One of the most important decisions an RRSP-holder will ever have to make is what to do with the money in the registered retirement savings plan when the plan is terminated, something that must be done by Dec. 31 of the year in which the investor turns 69.

Why does an RRSP have to be converted into something else? Simple: You have to begin paying the deferred tax accumulated within the plan. For most investors, the challenge is to keep tax payments as low as possible, while drawing down from their savings as long as possible.

There is a good chance that a couple who are both 65 can “live well into their 80s, and have 20 years of retirement or more,” says Judy Thomson, a Toronto-based director with BMO Mutual Funds, a wholly owned subsidiary of BMO Financial Group.

“That’s all the more reason why they need to get the right financial strategy.”

For the vast majority of investors, the choice boils down to two options: roll the RRSP proceeds into a registered retirement income fund (RRIF), or buy an annuity.

These are two very different investment vehicles, and both have pros and cons.

RRIF flexibility
Like many other financial professionals, Warren Baldwin, regional vice-president of T..E. Financial Consultants Ltd. in Toronto, likes the flexibility of a RRIF.

He believes a RRIF is suitable for most investors because it allows them to continue with the same investments they had in their RRSP, and retain control over their portfolio.

But a lot of investors don’t understand that, says Mr. Baldwin; he has heard many people say they don’t want to put money into a long-term RRSP investment because they’re going to be 69 in a few years, and are worried they will have to withdraw it shortly thereafter. “They don’t understand that a RRIF is basically like an RRSP. It will hold all the same investment vehicles,” he says.

Although you cannot make contributions to a RRIF, you can shift the assets inside it, such as selling equities and buying a GIC, just as you can with an RRSP.

While an RRSP focuses on saving for retirement, a RRIF’s job is to provide income for your golden years. A RRIF requires you to withdraw a minimum percentage each year. The withdrawal amount varies, depending on your age, and a couple can elect to use the age of the younger spouse. The remaining investments in the RRIF still accrue tax-deferred interest and continue to grow in value.

RRIFs often appeal to investors who wish to retain autonomy over their investment decisions. “The advantage of the RRIF is that this allows someone who wants to control the types of investments they have in retirement to do that,” says Gena Katz, executive director, tax at Ernst & Young LLP in Toronto.

And in the current low-interest-rate environment, many people opt for a RRIF so they can be flexible with their investments and take advantage of market conditions in the long run, says Ms. Katz.

Annuity a major shift
In contrast to a RRIF, buying an annuity involves a major structural change to your portfolio because you give up control of your money in return for a guaranteed stream of income, usually in monthly or quarterly payments.

Buying an annuity means paying the insurer a lump sum of money; the money is returned to you, with interest, in regular payments. The annuity can run for a fixed period of time, such as 10 or 15 years, or for your lifetime. Determining how long it should run depends on a number of factors, including the investor’s age, expected lifespan and other sources of income.

“If you’re worried that you’re going to outlive your funds, and that inflation is going to take a bite, you might choose to put all or some of [the RRSP proceeds] into a life annuity to protect you for the rest of your life,” explains Lynn Dean, an investment representative with Edward Jones in Halifax.

Annuities can simplify financial planning because you are purchasing a steady payment based on your age and current prevailing interest rates, which solidifies cash flow and makes budgeting easy, especially in the case of a life annuity.

“The annuity has the appealing aspect [of providing] a regular monthly payment of X number of dollars,” Mr. Baldwin acknowledges. But a big disadvantage is what happens to your investment in the annuity if you die prematurely.

“There are a lot of bells and whistles that you have to build on to the annuity to protect that aspect of the capital, whereas with the RRIF the money is always there,” Mr. Baldwin says. He notes that the two big decisions the annuitant will have to make involve whether to have a percentage of the payment stream continue to the surviving partner upon the annuitant’s death, or to the estate if the spouse dies shortly after the annuitant.

That will involve major decisions affecting the length of the annuity and the payment it will make, but “attention has to be given to all of these aspects of the annuity payment because once written, it can’t be changed,” Mr. Baldwin says.

Another disadvantage of settling for a fixed payment is what to do if circumstances change or emergency funds are needed, says Ms. Dean. “Say you’re getting $800 a month in your annuity, and you need $2,500 — you can’t change what you’re getting. That’s locked in.”

Analysts also note that when interest rates are low, as is the case now, people buying annuities could be stuck with a low rate of return for a long period of time.

That’s why one option for people who have a healthy RRSP portfolio is to hedge their bets and convert part of their investments into a RRIF and part into an annuity.

Also, if you initially choose a RRIF, you’re not locked in to that option; you can convert the proceeds into an annuity at any later date. “You may run into a time where you just don’t want to have to manage investments or even think about market conditions any more,” Ms. Katz says. “All you want is the assurance of getting that fixed sum.”

But the reverse is not true: If you put money into an annuity, it’s locked in. The funds cannot be transferred or converted into a RRIF later on.

The third option
The third alternative for closing your RRSP — cashing it out and taking an immediate tax hit on the proceeds — is rarely a good choice, say financial experts.

But, notes Ms. Dean, there are some circumstances where this could be a beneficial move. For example, a single person with a small RRSP who expects to qualify for the guaranteed income supplement might find that he is better off liquidating his RRSP to avoid being pushed to an income level that would disqualify him for the GIS. Such a decision is best made with the help of a financial and tax professional.

Special to The Globe and Mail