Converting an RRSP to a RRIF doesn’t have to be permanent, and the RRIF or a portion of it can be rolled back into an RRSP as long as the minimum withdrawal required for the year is paid out of the RRIF.DEAN HINDMARCH/iStockPhoto / Getty Images
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Retirement these days doesn’t always mean leaving the workforce without a backward glance. Some retirees shift to part-time work, pick up consulting jobs, or start a business. So, should people in their 60s with earned income still be contributing to a registered retirement savings plan (RRSP)?
“More so in the past five years, people are leaving that career job and then doing something else in their 60s prior to full retirement,” says Terri Szego, senior investment advisor and senior portfolio manager with Szego Jones Szego Lawrence Wealth Management at BMO Nesbitt Burns Inc. in Toronto.
“Whether they should be making [RRSP] contributions … comes down to what their marginal tax rate is at in their 60s, versus what they expect it will be when they’re forced to convert into a [registered retirement income fund (RRIF)] at age 71,” she adds.
With a low marginal tax rate today, the tax savings resulting from an RRSP contribution are modest and the money won’t have much time to benefit from tax-deferred compounding within the RRSP. Ms. Szego says that may be an opportunity to save extra money somewhere else, such as in a tax-free savings account (TFSA).
For example, consider someone who retires and takes a part-time job at a tennis shop simply because they enjoy interacting with other people who love tennis, she says. If they earn $25,000 a year from that job, even if they’re taking the Canada Pension Plan (CPP) and Old Age Security (OAS) at the same time, their marginal tax rate will likely be around 20 per cent.
“If they have quite a sizeable RRSP, then when they convert that to a RRIF, we’re going to assume they’re going to be in a higher tax bracket than 20 per cent. In that case, I would say, ‘Don’t put that money into an RRSP,’” Ms. Szego says.
“We might even say, ‘Hey, you should be actually taking an extra $20,000 or $25,000 from your RRSP today because your income is fairly low at the moment.’”
That decision would be very different for a retiree who is earning an annual consulting income of $120,000 at a marginal tax rate of 43 per cent. In that case, Ms. Szego says making an RRSP contribution could provide a valuable tax deduction and reduce OAS clawbacks.
Erin Roy, financial advisor with Edward Jones in Bayfield, Ont., adds that seniors with a relatively high income can defer CPP and OAS so they receive a higher amount later.
Furthermore, depending on their spouse’s income situation, they may want to use their RRSP room to contribute to a spousal RRSP instead of their own – keeping in mind that the attribution rules kick in if the money is withdrawn too early.
When providing advice to couples in this situation, Ms. Roy always considers the retiree’s and spouse’s ages because someone who leaves a full-time position at 47 rather than 67 has much longer to enjoy tax-deferred growth in an RRSP. She also looks at how much money they have and the impact of potential future asset sales and inheritances.
“Run scenarios making different assumptions [and] the correct approach will generally reveal itself,” Ms. Roy says.
When to convert an RRSP to a RRIF
Sometimes, it makes sense to convert an RRSP into a RRIF before it’s required, which is at the end of the year a client turns 71. But that’s not always the case, Ms. Roy says.
For example, clients may only need to dip into their registered savings to cover a one-time expense such as taking their family on a trip. In that case, it may not make sense to turn the RRSP into a RRIF and commit to regular minimum withdrawals.
However, if clients need a regular stream of income from registered investments to supplement their income in their 60s, Daryl Diamond, certified financial planner with Diamond Retirement Planning Ltd. in Winnipeg, often converts the RRSP into a RRIF before a client turns 71, partly for convenience. But there’s more to it than that.
“If someone is aged 65 and over, an RRSP withdrawal doesn’t qualify as eligible pension income for the pension credit – so, we want to make sure we have at least $2,000 worth of actual RRIF income,” Mr. Diamond explains. “Under the age of 71, if an individual either wants that pension credit or wants to split their income [from their registered savings] with a spouse, it must be in the form of a RRIF.”
Furthermore, he emphasizes that converting an RRSP to a RRIF doesn’t have to be permanent.
“As long as the minimum withdrawal that’s required for the calendar year has been paid out of a RRIF and the client is under the age of 71, we can roll that RRIF – or any portion of it – back into an RRSP.”
Have an RRSP exit strategy
Mr. Diamond says what always surprises him is that there’s still this belief among clients that they should defer their RRSP deductions as long as possible. Yet, what’s most important is “to make your [RRSP] contribution at a higher marginal tax rate than [the one you have when] you bring it into income.”
Thus, the aim should be to develop a strategy to unwind the RRSP in the most tax-favourable manner, he adds.
Some people defer their RRSPs, CPP, and OAS all the way to age 70, and then they’re obligated to receive all that income whether they want to or need to, he says.
“It’s a matter of how do we use all these different assets in a way that allows them to work in tandem, just so that the whole scenario is far more tax-efficient all the way through retirement,” Mr. Diamond says.
That’s a big reason why Kevin Hurlburt, executive vice-president, products and services, at Mississauga-based Investment Planning Counsel Inc., says advisors should become retirement income specialists.
The years in which clients approach and enter retirement are times when they may consider switching advisors. That can benefit those with the specialized skills to help clients make decisions about RRSPs, RRIFs, and every other aspect of retirement income planning.
“We know that something like more than half of all investors who are going to change advisors do so around retirement age,” Mr. Hurlburt says. “There is a tremendous opportunity for good advisors to be able to introduce themselves to new clients.”
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