With the holidays well behind us, ‘tis another type of season that comes but once a year: RRSP season. While many are familiar with the particulars around contributions and tax deductions, few have yet to grasp what happens to their RRSP when they retire.
So, what happens to your RRSP when you retire? You can contribute to your RRSP until the end of the calendar year in which you turn age 71. Afterwards, you must choose one or more of the following options:
Withdraw cash from your RRSP
You can choose to withdraw a portion or all of the funds from your RRSP as cash. The amount withdrawn would need to be declared as income on your tax return for the given year; a withholding tax would apply. Your financial institution is forced by the Canada Revenue Agency/Revenu Québec to withhold a certain percentage of tax based on the amount you withdraw.
“The tax that was withheld may not always be enough to account for the tax you owe at your tax bracket,” says the Canada Revenue Agency. “You may have to pay more tax on the withdrawal when you include the withdrawal on your income tax and benefit return for that year.”
If only a portion of the RRSP is withdrawn, any amount remaining would need to be transferred into a registered retirement income fund (RRIF).
|Withdrawal amount||Withholding tax rate (excluding Quebec)||Withholding tax rate in Quebec|
|Up to $5,000||10%||21%|
|$5,000.01 to $15,000||20%||26%|
Convert your RRSP to a RRIF
To avoid the tax implication of a large cash withdrawal, most people convert their RRSP and transfer their assets into a RRIF. You can choose to convert your RRSP to an RRIF any time before Dec. 31 of the year you turn 71.
RRSP and RRIFs are similar in many respects: they hold the same types of investments, investments continue to grow savings tax-free, and withdrawals incur taxes. Where the RRIF differs is that contributions can no longer be made to the account and mandatory minimum withdrawals are required.
The minimum withdrawal percentage is 4% at age 65, increasing to 20% at age 95. It’s currently as follows:
|Age||Minimum withdrawal amount|
For example, if you’re 70 and the value of your RRIF is $250,000, you’ll need to withdraw at least 5% or $12,500. Withdrawals are subject to income tax and if they’re in excess of the minimum, they’re also subject to a withholding tax (see above).
The amount and frequency of withdrawals are flexible, and can be adjusted according to individual needs. You can have more than one RRIF and RRIFs can be self-directed. Finally, if you name your spouse as a beneficiary on the account, they can inherit your RRIF tax-free and continue to receive payments.
Buy an annuity
An annuity is a product that can be purchased from an insurance company with funds from an RRSP or RRIF. In return for a deposit, the insurance company will provide a guaranteed income—with interest—for a defined period. Income payment amounts are locked, cannot be changed, and are received in regular intervals (monthly, quarterly, etc).
There are two types of annuities: term-certain and life. A term-certain annuity provides a guaranteed income for a fixed term, generally from time of purchase extended to the age of 90. If you die before the end of the term, regular payments are made to your estate. A life annuity provides regular income for your remaining life and stops at death; no money will go to your estate.
The Last Word
Your RRSP needs to be closed at the end of the year you turn 71. The funds in your RRSP can be withdrawn as cash, transferred to a RRIF, or used to purchase an annuity. A combination of all three options allows you to control your investments with the security of a guaranteed income. When the time comes to convert your RRSP into retirement income, consider speaking with a financial professional as your RRSP is likely only a single piece in your retirement puzzle.
Flickr: American Advisors Group