and maturity guarantees for some added peace of mind. These guarantees do not come cheap so make sure you understand the costs associated with segregated funds before you leap in. 4. Self- Directed RRIF. Self- directed RRIFs are the pinnacle of investing because you have the most investment flexibility. You can buy GICs, stocks, bonds, mutual funds and any combination you can think of. The more flexibility you have, the more complicated your decisions might be, so be sure to use the help of a qualified professional. The Moral of the Story Regardless of which type of RRIF you want the best advice I can give is to shop around. With so much choice and flexibility, decisions can become very confusing. Either shop around on your own or go out and find a financial advisor to help you make these important income decisions. 8

9 Be Aware of the Retirement Risk Zone One of the less commonly discussed risks of retirement is the risk of having too much market risk in your portfolio at a time when you need income. This risk is not new but thanks to some work by Manulife Financial and Dr Moshe Milevsky, a professor at York University, they are creating a new awareness for something known as the retirement risk zone. The Retirement Risk Zone is the critical period leading into and just after retirement when the retirement nest egg is most vulnerable to market downturns. Some have said it is the three to five years before retirement and the three to five years after retirement. The retirement risk zone should be important to people because short term portfolio losses due to markets during this time can have significant long term effects on the longevity of your portfolio. Average returns can be misleading Most financial and retirement planning is done using average return assumptions. For example, Jack's retirement planning assumes that his portfolio over a long period of time will get him an 8% return. The problem is Jack can't get an 8% GIC these days. Instead, Jack invests in a balanced portfolio of stocks, bonds and cash to try to get this 8%. Jack is not unlike most people these days reverting to mutual funds, stocks and other managed portfolios to try to enhance returns. Although I have seen some balanced portfolios and mutual funds achieve long term average returns of 8%, I have not seen any return consistent returns of 8%. In other words, a portfolio that is exposed to the market does not make 8% each and every year. Instead, it might make 20% one year and then lose 4% the next year to average 8%. Sequence is important Most investors these days including those that are in the retirement risk zone are exposed to markets, it is crucial that investors are aware that the sequence of returns can have a dramatic effect on the longevity of your portfolio. In an example presented by Manulife Financial, Two investors Phil and Anne start with a portfolio of $206,049 and need to withdraw 5% per year for income (indexed to inflation). Both receive the same 8% average return over 25 years. The difference is that Phil suffers significant losses in the first two years. Even though the portfolio is mostly positive thereafter, the portfolio only lasts 14 years. 9

10 Anne's returns on the other hand are the reverse of Phil's returns. As a result, Anne's returns for the first 7 years are positive and she does not experience the losses that Phil experienced until the last two years instead of the first two years. Anne not only makes it through the 25- year period but her $206,049 has grown to almost $800,000. The difference in results is simply due to the sequence of returns. When planning for retirement, retirees need to really review their portfolios and see how much exposure they have to market risk. As you can see, the losses in the retirement risk zone (the period early in retirement) can have devastating long- term effect. How to deal with the Retirement Risk Zone? 1 One of the ways to survive the retirement risk zone is to simply avoid the market altogether. While this may sound appealing to conservative investors, the reality is guaranteed investments may not be attractive in a low interest rate environment. Not all people are able to live comfortably in retirement based on a return of only 3% to 5%. When you take inflation into account, the picture looks even worse because guaranteed interest products are barely keeping up with inflation. So, retirees face a pretty big dilemma. Play it safe and stay out of the markets but risk low returns that may not provide enough income and chance not keeping up with inflation. Or move some money into the markets to try to earn higher returns knowing that early losses may be devastating to the portfolio increasing the risk that you may run out of money. A Simple Guide on Guaranteed Investing is the perfect book for investors who are discouraged by the volatility of the stock market. If your portfolio has taken a beating, then this book will teach you why it is important to guarantee your investments and how to enhance your returns but still play it safe. This book is for the truly conservative investor. To learn more, visit 10

11 Chances are for most people investing in retirement will have to have some form of 2 diversified portfolio where some of the money is invested in safe guaranteed investments like GICs and some of the money will be invested in non- guaranteed investments like stocks or mutual funds. One rule of thumb is to take your age and keep that amount as a percentage in safe guaranteed investments. For example, if you are 60 years old, the rule of thumb suggests you keep 60% of your money in safe investments. Some critics argue the rule of thumb is antiquated and applied at a time when interest rates were higher but on the other hand think about how many 60 year olds wish they had more money in safe investments even at low interest rates when the market takes huge hits in crashes, corrections or bear markets. One thought is to keep at least 5 years of income in safe, guaranteed investments. So when you are retired and drawing income, then you need to be more conservative because the math works against you. Let s look at another example. Peter is 65 and has $200,000 in his RRSP. He needs a total of $50,000 per year in retirement and his pension, Canada Pension (CPP) and Old Age Security (OAS) provides a combines annual income of $40,000. Thus, Peter needs to set op his RRIF to pay $10,000 per year of income. On that basis, Peter should keep at least $50,000 in safe, guaranteed investments ($10,000 times 5 years). The rationale for this thinking is that if markets drop, he can still take money from the safe portion of his portfolio and allow the riskier portion to recover. Most people think 5 years is sufficient to recover. If you are skeptical, then you will want to keep more than 5 years in safe investments. 3 Another possible solution may be something called guaranteed minimum withdrawal benefit products (GMWB). If you've never heard that term before, you may recognize a product called Manulife Income Plus. Manulife has invested millions of advertising dollars into promoting this product and so far it looks like it has paid off. If you have not seen or heard the advertising, you will probably hear about it from a financial advisor. Manulife Income Plus was the first of it's kind to come to Canada. But now, many other insurance companies have launched their versions to stay competitive. Although GMWB products have some merit, you need to watch that the sales pitch is not overly simplified. These products can be complicated and in most cases they are very expensive from a management fee perspective. 11

12 When money it taken out of the RRIF in the form of income it is 100% taxable at your marginal tax rate. Canada Revenue Agency (CRA) requires payment from a RRIF in excess of the "minimum amount" is subject to tax deductions at source using the withholding rates. Just like your employer withholds taxes and remits them directly to the government, your RRIF administrator is required to do the same. Minimum income RRIFs are not subject to withholding tax, but you can request any level of withholding tax desired. In all other circumstances, here is the minimum withholding rates: RSP Withdrawal or Annual RRIF Excess Amount Rate Payments made up to $5,000 10% Payments over $5,001 but no more than $15,000 20% Payments in excess of $15,000 30% Let s take a look at an example. Betty lives in Alberta and has made a request to have monthly payments of $1,000 per month totaling $12,000 from her RRIF plan. Her payments are greater than the required minimum income of $4,800 per year or $400 per month. This means that the remaining $600 per month or $7200 per year will be subject to the withholding tax. This translates to $120 dollars of withholding, which is $600 at 20%, resulting in a net monthly payment of $880. If Betty had the funds in two different financial institutions the withholding tax only applies to the income taken from each financial institution. In other words, if she had 2 RRIFs and was taking $500 per month from each, the withholding tax would actually drop to 10% instead of 20% because the amount of income in excess of the minimum would not exceed $5000. One final word of caution The Taxation of RRIFs Remember that the total amount of tax paid is based on your total income and the marginal tax rate that you are in. Many people try to minimize withholding tax only to find that at the end of the year, they owe money in tax. Make sure you do not confuse withholding tax as the amount of tax you will pay in total to the government. 12

13 Top RRIF Tips You must convert RRSPs to income by age 71. Even if you do not need periodic income or any income at all, you must convert the RRSP into income in the year you turn age 71. Converting to a RRIF will subject you to the minimum income rules but you do not have to start income until the year you turn 70. You cannot contribute to a RRIF. If you have a RRIF and you want to make an RRSP contribution, you cannot contribute directly to the RRIF. Instead you must contribute to the RRSP, prior to age 71 and then convert the RRSP to the RRIF. The first decision is income The first thing you will need to determine is how much income you need or want. This decision will have the greatest impact on the longevity of your money. If you spend too much too fast, you will run out of money. Even if you don't need or want the extra income, you have the minimum income rules to contend with. You can tailor your income to your needs, subject to minimums imposed by the federal government. If you need steady monthly, quarterly, or annual income, it's available. If you require a large lump sum for a major purchase, travel, or some other purpose, that's available too. Have as many RRIFs as you want You can have as many RRIFs as you want. You can have one that pays a level income for the next 5 years to bridge income until government benefits. You can have another that is a capital preservation RRIF for a more stable long term level of income. Generally, many people consider consolidating into one RRIF. With a single RRIF, you can easily manage your investments and you'll only have to worry about one minimum withdrawal. Several RRIFs require more time and energy, and you'll have to arrange to withdraw at least the minimum from each one. 13

14 Minimum income can be based on a younger spouse s age. For maximum tax deferral, you want to take out as little as possible from your RRIF for as long as possible. One of the ways to stretch the income is to base the minimum income on a younger spouse s age. This will allow you to withdraw less out of the RRIF if you do not want the income nor want to pay income tax on the income. This option can not be changed. What will happen to your RRIF when you die? You can leave your remaining RRIF assets to your heirs upon your death. Not all other retirement income options provide for this. Naturally, your desire to provide an estate for your spouse, beneficiaries or charities may have an impact on how you set up your RRIF. While this may or may not be an issue, income and investments should remain the priorities. Understand the beneficiary designation. Under the current rules, if you name your spouse as the beneficiary of the RRIF, the plan can be transferred to the spouse without triggering tax. If the surviving spouse is over the age of 69, the RRIF must be transferred to a RRIF. If the surviving spouse is less than 69, the RRIF can be converted back to an RRSP, or RRIF. At the time of application, you can also designate the beneficiary as a successor annuitant, which means the payments will simply continue onto the surviving spouse without liquidation of assets. Other than some provisions made for dependent children and beneficiaries under the age of 18, any beneficiary other than the spouse will cause the entire value of the RRIF to come into income to the estate. Watch the attribution rules. If the RRIF is being set up with spousal RRSP money, you must be aware of the attribution rules. If any contribution has been made to any spousal RRSP with any institution in the year of income or the two preceding years, there will be attribution of income to the original contributor. This attribution only applies to amounts in excess of the minimum income. If you need income but want to avoid attribution, you can withdraw just the minimum. RRIF income qualifies for the $2000 pension income credit. If you are over the age of 65 and you do not have a company pension plan, you may be able to withdraw $1000 per year of income from the RRIF tax- free. As you can see, there are a lot of issues to deal with when it comes to planning your RRIF income. Take the time to plan wisely. 14

15 Everything You Need To Know About RRIFs Be Careful about not spending your RRSPs As discussed previously, RRSPs are a form of tax deferral. If you don t take the money out, then you will not have to pay the tax. Some people, as a result, avoid taking money out of the RRSPs because they either don t need the money or they don t want to pay the tax. Remember, the whole point of putting money into the RRSP in the first place is to enhance your lifestyle in retirement so if you have no plans to use the money, then why put the money into the RRSP in the first place? When you turn 71, you will be forced to convert the RRSP into a RRIF and start drawing income. The problem is if you have not used the money by the time you are 71, what makes you think you will use the money after 71? My point is simply to develop a strategy to get the money out of the RRSP when you retire. It might be part of a spending plan or it might be solely based on when it is most tax advantageous to get the money out. 10 Things I Wish Someone Told Me About Retirement Three of Canada s foremost retirement and life educators bring their collective insights, experience and knowledge to bear on the problems that Canadians face in planning for retirement. Using 10 key planning principals, the authors outline a perspective on planning that incorporates lifestyle planning, management of debt, investment planning, risk management, tax efficiency, legal and estate planning and income design. Visit JimYih.com for more about Jim s books, CDs and software tools. Keynote AUDIO CDs Jim has entertained, educated and inspired audiences. Now you can get a chance to hear a recording of some of his most popular Keynote Presentations: Retire Happy: Make Retirement the Best Years of Your Life Investing is Not Rocket Science: The Secret to becoming a successful investor Take Control of Your Money: The Seven Habits of Wealthy People 15

16 This special report was brought to by: Timeless Planning Information Retirehappy.ca is one of the leading resource centers for timeless planning information on building, protecting and managing wealth. There are over a thousand articles written by Jim and other various experts on financial, retirement, investment, estate, tax and lifestyle planning. The focus of these articles and all of the information you will find on the site is to provide timeless planning information. You won t find up to the minute information or prices on mutual funds, stocks or stock markets. There are many other great sites for that. Instead our focus is on planning which forms the foundation for a lifetime of great information. All the information is so easy using the various category headings or best of all, the search feature. Type in any word or phase and every article with those words will show up. Jim is one of Canada s leading experts on money, retirement, investing and personal finance. He has a passion for teaching and helping people make better decisions with money so they can all retire happy and achieve financial freedom. As a well- known financial speaker, he has entertained audiences large and small with his common sense, to the point approach. Audiences rave about Jim s ability to take complex matters and deliver them in a way that makes sense. He believes that true success of a professional speaker comes from not only education but also entertainment and inspiration. You can also find Jim s other products like books, CDs, DVDs and financial tools by visiting his other website 16