Does an RRSP have to be Converted to an RRIF?


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A proverb that dates back to the 1300’s states “all good things must come to an end”. 

Unfortunately, RRSPs are no exception to this rule. By December 31st of the year you turn 71, you must close out your RRSP.

A common method for closing out an RRSP is to convert it into what is called a Registered Retirement Income Fund, also known as an RRIF.

Does an RRSP have to be Converted to an RRIF?

Unlike opening a TFSA or an RRSP, which are no brainers, opening an RRIF has its fair share of pros and cons that you must consider.

If you haven’t opened an TFSA or RRSP yet, I’d recommend doing so with Wealthsimple for the reasons I talk about here.

Because of this, Canadian investors often wonder if there are other options available when it comes time to closing out their RRSP.

Does an RRSP have to be Converted to an RRIF?

When you close out your RRSP, or it matures, it does not need to be converted into a RRIF. If you don’t want to convert your RRSP into an RRIF then you can either cash it out completely as a lump sum or purchase an annuity.

To summarize, the three basic options you have to choose from when you close out your RRSP are:

  1. Convert it into an RRIF.
  2. Make a Lump Sum Withdrawal.
  3. Purchase an Annuity.

It’s important to note that while you don’t have to convert your RRSP into an RRIF, there are pros and cons to the other two options as well, which we will discuss shortly.

Quick Note #1 – These options aren’t mutually exclusive. For example you could decide to convert a portion of your RRSP to an RRIF and withdraw the remainder as a lump sum.

Converting a RRSP into an RRIF

Pros

  • No Conversion Taxes. You don’t have to pay taxes when you transfer your RRSP into a RRIF.
  • You Don’t Have to Liquidate Your Assets. Investments held in your RRSP can be directly transferred to an RRIF. In other words, you don’t need to sell your assets (stocks and bonds) when making the conversion.
  • Tax Deferred Growth. You only pay taxes when you withdraw your money from your RRIF which allows your investments to continue to compound with tax-deferred growth.
  • Keep Control of Your Investments.  You have more say in how much money you wish to withdraw from your RRIF each year which gives you more financial flexibility.

Cons

  • Strict Withdrawal Rules. You must withdraw a minimum amount from your RRIF each year.
  • Withholding Tax. Withdrawing more than the minimum amount will cost you in withholding tax.
  • Withdrawals Count Towards Your Taxable Income. Your annual RRIF withdrawals will count towards your taxable income.
  • Potential Money Shortage. If your withdrawal amounts are continually greater than your investment returns, you run the risk of running out of money.

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Making a Lump Sum RRSP Withdrawal

Pros

  • I tried.. I really couldn’t come up with one positive thing about this option.

Cons

  • Withholding Tax. Withdrawal amount is subject to withholding tax up to 30%.
  • Withdrawals Also Counts Towards Your Taxable Income. Depending on how much you have in your RRSP and where you live, you could end up giving back over half of your withdrawal.
  • No Future Earnings. Once you withdraw this money, assuming you don’t invest this money and have no other income, you won’t have much cash coming into your bank account each month.

We give an example later in the article showing you how it cost Ryan roughly $645,000 to withdraw money from his RRSP. Ouch!

Long story short, don’t withdraw money from your RRSP as a lump sum unless you want to lose most of it.

Use your RRSP Funds to Purchase an Annuity

The purpose of this article is not to dive too deep into annuities, but in short an annuity is a financial product usually used by seniors to guarantee them regular income as they get older.

Does an RRSP have to be Converted to an RRIF?

Pros

  • Guaranteed IncomeAn annuity will guarantee you income for life or a set period of time.
  • No Taxes Will Be Withheld. Your RRSP issuer won’t withhold any taxes on the money used purchasing your annuity.
  • Peace of Mind. Guaranteed income until the day you die will ensure you and your spouse will never have to stress about the potential of running out of money.

Cons

  • Loss of Control – When you purchase an annuity you lose control of your hard earned savings.
  • Lower Returns – Your rate of return will likely be lower than what you could earn with diversified mutual funds or ETFs.
  • Potentially Small Inheritance to Pass On – If your annuity guarantee expires or you didn’t take out a guarantee to begin with, your beneficiaries won’t inherit any of these funds when you die.

Related Financial Geek Article: How to Open an RRSP with Wealthsimple

Should You Convert Your RRSP into an RRIF?

Now that you better understand the different options available to you when it comes time to closing up your RRSP, you might be wondering…. well what option do I choose!

Does an RRSP have to be Converted to an RRIF?

Should I convert my RRSP into an RRIF or should I just purchase an annuity?

Like a lot of personal finance questions, the answer really depends. I know, what a brutal answer, but it’s true!

There is not a one size fits all choice for when it’s time to convert your RRSP into another financial product but my strong recommendation would be to talk to your financial advisor or some sort of retirement planner.

Quick Note #2 – Speak with people who won’t profit over the decision you make. To put it another way, avoid sales people. Speak with independent advisors or experts who have no reason or motive to give you bad advice.

They will look at your situation more personally and be able to figure out the best option for you moving forward.

Things that could be considered when analyzing your situation: 

  • Expected lifetime
  • RRSP Account Value
  • Other Sources of Income
  • Standard of Living
  • Outstanding Debts
  • Other Financial Obligations
  • Inheritance Goals

Based on some of the considerations listed above, plus many more I am sure, a finance professional should be able to point you in the right direction.

Quick Note #3 –  Speaking with a few different people is a good idea as well, a second or third opinion can never hurt.

For many Canadians who have built up 7 figure RRSPs, making the wrong choice here could potentially cost them hundreds of thousands of dollars, if not more.

All this to say, don’t rush this decision. Make sure you continue to do your research so you can make the best possible decision for you and your family.

Why You Shouldn’t Convert your RRSP To Cash

I purposely didn’t include this option in my brief analysis above because I beg you, please don’t convert your RRSP to straight cash.

Once you look at this example, you’ll see why.

A nice chap named Ryan lived in Halifax, Nova Scotia. Over the course of his working career, with regular contributions and solid returns, he accumulated $1,000,000 in his RRSP by the time he wanted to retire at age 65.

Ryan unfortunately didn’t know he could convert his RRSP into an RRIF or purchase an annuity, so he just decided to withdraw his entire $1,000,000 and cash out.

Do you think the next day he had $1,000,000 in his bank account? Nope, MUCH less.

Straight away, Ryan’s RRSP issuer withheld 30% of that money which then went straight to the government.

Does an RRSP have to be Converted to an RRIF?

So right off the bat Ryan lost $300k, poof! She gone.

Okay no big deal, Ryan still receives $700,000 right? Unfortunately not.

RRSP withdrawals count towards your taxable income so Ryan had to pay taxes on his $700,000 withdrawal. (Let’s assume this was Ryan’s only source of income during the year)

While I won’t do the math out here, a Nova Scotia resident (Ryan) with a taxable income of $700,000 will pay roughly $344,835 (Neuvoo Income Tax Calculator) in provincial (21%) and federal (33%) income taxes

Note that the percentages shown in the graph above are based on the original $1,000,000.
NOTE THAT THE PERCENTAGES SHOWN IN THE GRAPH ABOVE ARE BASED ON THE ORIGINAL $1,000,000.

So as you can see from the chart above, after it’s all set and done, Ryan is only left $355,165 which equates to 35.5% of his original $1,000,000 retirement fund.

Guys and girls, please let this sink it.

It cost Ryan $644,835 to access his money, which was basically gone by the time he got it!

Please don’t be a Ryan, I plead.

Quick Note #2: If you haven’t opened up an RRSP yet, but you want to, sign-up for one with Wealthsimple here and get a $50 bonus for doing so.

Conclusion

To conclude, remember that an RRIF is not your only option when it’s time to close up your RRSP.

While converting your RRSP to an RRIF is a solid option, purchasing an annuity is also a very popular choice for many retirees.

Lastly, unless you are in the business of making terrible financial decisions, then don’t withdraw your RRSP as a one-time lump sum payment to yourself.

I want to reiterate, DON’T RUSH this decision.

Having a lack of financial resources during your retirement years could make what should be some of the most enjoyable years of your life a stressful not so enjoyable existence.

All the hard work is already done!  You’ve presumably worked for 40+ years, you’ve been disciplined with your savings, you’ve made smart investments, you’re done! You are there!

All you have to do now  is make one last smart decision and cross the finish line with a responsible exit plan for your RRSP.

Thanks for coming!

Geek, out.


How to Open an RRSP with Wealthsimple

(4-Step Guide)

If you are interested opening up an RRSP for yourself, check out The Financial Geek’s Step-by-Step Guide on how to do so with Wealthsimple.


Noel

Noel is the founder and main contributor for his blog - Noel's passion for personal finance has helped him amass over 600k readers to his Financial Geek blog.

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