Maximizing RRSP Benefits
RRSPs can be topped up or have their contribution room expanded by use of retiring allowances. These include certain amounts of severance pay and amounts received for wrongful dismissal and unused sick leave credits. Such sums can be transferred tax-free to an RRSP. The amounts that can be transferred are limited as follows: $2,000 for each calendar year or part year of employment before 1996 plus $1,500 for years of employment before 1989 for which employer contributions to pension plans have not vested as locked-in benefits for the employee.
Termination of an RRSP can be done in four ways:
- Funds can be withdrawn. At that time, the entire amount becomes taxable as ordinary income regardless of the source of the funds. Capital gains and dividends that would have been taxed at a preferentially low rates outside the plan become taxable at full income rates once dispensed from the plan.
- Funds can be used to purchase an annuity. None of the RRSP proceeds are taxed at the time of purchase but only as paid out by the annuity. Annuities come in many flavours. The highest rate of pay is for the simple life annuity. The life annuity stops when the annuitant dies. A joint and last survivor annuity can pay benefits until the second of two persons, usually spouses, dies. Annuities may also have guaranteed periods of payment so that the death of a person or of spouses still leaves a defined stream of income for heirs or others. Annuities may be set to decline once OAS payments begin, thus preserving them from the clawback, and may be indexed. Financial planners and life insurance agents can explain the intricacies of these plans, often regarded as insurance policies running backwards. The advantage of an annuity is that, once established, it takes no administrative efforts to run it. Market crashes will not affect payouts and the insurance companies that pay them have their own backup rescue plans that use pooled contributions from other insurance companies to pay defined levels of annuity income.
- An RRSP can be converted to a RRIF (Registered Retirement Income Fund). A RRIF is really an addition to an RRSP that makes the plan operate as a payout mechanism. Registered Retirement Savings Plans can be RRIF'd at any age. Registered Retirement Income Funds established in 1993 or later have a minimum payout formula of 1/n x value of RRIF assets at the beginning of the year where n is the number of years remaining until the planholder turns 90. At age 94, 20% of the RRIF must be paid out each year. RRIFs are really self-administered wealth management vehicles. The recipient of RRIF income can continue to invest, to follow stock market fashions, and to prosper or not as his or her wisdom allows. The RRIF is as flexible as the annuity contract is inflexible.
- Finally, a locked in retirement account, often a sum of money held in an account following retirement or apportionment of assets in a divorce, can be converted to a Life Income Fund, LIF, or to a Life Retirement Income Fund, LRIF. LIFs and LRIFs have minimum and maximum withdrawal limits to age 80. Funds in them therefore remain locked in until a person has reached that age. Any funds remaining in the LIF must be used to buy a life annuity by Dec. 31 of the year in which the person turns 80. A life income retirement fund resembles a LIF except that there is no requirement to buy a life annuity at age 80. LIFs operate in all provinces except PEI.