Category Archives: Retirement Planning

Nothing more appealing than the notion of spending the golden years bobbing around on a 48 foot boat in the Virgin Islands, sipping coctails, socializing with your loved ones and friends and writing your memoirs in your spare time… Wait a second, this is not my life! How to get there—sage advice from Jamie List, money guru at HeadsUp Dad

Retirement Income Options – So Many Ways

As each year passes, the Canadian population becomes older on average.  The well documented effect of the boomer generation means that there are more and more Canadians approaching the age of 71, which is the year in which a taxpayer is forced to convert their RRSP’s into some form of retirement plan.

Let’s take a look at the variety of accumulation accounts at the average Canadian’s disposal, and then explore the different methods that can be used to access the funds in retirement.

We’ll start with accumulation, because the options you have at your disposal when you convert your accumulation plan to a income plan depends on what kind of accumulation asset you have.  There are two basic types of tax-deferred plan that you can have as you save for retirement, a personal plan, or an employer sponsored plan, or pension.

Personal Accounts

Registered Retirement Savings Plan (RRSP):  This plan allows for contributions of 18% of income up to an annual maximum.  A taxpayer must convert an RRSP into a retirement vehicle by December 31st in the year in which they turn 71.

Tax-Free Savings Account (TFSA):  The federal budget that was read in February introduced a which is designed to augment the tax deferred savings available to Canadian taxpayers.  Each taxpayer can contribute $5,000 per year into this, and there are no stipulations on withdrawal.

Locked-in Retirement Account (LIRA): This investment account is created when an employee leaves a company sponsored pension plan “rolls over” a certain portion of their pension into the LIRA.  Like the RRSP, the investor can control the investment decisions, but there are strict guidelines as to how the funds must be withdrawn.

Employer Sponsored Accounts

Many companies will have a pension plan for their employees, but these can take a variety of forms.

Defined Contribution Pension: This plan simply states up front what amount the company and the employee are each going to contribute to the plan.  Once the contribution is made, the funds are invested, and the employee has a variable pension depending on the investment performance of the pension fund.

Defined Benefit Pension: This plan uses a formula to determine what benefits are due to the employee upon retirement, based on years of service, income levels, etc.  The employee or the employer, or both, can contribute to the plan.  The corporation is liable to ensure that the plan is funded to meet the amounts that their employees are entitled to.

Group RSP: this is not really a group plan in the same manner that the pensions plans mentioned above are.  The group RSP functions just like a personal RRSP, except that the employer usually bears some of the costs of investing in the plan (i.e. account fees, lower fund management costs), and may match contributions as an employee benefit.

Commuted Pensions

Often, employees are given the option to “commute” their pension when they retire.  This means that they will be given a sum of money in lieu of an income stream from the pension fund.  This is most often made available to people given early retirement, and the funds are usually transferred a combination of a LIRA (tax free) and sometimes an open investment account (taxable).

A commuted pension can be a highly attractive option for a departing employee, specifically if they are planning to work again after they have left their current employer.  However, too often investors are encouraged to commute their pension in search of high returns.  However, when an investor commutes their pension, they often forgo other benefits that provide significant value.

For instance, an employee may have lifetime medical/dental benefits associated with their pension plan.  If the employee commutes their pension, they usually lose the right to have such types of benefits.  This leaves the investor open to significant long term risks of covering the cost of long-term care.

One final thought: the pension fund sees each pensioner as a liability.  When it commutes a pension, it pays an amount out to the employee to relieve themselves of that long-term risk.  When commuting a pension, be careful about taking that risk off the pension fund’s hands.  In this process, greed is not good.  A careful look at your risk management and tax planning options should be considered in this decision, not just the potential for big investment returns. 

Retirement Options

So what is an investor to do once they have reached the age of 71, and is faced with the choice between income options?  Well, it depends on the account you have used to accumulate your retirement income.

Registered Retirement Income Fund (RRIF): this account is created when an RRSP is rolled over into a newly formed RRIF.  The RRIF has an annual minimum withdrawal amount that is prescribed based on either the owner’s age, or the age of the owner’s spouse.  Since the minimum withdrawals rise as the age increases, it is usually beneficial to calculate the RRIF payments from age of the younger spouse.  The investment options are similar to an RRSP, and there is no maximum withdrawal amount that can be made in any given year.

Segregated Funds with Income Guarantees: these types of “variable annuities” have been available for many years in the US, but have really gained ground in recent years.  These are segregated funds that offer guaranteed income streams (usually 5% simple interest), with an account value that rises and falls with the investments selected.  This allows the investor to receive a guaranteed life income (usually available once investor reaches 65), while also participating in the upside of the market.  On the upside, there is potential for capital appreciation, and on the downside, the market value of the investment could deteriorate to nothing, leaving the investor with little value beyond the annuity-like contractual guarantee.  However, this is a powerful option for investors who wish to expose themselves to upside, without risk of losing an income stream.  

Life Annuity: Converting to a Life Annuity will guarantee income for life, which provides security to the individual who is receiving the funds.  However, this means that the (potential) estate value of the funds invested into the Life Annuity will be lost, should the investor die prematurely.  The annuity option can also be selected to guarantee income to age 90 (of either spouses’ age), so that if both spouses die prior to the 90th birthday chosen, there will be some estate value.

Lifetime Income Fund (LIF):If an investor elects to have a LIF, withdrawal minimums are the same as for RRIFs. LIF’s however, have a maximum withdrawal amount whereas RRIFs do not.  In some provinces, LIFs must be converted to a Life Annuity when the owner turns 80.  This means giving up investment control at age 80, which may or may not be a good thing.  Investors should be careful to manage volatility as age 80 approaches.

Locked-in Retirement Income Fund (LRIF): This is a more flexible version of the LIF, that eliminates the requirement to convert the account to an annuity at age 80 (not available in all provinces).

A note on small “locked-in” balances

If you are age 55 or older and the total value of all of your locked-in accounts is less than 40 per cent of the years’ maximum pensionable earnings (YMPE), you can request to have these locked-in funds transferred to an RRSP or RRIF, thus removing the locked-in status. The YMPE is currently $44,900, so this feature applies only to balances of $17,960 or less.

This is just a cursory look at all of the options available, but it should allow you to start to investigate the options that may or may not be available to you.  As with everything, try and determine what your objectives are before you make the decision.  Here are some basic points to consider in making your decision:

  • What kind of retirement assets do I have at my disposal?
  • Do I need a guaranteed income amount (i.e. x dollars)?
  • Do I need a guaranteed income term (i.e. for x years)?
  • Do I want to leave an estate value for my beneficiaries?
  • Do I want to manage the asset?
  • How is the asset going to be taxed if I leave a balance when I die?

For instance, an annuity might not provide the most attractive rate of return, but it will guarantee that you do not outlive your income.  For others, a prudently managed RRIF will deliver the retirement income that is needed, and maybe more.

Debt and the RRSP contribution – Worth it?

RRSP loans are generally recommended as a way to “jump-start” your savings, or advertised as a way to create wealth where it did not exist previously (check out this sample Google search I did – most of these entries encourage debt).  There are a number of strong opinions out there that can debunk the myth that borrowing to invest is  good for you.

Borrowing to invest is a tricky straegy at the best of times.  Using debt for investment will increase both the gains and the losses that you receive in the market.  However, using debt can mean that you lose more than you actually have – you have lost someone else’s money.  

Leverage can do more harm than good, and must be done carefully.  If you are going to make the executive decision to use debt to invest in the RRSP, then you should be able to answer yes to one or more of the following questions:

  1. Am I at the highest marginal tax rate? If you are, then you will get the maximum benefit (i.e. tax refund) from your RRSP deduction.  If you deduct at lower tax rates, you will get less in the form of a refund at tax time.
  2. Am I going to be able to pay this off before the next RRSP season?  If you are (or you expect some compensation, a bonus or some inflow of cash that you do not currently have) then go ahead.  If not, you will likely just be in the same boat next year, forced to borrow again, and get into a “vicious” circle of debt again and again.
  3. Am I going to get a cash refund by making the contribution?   If you are, then you can have some confidence that you will soon be able to reduce your debt.  If you are not going to generate a cash refund and instead only reduce your taxes owing, then you will not be able to reduce the balance of your “quick loan” at tax time, and you will be encumbered by a great deal of debt.
  4. Is your other debt generally under control?  If so, then you might consider this as a one-time event.  However, if the reason that you have not made an RRSP contribution in the past is because your cash flow is committed to servicing other debt burdens, then this is definitely a bad idea.  Spend time getting your debt under control, and then revisit your RRSP savings later on.

So, in general, an RRSP loan is not a good idea, unless you are simply using it as a bridge until you get other funds coming in.  Also note that the interest payments on RRSP loans are not tax deductible, so there is no added deduction benefit to the investor.

I would venture to guess that, over the long term, taking a year off your RRSP contribution would serve you far better in the long run.  Perhaps, instead of borrowing to make an RRSP contribution, you start a monthly deposit plan and get ahead of the debt curve.

Tax Free Savings Accounts

The government of Canada gave us Canadians another tax savings option in the 2008 federal budget that will go far in helping Canadians accumulate wealth in a tax-effective manner.  The Tax Free Savings Account is quite simple, and the features of the plan are as follows:

  • It is open to all Canadians over the age of 18, and continues for life.
  • The maximum contribution into this plan will be $5,000 per year. That amount will be increase with inflation in increments of $500 in future years.
  • There is NO tax deduction available for deposits.
  • All income and growth is exempt from taxation, even on withdrawal.
  • Unused contribution room can be carried forward.  If you make a withdrawal, the amount withdrawn can be replenished to the account in subsequent years without any penalty.
  • As with an RRSP, the plan contemplates spousal contributions without affecting the contribution room of the spouse receiving the spousal contribution.
  • TFSA can then be used for whatever purpose at whatever time. (buying a house, paying for a wedding, starting a business, etc.).

We think that every Canadian over the age of 18 should have this account. For the time being, your TFSA balance will be small, and that will limit your investment options, but it is a great place to hold any extra cash – since the account has no penalties to your “room” when you withdraw, you can move funds in and out without penalty.  And, with interest rates at record low levels, we need all the help we can get on interest savings after tax and inflation are taken into account.

Here are two strategies that you can implement in the future:

  • Lower income taxpayers: for taxpayers who are saving their money while earning a lower income, the TFSA is a better deal than the RRSP (i.e. for the spouse during maternity leave). This is because the positive effect of the RRSP deduction is less if the taxpayer has a lower income tax rate (lower tax rate = lower amount of tax back from your RRSP deduction). If an individual is in a situation where they expect to be earning more in the future, then the TFSA would be a far better choice, and the taxpayer could carry forward RRSP room for future deductions, hopefully at higher tax rates.
  • Funding Education for Adult Children: parents might consider funding more of a child’s education on the agreement that the adult child save the equivalent amount in their TFSA. This would allow the parents to take all relevant deductions and credits for funding their children’s education, and it would allow the children to begin to accumulate savings in their own TFSA. They are likely earning a very low income as a student, their contribution to the TFSA will come at a very low after‐tax cost.
  • All in all, I think that the TFSA is a good move for Canadians. If for no other reason, it simply provides you with another planning tool. If the tax benefits are not enough to persuade you, then the added planning options and flexibility should.