In my financial education programs for the workplace, I always get lots of questions on how to draw income from registered plans whether that's RRSPs or Pension plans. Here's a list of income options for RRSPs and Pensions
Options for regular RRSPs
RRSPs must be converted to income, not later that December 31st in the year in which you turn 71. You can convert your RRSPs to income sooner but you can't delay it past age 71. When it comes time to convert your RRSPs you have one of four options:
- Cash out the RRSP. Unless you have a fairly small RRSP, this option may be very costly because your entire RRSP will become taxable in the year of withdrawal.
- Life Annuity. A life annuity is really another word for a pension. In the conversion to a life annuity, you simply give your money to a life insurance company. In turn, they pay you a fixed stream of income that is guaranteed for the rest of your life. Once you pass away, your income stops. There are many variations of annuities (joint, guarantee periods, reduction factors, indexing). For more information on Life Annuities, check out me Online Guide to Life Annuities
- Term Annuity to age 90. The Term Annuity to age 90 is the same as a life annuity. However, regardless of your life expectancy, the annuity is paid until you reach age 90. If you pass away before age 90, you can designate a beneficiary to continue to receive the payments.
- RRIF. The RRIF is by far the most popular income option for RRSPs. It is flexible in many aspects. You can select the investments, income frequency, and amount of income. You can also make changes to all of these aspects in the future. For more information on RRIFs, check out my RRIF online Giude.
Which income option is best for you?
There has always been a debate over which is better: RRIFs or annuities. Both the RRIF and the annuity have their usefulness in a retirement plan. RRIFs give you plenty of flexibility and options. Life Annuities remove any flexibility but give you predictability of income and the security of knowing you won’t outlive your money. If you are not sure which is better, you have to run the numbers to really understand how much income you will get from each. If you can't do this yourself, you will need to seek the help of a Financial Advisor.
Related article: RRIFs vs Annuities – which is better?
Options for pension money
For anyone who has left an employer prior to retirement, chances are you have moved your pension money into a Locked-in Retirement Account (LIRA). A LIRA is similar to an RRSP except that it contains money that has been deposited through a pension. There are different rules when it comes to converting pension money into income.
Firstly, there is no option to cash out pension money. Pension money is always designed to provide lifetime income. Legislators were concerned that retirement plans could be taken out prior to retirement and exhausted before your death.
- Life Annuity – In the past, the life annuity was the only option for pension money. In the early 90’s, legislators developed some options to deal with Canadians who were not staying with the same employer for their working career. You still have the option of selecting a life annuity.
- Life Income Fund (LIF) – The LIF is very similar to a RRIF. You have the flexibility of choosing your investments, your income frequency and your income level. The only difference is that there is an imposed maximum income that you can withdraw each year. The maximum income is based on a factor known as the CANSIM rate. The LIF must eventually be converted to a Life Annuity (age 80). LIF rules differ from province to province so check the pension legislation for your area for more detailed information.
Which option is best for you?
To make the right decision, you will need to run some projections so you can compare the income levels from the three different income options.
If you are looking for immediate income the life annuity is likely to be your best bet. This will depend on the rate of return assumptions you use when projecting a LIF. When it comes to buying an annuity, you should shop annuities with different insurance companies. Annuity rates can vary drastically from one carrier to another. Once an annuity is set up, it is set up for life. There are no provisions for flexibility and change. You must also be aware of the survivorship issues if you are considering life annuities.
Related article: The math of Life annuities
If you are looking for more flexibility, you may also be given the option to purchase other retirement income vehicles like the LIF. While you may give up some current income, you will have lots of flexibility and control for the future. For example, you might elect to use a LIF until interest rates go up at which time to can lock into higher rates with a Life Annuity.
Just like RRIFs are more popular for registered plans, LIFs and LRIFs should grow in popularity over Life Annuities or pension funds.
One more thought
Pension legislation can be very confusing. Every province has it’s own pension rules and there is a separate legislation for federal pension plans. Not only is the subject more confusing, there is less mainstream information. In bookstores you will find lots of books on financial, investment, and retirement planning. You might find a few pages on pension plans but it will be basic. Before you make any significant decisions to move your pension plan money out, make sure you see a qualified professional.