Rosemary* turned 71 this summer and knows she has to convert her
registered retirement savings plans
(RRSPs) into
registered retirement income funds
(RRIFs), but isn’t sure how to do so and what the tax impact will be.
Divorced with three adult children, Rosemary is enjoying a comfortable
retirement
in British Columbia. She has an annual income of about $105,000 a year before tax, including $45,000 from an employer pension, $10,000 in interest income, $26,000 in rental income, $15,500 from the
Canada Pension Plan
and $8,600 in
Old Age Security
benefits. Her income far exceeds her annual expenses, which total approximately $48,000.
She has $670,000 in RRSPs invested in balanced
mutual funds
and
guaranteed investment certificates
held at multiple financial institutions and has several questions about her next steps, including whether to transfer or merge them with one single institution, how to start withdrawing from the RRIF and how much to take out.
In addition to her RRSPs, Rosemary has approximately $227,000 in GICs — the source of her interest income — and about $135,000 in tax-free savings account (TFSA). Rosemary’s estate also includes her primary residence, valued at $1.5 million and a rental property valued at $600,000.
She would like to sell the rental property, but is worried about the tax implications.
What the expert says
Transitioning from RRSPs to RRIFs is the perfect time for Rosemary to simplify and consolidate her accounts and investments, said Graeme Egan, a financial planner and portfolio manager who heads CastleBay Wealth Management Inc. in Vancouver.
RRSP holders have the option to convert to multiple RRIFs at different financial institutions, but he generally recommends consolidating all RRIFs with one financial institution for ease of management and to easily monitor the asset mix to ensure you are following an investment strategy that reflects your investor profile.
“For Rosemary, given her other sources of income and net worth, a 50/50 asset mix of stocks and bonds or even a 40/60 mix would be fine for the next 10 years,” he said.
The rules dictate that regardless of how many RRSP accounts you have, you must convert to a RRIF or RRIFs by the end of the calendar year in which you turn 71. From that point on, the holder is contractually obligated to withdraw a minimum withdrawal amount each year, which starts at 5.28 per cent as of Jan. 1 following the year you turn 71 and that increases to 5.4 per cent the next year, followed by marginal increases each subsequent year.
“There is no maximum withdrawal amount each year, but we would not recommend taking it all out in one year, as the whole amount would be taxable,” Egan said. “Assuming the total value of Rosemary’s RRSPs moves to one or multiple RRIFs, her first annual RRIF payout will be $23,103 in total. Rosemary’s current investment holdings will transfer as they are (in kind) into a new RRIF account.”
He said Rosemary does not have to sell or change any of her current investment holdings, but depending on how frequently she wants RRIF payments made, she and/or her adviser have to ensure there is cash in the account for RRIF payout purposes.
Annual RRIF withdrawals are taxable each year to the RRIF owner, who will receive a T4RIF slip showing the amount paid out. This amount is added to other income on the tax return.
“If you only withdraw the minimum stipulated amount each year, the financial institution holding your RRIF will not withhold any income tax at source,” Egan said. “Once you exceed the minimum annual amount, withholding tax will apply on the excess withdrawal amount.
Depending on your overall tax rate when you file your tax return, you may owe income tax on the minimum RRIF payment at tax time. If it is more than $3,000, then you may have to start paying quarterly tax instalments in the fall of that year and so on.
Egan said if Rosemary wants frequent RRIF payments, she could consider taking out the annual minimum amount monthly or quarterly, set some aside for taxes and gift the balance to her children each year. This provides an easy way to transfer some of her wealth to the next generation.
Alternatively, if she does not need the income during the year, she could elect to take out the minimum amount the following December (say Dec. 15) in one lump sum to defer any payout and keep the full RRIF tax sheltered during the year. She can then give the money to her children each Christmas.
In terms of investments in her RRSP, Egan said balanced mutual funds (50/50 equities/bonds) are suitable and easy to manage given her age, but she may want to consider investing in asset allocation exchange-traded funds (ETFs) that mimic balanced mutual funds in terms of a structured asset mix, but have much lower management expense ratios.
“These are no-fuss ETFs and are automatically rebalanced,” he said. “If she prefers a portfolio of ETFs, she can ask her advisers if they can access specific equity/bond ETFs for her to replace the balanced mutual funds she owns.”
For example, Egan recommends Rosemary’s TFSAs should contain 100 per cent equities and be in the form of equity ETFs and/or mutual funds since all the capital appreciation is tax sheltered and any future withdrawals are also tax free.
“There is an opportunity cost in the long term to having slow-growing GICs in a TFSA,” he said, adding that GICs are not as tax effective as the interest income is fully taxable. “If she would like to continue to hold that capital, she should consider dividend-generating ETFs, which pay out dividend income monthly into her account. Though more volatile than GICs, she will pay less tax given it is dividend income and any growth/appreciation is taxed as a capital gain, and equities typically outpace inflation over time, which is not generally the case for GICs.”
Egan also points out that Rosemary is earning a bit more than a four per cent income return on her rental property. Dividend ETFs are paying about four per cent annually, but dividends are more tax effective than rental income and don’t have the hassles that come with being a landlord and property owner.
Selling the rental property would incur some expenses, he said, but there would be little if any capital gains given her adjusted cost base versus value, though she would have to decide where to invest the proceeds and/or gift some of the money to her children.
*Names have been changed to protect privacy.
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