I receive a lot of questions from investors who want clarity on the nature of Registered Income Funds (RIFs) and really, RIFs are very simple and flexible vehicles. At age 71, everyone who has an RRSP has to convert the RRSP to a RIF. In reality, all this means is that a new account has to be opened and the holdings in the RRSP have to be transferred to the new account called a RIF. The actual investments don't necessarily have to change at all. Once you have a RIF, you cannot add to it. In fact, at age 72 you have to withdraw a minimum amount every year until you pass away or it runs out of money. The withdrawal amount is based on the balance in the RIF on December 31st of each year. That number is multiplied by a percentage which is based on your age and is stipulated by the government. Here are the current RIF minimum withdrawal percentages. The income that is withdrawn is fully taxable and you will receive a tax slip each year for it. If you take the required minimum from your RIF, then no withholding tax has to be taken. Withholding tax is just an amount that is remitted directly to CRA (Canada Revenue Agency) to prepay tax that may be owing at tax time. If you don't owe that amount at tax time then CRA will credit your account when they complete your review. You can also elect to take more than the minimum amount. In this case, withholding tax will be taken and how much is based on the amount withdrawn: On amounts up to and including $5,000 10% will be withheld, over $5000 and up to and including $15,000 - 20% and on amounts over $15,000 - 30% will be withheld.
Many investors are unaware of the flexibility of the RIF vehicle. Here are three highlights:
- RRSPs can be converted into RIFs at any point prior to age 71.
- RIFs can be converted back to RRSPs at any point prior to age 71 (e.g., the investor decides that they do not want to take the income).
- Prior to age 71, an investor can choose to convert only a portion of their RRSP to a RIF and the amount that has to be withdrawn will be based on the December 31st balance.
For example, an investor with a large RRSP who retires at age 60 may decide to convert a portion of her RRSP at age 60 so that she receives income to live on at a very low tax rate because she no longer has her employment income. She also knows that, if she waits until age 71 to convert and draws at age 72, her income will be higher because she will be receiving CPP (Canada Pension Plan), OAS (Old Age Pension) and RIF income.
It’s important for investors to be aware of what happens to RIFs when the investor dies. RIFs are a registered account and, therefore, have a designated beneficiary. This means that they pass outside of the will. This means that, when the investor passes, the funds can be immediately distributed to the beneficiary. Typically, spouses have each other as beneficiaries and, when one dies, the holdings are transferred into the spouse's RIF and there are no tax consequences. However, if the spouse is not the beneficiary, then there is tax payable. Upon death, the account can be liquidated and the funds sent to the beneficiary, but the estate (executor of the will) will be required to pay the tax bill to CRA. The tax owing is based on the amount remaining in the RIF which is deemed sold on the date of death. That amount is considered income, which the estate will receive a tax slip for and it will be added to any other income the individual earned in her final year of life and taxed accordingly. For example, if in an average year an individual earns $40,000 from various pensions and is in a low tax bracket, but has $200,000 in a RIF when she dies, then her total income in the year of death will be $240,000 and taxed at a much higher rate. It is for that reason that attention should be paid to the balance in one's RRSP and RIF when doing tax planning. Converting to a RIF early or withdrawing more than the minimum may be prudent strategies. As always, best to check with your accountant before making any change to fully understand the tax consequences.