No surprise, this post continues the theme I started two days ago about the basic tools and practices to reduce or even eliminate financial stress in retirement.

The first post and part of my second on this topic focused on pensions.  These are an obvious source of income and any citizen or legal resident who has lived in Canada at least 10 years and resides in Canada post retirement will get at least one pension (OAS). So,  a start to meet your post retirement income needs.  As noted you may be eligible for other pensions as well.  This being said pension income might not be enough.

After pensions (most of yesterday’s post) comes savings which can be either or both; registered (tax deferred) or unregistered (after tax).

Which brings us to today’s blog about financial products to turn the  saving into income to complement the pension income stream.  Of course income collection from the savings can be directly from the investments (no specific financial product) and I will talk about that a bit as well.

I was not planning on this being a four part series but I can see I won’t be finishing up until tomorrow with a summary of everything.   Then back to random musings.

Retirement Income Financial Products

Retirement Income Fund (RIF)

The RIF is used to maintain the deferment of tax on a registered product while taking a regular income over time.   The lump sum of a registered product can be transferred to a RIF without payment of tax.  This is you can transfer the funds from a RRSP; however, once the money is transferred annual withdrawals must start.  The minimum withdrawal amount varies with age from 2.86% at age 55 to  20% at 95 plus.    (There are charts showing the various rates by age.)

While you can start a RIF as early as age 55 you must collapse the RRSP by December 31st of the year you turn 71, so in a sense if you are going to have a RIF it is sort of a must have at 72.

By December 31st of the year you turn 71, you can move the balance to a RIF or withdraw all the funds to non-registered accounts (there are penalties for not doing  at least one of these) .

If you don’t move the outstanding balance at that time to a RIF than you will be subject to a withholding tax on the full amount at the time of withdrawal. (The withholding tax rate varies depending on the amount withdrawn.)  The actual amount of taxed owed is adjusted when you submit your annual tax return and the some of the withholding tax could be refunded (or you may need to pay more).  Remember marginal tax rates are linked to the amount of income so collapsing all at once can have negative tax implications.

If you transfer the balance to a RIF and choose to withdraw at the minimum rate no tax is withheld at time of payment and you just pay the tax when you submit your annual income tax return (if any is due).  If you select a withdrawal rate from the RIF higher then the minimum, tax will be withheld from the withdrawals at a rate based on the amount withdrawn.

So in essence a RIF provides you a fixed income amount until you run out of money in the account or die and the balance is transferred to your estate.  (This is a bit more complicated when talking about how your spouse get these funds after you die potentially still tax sheltered but I am not going to get into that here).

I should note depending on how you set the RIF withdrawal rate and how much investment income the RIF is earning you could preserve the capital and depending on your rate of return on investment even grow it.

To clarify the about point about rate of return,  your investment options in a RIF  basically mirrors the RRSP options and in fact you can transfer your RRSP assets in kind so however you had the funds invested in the RRSP can be mimicked in the RIF.  That is initially anyway, but of course overtime some investments might need to be collapsed to meet the minimum withdrawal amounts.   (Although withdrawals can be made in kind too so you don’t have to sell anything but you do need to figure out the associated tax and pay that).

 

Life Annuities

These are a life insurance product.  They can be purchased with registered savings or unregistered savings.

Basically you pay a lump sum and based on forecast future rates of return and how long you will live the insurance company will pay you an annual income till you die (guaranteed).   So what the economy is like when you purchase the annuity, your sex and how old you are determine the monthly payout.   Also there are variations on the annuity products which include single and joint options as well as guaranteed minimum payout periods.

A simple example based on today’s rate for a 65 year old male is a $6000/ yr payment for each $100,000 purchase increment.

In this case you would have to live 16 years just to get your original purchase price back.  If you lived 20 years you would make $20,000,  which is a simple rate of return of 1% a year.   The longer you live the higher the return.

When registered funds were used for the purchase, the monthly payment from the annuity is fully taxed ultimately at your regular marginal tax rate (subject to withholding at time of payment and adjusted on your annual income tax return – just like your employment income was handled).

For annuities purchased with non registered or after tax saving there is a tax on the amount of interest income assessed to be earned on the original purchase amount (e.g.  the 1% in the above example – this rate of return is guessed at based on your normal life expectancy at the time of purchase) but the basic return of the purchase amount over time is tax free (because tax has already been paid on it).

The value of annuities is the income is guaranteed (like a pension) until you die.  The insurance company is basically assuming the investment and longevity risks.  In the case of RIF income when the savings are gone the income stops.  The longer you live the more likely this becomes.

Of course with a RIF you might have some money left for your estate.  Not so with an annuity unless of course you chose one with a guaranteed minimum payout period (these pay out at lower rates though)

Income Direct from Investments

You can choose not to purchase a RIF or an annuity and just withdraw the income from your savings as earned.  For example if you save $500,000 and have a 10% rate of return you could withdraw $50,000 a year in income without eroding your capital.  The investment income would be taxable of course.

AND NEXT

All three of these income vehicles have pro’s and con’s and if you can swing it a combination of all of them (i.e.,  pension, RIF, Annuity and self managed investments) is best (lowest risk, highest return) but more on that in my summary blog tomorrow.