This is the fourth of a five-part commentary about an issue central to your financial wellbeing as you approach retirement age. It is an analysis of the sources of income necessary to support your retirement objectives.
In our earlier articles, we provided you with an overview of your various pension plan options as you approach that critical transition into retirement.
We described two company sponsored pension plans – a defined benefit pension plan and a defined contribution pension plan – and explained their distinctions and differences.
Now, we will review personal savings and retirement oriented investments, such as a Registered Retirement Savings Plan (RRSP).
Registered Retirement Savings Plans (RRSPs)
Like many Canadians, you probably have investments within an RRSP that you have built up over the years. Now, as retirement approaches, you may want to start withdrawing that money. What follows is some clarity about the issues involved.
You may access your RRSP savings at any time, but under current tax law you may keep the RRSP money tax sheltered until the end of the year that you turn 71. Once you withdraw any funds from the plan they will be fully taxed. With personal RRSPs you have four choices:
- Withdraw the funds.
- Purchase a Registered Annuity.
- Transfer the funds into a Registered Retirement Income Fund (RRIF).
- Pooled Registered Pension Plan (PRPP).
When you made your RRSP contributions you received a tax deduction, and any income earned in the RRSP was tax sheltered. Therefore, the monies in the RRSP have never been taxed, which means that any withdrawals are fully taxed as income in the year they are received. Given this fact, it is usually not recommended to start receiving the funds until you need them.
By purchasing an annuity with your registered funds, you will receive a steady stream of payments over time, on which you will have to pay tax. The amount you receive from your annuity is based on interest rates that may be low at your time of purchase.
RRSPs are designed to build up funds while RRIFs are designed to pay funds out. RRIFs look just like RRSPs from an investment perspective, with the same flexibility of investment choices. When you establish a RRIF you will be required under tax law to withdraw a minimum amount each year.
This amount will be included in your income for tax purposes. There is no maximum withdrawal limit on an RRIF, so you can take out as much as you need, provided you are prepared to pay the resulting tax. The younger you are when you establish the RRIF, the lower the minimum withdrawals will be.
The Federal government recently introduced the Pooled Registered Pension Plan (PRPP), a new kind of deferred income plan designed to provide retirement income for employees and self-employed individuals who do not have access to a workplace pension. Because individuals’ assets will be pooled, the PRPP will offer investment and savings opportunities at lower administration costs.
An individual can be enrolled in a PRPP by his or her employer, if the employer chooses to participate in the plan. A self-employed individual and an individual whose employer chooses not to participate can open a PRPP account by approaching a PRPP administrator directly. Investment options in a PRPP are similar to those available in a registered pension plan.
The main difference between registered (RRSPs and RRIFs for example) and non-registered funds is taxation. All income received from a registered plan is fully taxed as income at your marginal tax rate. The taxation of non-registered investments depends on the type of income earned. Capital gains, dividends and interest are all taxed differently and will have implications for your income and investment decisions.
In offering this overview of an RRSP investment, it is important to note that integrating your potential pension income streams is an issue that needs discussion with a knowledgeable professional. If you do not have a financial advisor, one of our partner credit unions (Coastal Community Credit Union, Interior Savings Credit Union, or FirstOntario Credit Union) would be happy to help.
Healthy, wealthy and wise is an expression with which we are all familiar. Retirement income planning is a fundamental building block of that crucial challenge as you prepare for one of the most critical of all life’s transitions. Getting informed, professional advice is both sensible and necessary.