RRIF or annuity: Which one is right for you?

I will be 71 in July 2016. I currently work and receive OAS and CPP. My wife is 70 in July 2016 and also receives OAS and CPP.

After I hit my age of 71, I must start withdrawals from my RRSP and I need to make my selection between RRIF and annuity.

—Igor

A: Since you’re turning 71 in 2016, Igor, you need to do something with your RRSP by the end of the year. The applicable date with RRSPs is December 31 of the year in which you turn 71. By that that date, you need to do one of three things:

1) Cash out your RRSP completely and add the full market value to your income for the year, paying tax on the full amount. This isn’t a great option.

2) Convert your RRSP to a Registered Retirement Income Fund (RRIF) and start taking minimum withdrawals starting the following year.

3) Purchase an annuity from an insurance company with your RRSP funds and receive pre-determined payments for the rest of your life, beginning the following year.

If you convert your RRSP to a RRIF, your minimum required withdrawal is based on your age. The year you turn 72, your minimum withdrawal is 5.28% of the market value as of December 31 of the previous year. You can choose to base your minimum withdrawal on your spouse’s age and if they are younger, you will have a lower required minimum withdrawal.

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In your case, Igor, if you use your wife’s age, your minimum withdrawal will be 5.00% in 2017.

As time goes on, the minimum RRIF withdrawals rise to 5.67% by the year you turn 75, 6.58% by the year you turn 80 and so on, before hitting 10.99% by the year you turn 90. If your RRIF isn’t generating a return in excess of the withdrawal rate, you will be drawing down on the capital in your account over time.

If you purchase an annuity instead, Igor, your income would be based on the annuity features you chose. For example, a single life annuity with annual payments and no guarantee period would generate an income of $7,939 per $100,000 or RRSP based on current annuity interest rates (which are fairly low, like all interest rates). The insurance company would pay you this income for the rest of your life.

You could choose to have your annuity payment based on both your life and your wife’s life and payable until the second of your two deaths. Or you could choose to have a guarantee period for your payments, even if you died before the guarantee period expired. Features like this would cause your annuity payment to be lower because these features have a “cost”.

Your CPP or OAS aren’t really impacted by the choice you make. The fact that you’re still working, Igor, doesn’t really impact the decision either. On $100,000 of RRSPs, the minimum RRIF withdrawal would be $5,000 in your case in 2017, Igor, versus a $7,939 annuity payment, so you’d have to pay slightly more tax on the annuity than the RRIF.

If you choose to go with a RRIF and your account earns a 4% rate of return, it could provide you with the same $7,939 of annual income for 17 years, at which point, the RRIF would be depleted to zero. At 71 years of age, your life expectancy is about 15 years, so the annuity provides a little more than a 4% rate of return on your RRSP money. I suppose whether 4% is a good return depends on who you ask.

If you live until age 100, your annuity provides a great “rate of return” equal to about 7.5% on a RRIF.

Both RRIF withdrawals and registered annuity income are taxable in the same way and at the same rate on your tax return, so there is no tax advantage to one choice versus the other. The only difference is that your annuity isn’t taxable on your death – payments simply end in the absence of a guarantee period – but your RRIF is taxable. A RRIF can be transferred to your surviving spouse tax-free on your death, or if you’re the second to die, it’s taxable to your estate and added to the rest of your income for that year.

When making the choice between a RRIF and an annuity, I think you need to consider the following, Igor:

1) The greater your desire for flexibility, the more I would be inclined to choose a RRIF.

2) The higher your investment risk tolerance, the more I would be inclined to choose a RRIF.

3) The more other sources of annuity/pension income you have beyond CPP or OAS, thereby providing a degree of longevity protection, the more I would be inclined to choose a RRIF.

4) The shorter you think your life expectancy will be, the more inclined I would be to choose a RRIF.

5) The higher your desire to provide for a spouse or other beneficiaries on your death, the more inclined I would be to choose a RRIF.

The vast majority of Canadians choose a RRIF over an annuity for their RRSP savings. What’s right for you depends on your personal circumstances, Igor.

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Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.

About Jason Heath, CFP

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.

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