RRIF versus ANNUITY
This article was written by James Kraft, Deborah Kraft and Ian Taylor and reproduced from the Canadian Association of Insurance
and Financial Advisors, January, 2001 .
When your Registered Retirement Savings Plan (RRSP) matures, you (as the plan holder or "annuitant") have three choices. The first, collapsing the plan, will create an immediate tax liability on the full value of the RRSP. You have, however, two tax-deferred choices - a Registered Retirement Income Fund (RRIF) or an annuity.
A RRIF is structured to pay out a minimum annual income, based on a government-legislated schedule, starting in the year following the RRIF purchase and continuing for the plan holder's lifetime. The minimum payout increases year over year, based on the age of the RRIF holder as of January 1st of each year (or on the age of a younger spouse or, beginning in 2001, a common-law partner if this decision was made at the time of purchase). At age 70 for example, the minimum payout is 5%, whereas at age 80 it is 8.75% and increases to 20% annually, beginning at age 94.
All income received from the RRIF is fully taxable to the plan holder in the year it is received. While there is an annual minimum payout required, there is no maximum limit on the withdrawal. A RRIF provides the plan holder with the opportunity to continue to manage and access the remaining capital. This creates the potential for continued capital growth; however, depletion of capital occurs when the minimum payout exceeds the investment earnings. With a RRIF, the plan holder assumes the investment risk.
A RRIF holder may choose to draw any amount of income from the RRIF, but income withdrawals directly affect the amount of capital that remains. Minimum income is not guaranteed as a dollar amount but differs annually based on the increasing percentage rate applied to the value of the fund assets at the beginning of each year. Investment and income flexibility are RRIF features that must be considered relative to investment risk and capital depletion.
An alternative to a RRIF is an annuity. Two types of annuities may he purchased on a rollover from an RRSP - a term -certain annuity to age 90 (measured by thee age of the plan holder or, if younger, the spouse or common-law partner) or a life annuity. Life annuities offer an income guaranteed for as long as the annuitant lives, or as long as either one of the annuitant and the spouse or common-law partner lives. The amount can also be guaranteed beyond the annuitant's lifetime through a guarantee period (up to age 90 of the plan holder or, if younger, the spouse or common-law partner). The longer the guarantee period, however, the lower the annuity income. Calculation of income is based on the capital available and actuarial tables that reflect the life expectancy of the annuitant or Joint annuitants. These actuarial tables differ from those used for life insurance. Income from either type of annuity is fully taxable as the annuitant receives it.
Annuities may appeal to those who do not wish the risk of managing investments, those who feel that there is longevity in their genes or those who desire a guaranteed steady income flow. The downside of an annuity is the loss of access to capital. Once purchased, the individual has a locked-in flow of income but no access to the underlying capital.
A RRIF or a life annuity are both good options depending upon the individual's specific circumstances. Rather than picking a single option, one strategy is to use a combination of a RRIF and an annuity. Splitting the capital between an annuity and a RRIF can provide guaranteed income and capital growth potential.
Another alternative is to begin with a RRIF and convert to an annuity (on a tax-deferred basis) at a later time. Age of the annuitant and income work together; the older the annuitant is when the annuity begins, the higher the income amount. This may make the annuity more attractive at older ages (as would an unwillingness or inability to continue to manage a self-directed RRIF at more advanced ages).
Strategies for handling your RRSP at maturity should not be driven purely by the numbers but should consider important qualitative features relative to your specific circumstances.
