Financial advisors help investors get into the habit of saving and building a retirement nest egg as well as taking advantage of the tax deferral in their registered retirement savings plans (RRSPs). But once those clients reach their golden years, the conversation must turn to drawing those assets down and giving the tax authorities their due.
Specifically, in the year investors turn 71 years of age, the assets in their RRSPs must be rolled into an instrument that will yield a minimum annual income, typically a registered retirement income fund (RRIF) or an annuity. The annual income is then taxable.
“The biggest ‘Aha!’ moment [for clients] is how much they have to take out [a year],” says Carissa Lucreziano, vice-president, financial planning and advice, at Canadian Imperial Bank of Commerce in Toronto.
Individuals must draw down at least 5.28 per cent of their total fund in the year after they turn 71; that percentage rises as clients age until it hits 20 per cent at age 95.
“Some clients are pretty astute. They come in prepared and just want to understand what the payments will look like on an annual basis. But for the most part, it’s a really good opportunity to have those discussions and understand the cash flow and what their retirement needs are,” Ms. Lucreziano says.
The first decision will be whether a RRIF or an annuity works best to handle their income needs. With low interest rates pushing down returns on annuities, most clients are opting for RRIFs.
Cash-flow needs and taxes dictate the best strategy for the withdrawal to make each year, but clients also have to develop a long-term investment plan to ensure they don’t run out of money. Ideally, those discussions should begin long before clients reach the age of 71.
Janet Gray, certified financial planner and money coat at Money Coaches Canada in Ottawa, says clients may want to take an income stream from a RRIF even before they hit that age – and they can do a partial conversion of their RRSP to achieve that.
Between the ages of 65 and 71, RRIF withdrawals can offer pension income splitting with a spouse and tax credit advantages for some clients, she says.
“Sometimes, it’s more beneficial to withdraw from a RRIF early, say at age 65, and delay Canada Pension Plan and Old Age Security to age 70,” Ms. Gray says. That’s because the payout rates for those government programs increase significantly if taken at a later age.
Wilkie Kam, vice-president, senior investment advisor, and associate portfolio manager at BMO Nesbitt Burns Inc. in Vancouver, says there’s no one answer on whether delaying government pensions makes sense because it depends on whether the client lives past the break-even age at which there’s a total benefit.
“Life has many curveballs,” he says, adding that the client’s big financial picture is also crucial.
Brad Pashby, financial advisor and financial planner with the Narrative Financial Services Inc. team at Sun Life Assurance Co. of Canada in Vancouver, says that “a good financial planner will find out about the client’s income [sources] and which buckets the client has to draw from.
“What happens if your client is 71 and still working? What happens if they have a group retirement plan through their employer who, up until this point, has been contributing to a group RRSP? … There are a lot of questions [that need to be asked],” he says.
While professionals such as doctors and accountants may have corporate accounts that have to be considered, some clients may have a locked-in retirement account that holds pension money, which must also be converted to an income-producing life income fund (LIF) or annuity at the age of 71. (A LIF has both a minimum and a maximum amount which the client can withdraw each year.)
Mr. Pashby says the least flexible buckets of income should be used first. For example, while respecting regulated withdrawal minimums, pulling more income first from the fund with a withdrawal maximum might prevent a problem in the event of an emergency later in life.
If the minimum withdrawal required is more than a client needs, there are some tactics to consider. Having a younger spouse or common-law partner with whom they can split pension income can keep minimum payments lower, for example.
Some clients like to take withdrawals in lump sums and others prefer monthly payouts.
“I like to tell people to take it out on the 15th of the month,” Ms. Gray says. Most company and government pensions come at the end or the first of the month leaving a wasteland in the middle. “It’s nice to have an influx of cash on that date.”
While advisors and clients should meet annually to plan ahead and rebalance investments, 71 is a good time to reassess a portfolio. There still needs to be the growth engine of equity investments in the RRIF along with more conservative investments, particularly for younger retirees.
“You need to ensure there’s enough liquid cash in the RRIF to meet the withdrawal requirements every single year to avoid paying penalties on early withdrawals [from investments such as guaranteed investment certificates],” Ms. Lucreziano says.
Estate considerations should be taken into account as well, she adds.
“By naming a spouse or common-law partner as the successor annuitant of the RRIF, tax deferral can continue until the spouse or partner takes the withdrawals or passes away to avoid administration and probate fees on the RRIF,” Ms. Lucreziano says.
At some point, and for some clients – namely those who are older and require guaranteed income for housing or health needs – annuities might be an alternative worth considering as they provide a hands-off, certain income stream.
But Mr. Kam points out that the annuity rate is only about 3.25 per cent. And inflation, driven by big national debts built up during the pandemic, is a concern.
“If investors are going to be faced with a high inflation rate and committed to receiving a payment at the low rate we have now, that may affect them,” he says.