Is there any advantage to opening a RRIF account before age 71?

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By Julie Cazzin with Allan Norman

Q: Is there any advantage to opening and starting a registered retirement income fund (RRIF) account before I reach the age of 71? — Sanjay

FP Answers: Sanjay, there are multiple reasons for starting a RRIF before age 71, such as your income needs, tax management, the pension tax credit, pension and income splitting, large purchases, guaranteed income supplement (GIS) and old age security (OAS) optimization, a Canada Pension Plan (CPP) substitute and more.

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The ones applicable to you will depend on a combination of your circumstances and the unique attributes of a RRIF. I’ll review a few of the reasons for starting your RRIF early, but think about which RRIF attributes may convince you to convert your registered retirement savings plan (RRSP) to a RRIF before age 71.

Probably the most common reason for starting a RRIF early is your need for a regular income. Keep in mind, though, that once converted, you must withdraw the mandatory minimum every year following the conversion date. The minimum withdrawal amount is a percentage based on your age and the value of your RRIF on Jan. 1 of each year.

The minimum percentage withdrawal amount increases every year until topping out at 20 per cent at age 95. If you have a partner, you can base the minimum withdrawal on the withdrawal rate for the youngest of the two of you. For example, at age 72, the minimum RRIF withdrawal amount is 5.4 per cent, and at age 65, it is four per cent. Basing the minimum withdrawal on the younger spouse means drawing down less money, paying less tax and leaving more money in your RRIF to grow.

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You may be wondering why you should convert to a RRIF when you could just draw money from your RRSP as needed and not worry about mandatory minimum withdrawals. If you only need extra money this year and nothing next year, then sticking with the RRSP may be the best option. But remember that a RRIF can be converted back to a RRSP, and taxes are better managed with a RRIF.

Converting your RRSP to a RRIF before age 71 is not a one-way street. If you no longer need RRIF income, you can convert it back to a RRSP anytime before the year you turn age 72. The only thing to know is that the minimum RRIF payment must be paid out for that year. In other words, if you know you won’t need money from your RRIF next year, convert it back to a RRSP this year.

A RRIF also provides the opportunity for better tax management since there is no withholding tax on a minimum RRIF withdrawal in the years after the conversion year. If you know you are going to start to draw from your RRIF next year, set it up this year. There is no minimum withdrawal requirement in the first year and there is no withholding tax on the minimum withdrawal in the second year unless you have asked for some tax to be taken off.

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Turning 65 presents two other reasons for converting to a RRIF: the $2,000 pension tax credit as well as pension splitting. The pension tax credit is a credit and not a way to get $2,000 out of your RRSP tax free as some people think, but it’s still worth doing if you qualify. If your only reason for converting to a RRIF is the tax credit, then only convert a portion of your RRSP to ensure the minimum withdrawal stays below $2,000.

Pension splitting, assuming you need the income, is the biggest benefit of converting at age 65. You can’t pension split RRSP withdrawals, but you can pension split RRIF withdrawals once you turn 65 and you do it to save tax.

One person earning $150,000 a year in Ontario will pay about $36,600 in tax and lose their OAS, whereas two people earning $75,000 each will pay a combined total of about $26,500 in tax. That is a difference of about $18,000 when accounting for the tax difference and loss of OAS. Pension splitting is huge for couples. Staying together or finding a partner has its tax benefits.

Continuing with pension splitting, consider a 68-year-old who needs $40,000 from his RRSP for a truck purchase and will have to draw about $58,000 to get the $40,000 after the 30 per cent withholding tax. Adding $58,000 to his $60,000 income means his OAS will be impacted. Fortunately, his wife has a lower income. We will sell the amount needed for the truck in his RRSP, convert that amount to a RRIF, pay him out of the RRIF and then close the RRIF account. This way, he pension splits with his wife and avoids any OAS impact.

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Income splitting with a spousal RRIF can be beneficial for another reason. Withdrawals from a spousal RRSP are taxed at the spouse’s rate, provided the last contribution to a spousal RRSP was more than two full calendar years ago, starting Jan 1.

However, there is an exception with a spousal RRIF since there is no waiting period on minimum spousal RRIF withdrawals. If you make a large spousal RRSP catch-up contribution, your spouse could convert the account to a spousal RRIF, draw the minimum, be taxed at their rate and convert it back to a spousal RRSP if there is no further need for income.

Sanjay, there are lots of reasons for starting a RRIF before age 71. I didn’t touch on looking at the big picture to see your future tax story. Does it make sense to deplete or reduce your RRSP to optimize your GIS or OAS? Hopefully, the ideas I provided for you here will help you see how an early conversion can help you.

Allan Norman, M.Sc., CFP, CIM, provides fee-only certified financial planning services through Atlantis Financial Inc. and provides investment advisory services through Aligned Capital Partners Inc., which is regulated by the Canadian Investment Regulatory Organization. Allan can be reached at alnorman@atlantisfinancial.ca.

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