In Canada, the primary savings vehicle for retirement is the Registered Retirement Savings Plan (RRSP). The RRSP is an account that is designed to accumulate money for retirement. I often describe the RRSP as a bucket of money. When you put money into the bucket, you get a tax deduction. Once the money is in the bucket, you can invest the money in many different options including GICs (Guaranteed Investment Certificates), Bonds, Stocks, Mutual Funds, and lots of other choices. The great news is any growth, interest or profits on the investments stays tax sheltered as long as the money stays in the bucket. If you take money out of the bucket, then you have to pay tax on any withdrawals. Although you can take out lump sums of money out of the RRSP, the RRSP is still designed primarily as an accumulation vehicle for retirement.
What is the RRIF?
A Registered Retirement Income fund (RRIF) is simply just another bucket. In fact, the bucket looks very similar to the RRSP bucket but it has a different label on it. There is one big difference; there is a hole at the bottom of the RRIF bucket. Since there is a hole, some of the money inside the bucket will drain out which essentially creates an income stream.
In other words, the RRIF is a vehicle to create a regular stream of income from the RRSPs. Typically this happens when you need a regular paycheque at retirement.
When can I convert the RRSP to a RRIF?
Essentially you can convert an RRSP to a RRIF whenever you want. Theoretically you can convert the RRSPs to income in your 20s, 30s, 40s, 50s, or 60s. Practically, however, you would only convert to income when you NEED regular, consistent income and that usually happens when you retire.
If you have not converted your RRSPs into income by December 31st in the year in which you turn 71, the rules state you must convert your RRSPs to income. You can do so by either purchasing a Life Annuity or move the RRSPs to a RRIF.
How much income can I take out?
Remember that hole in the bucket? That hole can be as big as you want it to be. In other words, there is nothing restricting you from taking out more money by making the hole bigger. The key is you cant make the hole smaller than the minimum size. Every RRIF has something called a RRIF minimum income.
The minimum income is determined by a formula: Your RRIF balance x 1/(90 – age). For example, if you were 65, your minimum income would be 1/25 or 4%. The way the formula works, your minimum income increases every year and then at age 71, the minimum income moves to a preset amount that changes every year. Here’s a handy chart:
How does the tax work?
When you move from a RRSP to a RRIF, it is considered a transfer and there is no tax paid on the transfer of money from a RRSP to a RRIF. Tax is only paid when money is taken out of either bucket and used. For a RRIF, only the income is taxed and the amount that comes out of the hole is taxed at your marginal tax rate at the time of withdrawal.
RRIFs can be a retiree’s best friend if used properly. To learn more about RRIFs, visit my handy online RRIF guide.
Jim Yih is a financial speaker, fee-only advisor and the man behind Retire Happy Blog. For the past 20 years, he has written extensively about retirement, government benefits and personal finance.