We all know that in the year you turn 71 you will have until December 31 to convert your RRSP into a RRIF or an annuity. Which do you choose?
First, let’s recap the basics.
The year after you set up your RRIF you will have to start withdrawing a mandatory minimum amount. At age 71 the minimum is 5.28% of your balance on January 1. That percentage increases as you get older. Of course, you can withdraw more than the minimum and there is no maximum withdrawal amount for a regular RRIF. For this comparison we’ll use the minimum amount.
You will continue to decide where to invest your RRIF assets and your investments will continue to grow on a tax-sheltered basis, but the amount you withdraw is taxed at your marginal tax rate.
On your death, the remaining assets are generally transferred to the surviving spouse, tax free, or goes to your estate and is taxed.
An annuity is a specialized financial product provided by an insurance company. In exchange for a lump sum investment from your RRSP you receive regular retirement income for the rest of your life.
Once you choose to purchase an annuity there is no access to your capital. You basically are giving it up for a guaranteed income that never decreases. It creates a personal pension plan for those without pension plans.
Annuity income is based on several factors:
- The purchase amount.
- The type of annuity purchased.
- Current interest rates.
- Age and gender of the annuitant (and survivor for a joint annuity).
- The selected payment guarantee.
- Expense and mortality experience of the insurance company.
Comparison between a RRIF and an annuity
Evan and Rebecca, childhood sweethearts, have been married for fifty years. They are both 71 years old. If they choose the RRIF option for Evan, Rebecca will be designated the successor annuitant, which means she will continue to receive the original payment set up after Evan’s death.
Evan’s twin sister, Evelyn, is single and on her death the remaining RRIF balance goes to her estate.
The following chart shows a RRIF containing a sum of $500,000 at the beginning of the year following set-up. We’ll assume an average annual rate of return of 4% and the minimum payment is withdrawn monthly.
The chart shows the percentage, as well as the monthly withdrawal, increases every year until age 95. After that age the payments start to decrease quite a bit. This decrease will obviously be a concern to those who believe their longevity will be much greater than average.
One of the reasons why annuities were not popular was the fear that once you handed over all your life savings you’d be hit by a bus after leaving the office. The industry addressed this fear by introducing Term Certain annuities which provide guaranteed income for a specified period of time.
These annuity figures were provided (with my thanks), by Steve Krupicz from Manulife.
Let’s look at a joint-life annuity purchased with the same $500,000 at age 71. At Evan’s death, Rebecca will continue to receive the same monthly payment.
This is what Evan (and Rebecca) could receive:
- A three year guaranteed income period would pay out $2,275 per month.
- A fifteen year guaranteed income period would pay out $2,163.02 per month.
On the other hand, a 15-year guaranteed income period annuity would pay Evelyn $2,493.92 per month but there would be no residual funds to her heirs if she dies after that term has expired.
Clearly, the income from the RRIF is higher for someone who may be considering a joint and survivor life annuity and, for most years, the opposite is true for a single annuitant.
However, your RRIF investments will likely not have a linear 4% return every year. What if your investments should drop by 8%? 15%? Or even 30% or more? Either your minimum payment (your income) will decrease, or you will take out a greater percentage thereby reducing your capital more.
The advantage of an annuity is the payment is guaranteed month after month until you (or your joint annuitant spouse) dies. This is especially beneficial if your spouse is considerably younger than you are.
Yes, some of you like the greater flexibility of a RRIF in terms of gaining access to your capital and leaving a sum to your heirs.
It therefore can make sense to combine the two options.
I suggest you try to cover your basic retirement expenses with an annuity combined with your CPP, OAS, and any other pension income you may be receiving to give you a guaranteed income stream for life. This allows your RRIF to provide you with investment growth opportunities and easier access to your money for your more enjoyable lifestyle expenses.