Converting your RRSP into a RRIF
By Jim Middlemiss • Bankrate.com

While a Registered Retirement Savings Plan (RRSP) is a good vehicle to help defer taxes and set money aside for your golden years, it doesn't last forever.

Regardless of your age, the government still wants its pound of flesh in the form of taxes. So, by December 31st of the year in which you turn 69, you must decide what to do next with the money in your RRSP.

There are three main options: you can collapse your RRSP and cash out your savings, buy an annuity with your savings or roll your savings into a Registered Retirement Income Fund (RRIF).

"One option you don't want to do is cash in your RRSP," cautions Dave Ablett, a manager in advanced planning at Investors Group, in Winnipeg. That's because you'd be taxed on your savings at the highest marginal rate, defeating the purpose of stashing it away in an RRSP in the first place, which was to defer paying tax on the growth.

The better route, advisers agree, is either to buy an annuity or roll your savings into a RRIF. Both strategies have pros and cons. Here's how to decide which strategy is best for you.

Buying an annuity
An annuity is a contract between an investor and a financial institution. The investor turns over a non-refundable lump sum and, in exchange, receives a pre-determined stream of income for a set period.

Joanna Saar, a certified financial planner with the Canadian Imperial Bank of Commerce, in Mississauga, Ont., says annuities appeal to people who don't want to manage their own finances.

There are three main types of annuities: single-life, joint-and-last-survivor and fixed-term.

Ablett says single-life annuities provide buyers with an income stream for life. But when the holder dies, the payments cease and nothing goes to the estate.

"A person who would use a single-life annuity is somebody who doesn't have a spouse and wants to maximize their income," he says. He says they are good for "people who are totally risk averse and don't want a situation where there could be a change in the value of their retirement money due to a bear market."

On the other hand, a joint-and-last-survivor annuity is geared toward couples and provides income protection for the surviving spouse. That's because the annuity payments continue after one spouse dies. "You can set them up so that the annuity payments can be level for both people or reduced on the death of the first spouse," says Ablett.

A fixed-term annuity provides a benefit to a specific age, such as 90, or for a set period, such as five or 10 years. If the person dies before the end of the term, the remaining payments go to her estate or a designated beneficiary. In some cases, there may be a lump sum payment.

"Annuities are better in a higher-interest-rate environment," says Saar. That's because the income stream is tied to interest rates. The problem, she says, is that it's a one-time shot and you are stuck with the going interest rate at the time you buy the annuity. There is no way you can take advantage of rising rates, and there is no protection from inflation.

So, in a low-rate environment like we have today, where rates are expected to start rising, few people are choosing annuities. Saar says the choice for most investors today is to roll their RRSP savings into a RRIF.

Rolling into a RRIF
Doug Macdonald, a fee-only financial adviser at Vancouver's Macdonald, Shymko & Company Ltd., says that when it comes to converting an RRSP into a RRIF, "A lot of people think this is a major event. It's not a big deal." When the time comes, "most financial institutions can accommodate you and move the assets quickly," adds Ablett.

A RRIF operates much the same way as an RRSP. The primary differences are that you can't contribute more money to it once it's established, and you must withdraw a minimum annual amount from it starting in your 70th year.

How much you have to withdraw varies according to a formula established by the federal government. Essentially, you must take out a percentage of the RRIF's total value each year according to your age. While a RRIF can last as long as you live, by age 94, for example, the annual minimum withdrawals rise to 20 percent of the assets in the plan.

Before you set up a RRIF, there are a few factors to consider, so "it's a good idea to start thinking about it early in the year so things can go smoothly."

First, the amount of money you must withdraw each year is determined by your age. So if you have a younger spouse, you should designate her as the beneficiary because it will lower the minimum withdrawal.

Gord Nicholls, a vice-president at RBC Dominion Securities, in Toronto, says that like an RRSP, RRIFs can hold a range of investments, including equities and fixed-income products. "You still own the same investments. It's really just a different account number," he says.

However, you should take steps in advance to structure your investments to accommodate the minimum withdrawals you'll have to make. That means ensuring you have something turning over into cash regularly. Otherwise, Nicholls says you could find yourself selling investments before their maturity in order to meet your withdrawal obligations, which could decrease your return.

"Bond laddering is the most useful and straightforward approach," he says. That's when you buy a series of bonds that mature at different times so that money comes due at regular intervals. For example, a typical bond ladder would feature equal amounts invested in one-, two-, three-, four- and five-year bonds.

The amount of money that must be withdrawn from a RRIF is simply the minimum; you can always take out more. But while the minimum payment is not subject to withholding tax, anything above it is.

Just because you have a RRIF doesn't necessarily mean you can't still take advantage of an RRSP, notes Macdonald. For example, if your spouse is under 69, you could contribute to a spousal RRSP in her name and still claim the deduction that comes with the contribution.

Saar adds there is nothing stopping investors from converting an RRSP into a RRIF earlier than age 69, though it is uncommon. But it is worth considering in some cases. For example, if you have a gold-plated pension but retire before it kicks in, it might be worthwhile to convert your RRSP to a RRIF and live off that income. That way, you'll reduce your tax burden when the pension kicks in.

Jim Middlemiss is a freelance writer and lawyer based in Toronto. He's a frequent contributor to National Post, Investment Executive and Wall Street & Technology.