Trust Reporting for the 2024 Tax Year: Here’s What You Need to Know
We want to keep you informed of an important update from the Canada Revenue Agency (CRA) this week regarding trust reporting requirements for the 2024
Home » News » Accounting News » RRSP Contribution Explained
An RRSP contribution can generate a tax refund of 43 percent for high-income earners; it is viewed as a good tax strategy.
But what happens when an individual has already retired and wants to reap the benefit of the hard-saved RRSP dollars contributed over the years?
An individual must terminate RRSPs by December 31 in the year he or she turns 71. The following options are available.
In the case of the lump-sum payment, the withdrawal is taxable. That may not be the most effective tax strategy.
Given the current level of interest rates, if the funds are used to purchase an annuity, the annuity will be locked at the low rates. The corresponding monthly payments throughout retirement will remain low.
Registered Retirement Income Funds
An RRIF is like an RRSP in that it is a vehicle for growing investments but the individual is not allowed to make contributions. Since the RRIF is the extension of the RRSP, it may be self-directed and can hold the same investments as an RRSP.
Starting the year after the RRIF is established, a minimum amount must be withdrawn each year, calculated on a percentage of the market value – between 7.38 percent at the age of 71 to a maximum of 20 percent after the age of 94.
If a person starts to withdraw funds from the RRIF before age 71, the minimum annual withdrawal is calculated every year using a formula that divides the difference between 90 and the age of the individual at the start of the year over the fair market value of the RRIF at the beginning of the year.
In considering whether to transfer the RRSP to a RRIF, an individual must keep in mind the following points.
Registered Retirement Income Funds at Time of Death
If the individual is married or has a common-law spouse, there are a number of planning options available to the owner of the RRIF.
Lump-Sum Payments
Individuals can close their RRSP by withdrawing the funds as a lump-sum payment. Those payments are included in income and may push the individual into a higher tax bracket, which may not be a favourable option for the retiree. That may not be as important if the individuals are already in the highest tax bracket when they retire or reach 71 but this strategy will eliminate the tax-free deferral if the funds are transferred to the RRIF.
The strategy to withdraw funds may be useful when the individual wants to withdraw funds from RRSP between the date of retirement and when the funds are transferred to the RRIF. That strategy is used when the individual requires funds to finance his or her lifestyle if other income is not sufficient.
When the funds are withdrawn from the RRSP, they are subject to withholding tax as follows:
Annuity
The funds of an RRSP can be used to purchase an annuity, usually from an insurance company. With an annuity, the individual will receive a monthly income for the remainder of his or her life. The amount of the monthly income will be based of various factors.
With the annuity, an individual receives a fixed stream of payments for the remainder of life. A younger individual likely will live longer than an older individual and thus will receive annuity payments for a longer period — so the younger individual, the lower the payments. Higher interest rates at the time of purchase result in higher monthly payments, as well.
The annuity payments stop when the individual dies. Some annuities offer options where payments are guaranteed for a determined period to offset the risk of early death, but those options will reduce the number of monthly income streams.
A disadvantage of purchasing an annuity — other than when the interest rates are low — is that it does not offer inflation protection and flexibility. Once the annuity is purchased and the payments established, the annuity does not provide for additional funding in case the individual requires more income. On the other hand, the RRIF option provides for additional funds to be withdrawn if necessary, over and above the minimum annual withdrawal.
Annuity payments are usually fixed for the life of the annuitant, therefore inflation is an issue. The individual can purchase an inflation-protection option but of course, that option will lower the monthly payments.
Generally, annuity payments stop when the individual dies. There are, however, various options available to individuals to receive annuity benefits after the death of the annuitant.
To conclude, any individual must consider various circumstances while deciding if the RRSP should be transferred to a RRIF or should be used to purchase an annuity — or a combination of both.
The issues to consider include the following:
Guaranteed Payments
Change in Needs
Flexibility
Age
Tax Sheltering
Life Expectancy
The information in this article should not be used in any actual transaction without the advice and guidance of a professional Advisor who is familiar with all the relevant facts. Although the information contained here is presented in good faith and believed to be correct, it is general in nature and is not intended as tax, legal, or investment advice. Furthermore, the information contained herein may not be applicable to or suitable for the individual’s specific circumstances or needs and may require consideration of other matters.
If you would like more information on this topic, please contact a member of the Empire CPA team by filling out the contact form below.
Canadian and foreign tax laws are complex and have a tendency to change on a frequent basis. As such, the content published above is believed to be accurate as of the date of this post. Before implementing any tax planning, please seek professional advice from a qualified tax professional. Empire, Chartered Professional Accountants will not accept any liability for any tax ramifications that may result from acting based on the information contained above.
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