Converting RRSP to income

As I said previously, converting RRSPs to income can be a very complex decision. I must re-emphasize that everyone’s situation is unique and different and generalizations can be very dangerous. I will present some examples in this article but be very careful before applying strategies to your personal situation. You should seek the help of a financial advisor or purchase good software programs to help you through the maze of creating income in retirement.

“Income flow possibilities”

Many readers asked me to provide examples of income flow differences between the annuities and the RRIFs. In the following chart, you will see a comparison of some income flows for a $100,000 RRSP for a 65 year old male and female.

If we are looking at income and income alone, the Single Life annuity provides the highest immediate income. This income is guaranteed for the life of the annuitant no matter what happens to interest rates, markets or the economy. Compcorp guarantees life annuities up to $2,000 per month of income per Life Insurance Company.

The disadvantages to life annuity are the inability to make future changes and the loss of any use of the capital. Once annuities are set up with registered funds they are pretty much set up for life.

Looking at these numbers, it is easy to see why most people are choosing RRIFs over annuities today. Take these numbers and add the fact that you retain control over your future income, investment options and decisions of capital and you have a pretty compelling reason why RRIFs are so popular. The only people who tend to choose annuities today are ultra-conservative investors who want a hassle-free approach to income.

Which option is best for you?

You can look at this from a number of different perspectives:

If you feel that you can earn a 9.3% investment return on the RRIF, you can create an equivalent income stream to the single life annuity ($775.97 per month) and protect your capital. In other words, if you feel you can manage an RRIF to earn greater than 9% over time, you should consider the RRIF.

A balanced portfolio of bonds and equities has returned an excess of 9% over the last decade but there can be significant short-term fluctuations from time to time. Nobody can guarantee returns in the future so you and/or your financial advisor must determine if that figure is realistic.

If you are more conservative on your assumptions and think a 7% return on the RRIF is more realistic but would like an income of $775.97 per month (equivalent to the Life Annuity), you can do it with the RRIF. After all, you can set any income amount you want as long as it meets the minimum income requirement. However, setting the income level too high means the capital will exhaust over time. In this example, the capital would exhaust at age 85. Another way to look at it might be, if you know your date of death, your decision would be a lot easier.

Survivor issues

As mentioned in the previous article, comparing income is simply one aspect of choosing the right income option. “Providing survivorship options for your spouse can be facilitated under any route you choose — RRIFs or annuities. In the case of annuities, however, you must make sure they are set up properly.

In the annuity, you are guaranteed to have no survivorship unless you choose the joint-life option or the term to age 90.

Most people will take the RRIF but there was one case I ran across where the annuity was chosen on the basis that the surviving spouse was not inclined to manage money and only wanted to have a fixed income in her bank account. The Joint Life Annuity was chosen without a reduction on the basis of easy management for the spouse should something happen to the primary annuitant. This example further emphasizes the fact that everyone has unique circumstances and while the RRIF appears to be the most popular vehicle of choice for income for registered funds, it will not always be the right choice.

Words of caution

The data in this chart was run in 2002. The chart used here represents a male age 65 in average health. The investment return on the RRIF is 7%. Many variables can change the numbers provided in the chart above. A change in age, health, interest rates, guarantee periods, reduction factors, investment options can alter the numbers dramatically. Use this information with caution and skepticism. If you are converting your RRSP into income, ask a financial advisor to provide numbers specific to your situation.

Next week, I will provide some numbers for LIFs, LRIFs and Life Annuities for Pension money.