Making Sense of RRIF’s, LIRA’s and LIF’s

September 12th, 2016

Many of us know what an RRSP is, but for a lot of people, retirement investment tools like RRIF’s, LIRA’s and LIF’s are an alien language. My goal in this article is to shed some light on these important but sometimes poorly understood tools.

Before going any further we should translate the acronyms into English:

RRSP – Registered Retirement Savings Plan
RRIF – Registered Retirement Income Fund
LIRA – Locked-In Retirement Account
LIF – Life Income Fund

RRSP’s and RRIF’s, LIRA’s and LIF’s are not investments as such. They are “vehicles” that contain actual investments such as stocks, bonds, mutual funds and exchange traded funds. These vehicles are used to accumulate retirement savings (in RRSP’s and LIRA’s) and to provide retirement income (RRIF’s and LIF’s) in a tax sheltered environment.

VEHICLES FOR INDIVIDUAL SAVINGS

Different vehicles are used, depending on the starting point. First off, we’ll look at RRSP’s and RRIF’s which are the vehicles for funds contributed directly by the individual.

Registered Retirement Savings Plans

Registered Retirement Savings Plans or RRSP’s are voluntary retirement saving plans that provide the most significant tax savings opportunity and the most effective way for individual Canadians to save for retirement.

Contributions, subject to maximums, are tax deductible. Funds inside an RRSP accumulate free of tax, which defers income taxes on the investment income, potentially for decades. All funds withdrawn from an RRSP are taxable. If these withdrawals are deferred until after you’re fully retired and pay cheques stop landing in your bank account, it is likely that your income has dropped and you are in a lower tax bracket.

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Registered Retirement Income Funds

An RRSP can be closed at any time, but it must ultimately be closed no later than the end of the year in which you turn age 71. At this point, you have three options. The first is to take all the assets in cash. From the point of view of the income taxes payable, this is usually unthinkable. The second option is to purchase a life annuity from an insurance company. Given today’s low level of interest rates, this is not an attractive option. The third is to transfer the assets into a Registered Retirement Income Fund or RRIF. The rules for eligible investments in RRIF’s are the same as the rules for RRSP’s.

There are several changes after you transfer your RRSP assets to a RRIF. The first is that you cannot contribute to a RRIF. In fact, you are now required to withdraw a minimum amount each year. The amount is a percent based on your age and the market value of the RRIF on January 1 of that year. Note that you have the option to use your spouse’s age, if younger. There is no tax withheld, if you withdraw the minimum amount. There is no limit on the maximum amount that can be withdrawn, but keep in mind it is fully taxable.

In effect, an RRIF takes the accumulated savings of a RRSP and spreads the income over the rest of your life while at the same time investing, tax free, the funds not needed to cover the mandatory withdrawals.

The table below, shows the minimum percent withdrawal factors for RRIFs

VEHICLES FOR FUNDS FROM A COMPANY PENSION

A different set of vehicles must be used when the source of funds is a company pension plan.

Locked-in Retirement Accounts

When a member of a defined benefit or defined contribution pension plan leaves an employer, one of the options available is to transfer the value of their pension benefit to a Locked-in Retirement Account or a LIRA. A LIRA is like an RRSP but with additional rules that restrict the use of the funds to the provision of a life time retirement income. You can withdraw money at any time from an RRSP but you are locked in until you retire with a LIRA. (This restriction is imposed by the federal or provincial legislation that regulated the original plan and there are significant variations from province to province.)

LIRA’s are subject to the same investment rules as RRSP’s. The funds held in a LIRA accumulate on a tax deferred basis.

Life Income Funds

As is the case with RRSP’s, LIRA’s must be closed no later than the end of the year in which you turn 71. Taking the cash in a lump sum is not permitted. In Ontario there are two choices: to purchase a life annuity or to transfer the funds to a Life Income Fund.

The rules for minimum withdrawals from a LIF are identical to those for RRIF’s. The significant difference compared to RRIF’s is that the appropriate pension legislation imposes a maximum percent that can be withdrawn in any year. Again, the percent factor is based on your age with no option to use your spouse’s age.

The factors vary by the relevant pension legislation. The federal government and each province use different formulae to calculate the factors. In general, they are based on prevailing interest rates which means that they can change from year to year.

The table below, shows the maximum withdrawal factors for LIF’s in Ontario in 2016.

To illustrate, assume

  • You live in Ontario
  • You have $500,000 in a LIF at January 1, 2016
  • As of January 1, 2016, you are age 75

The minimum amount that you are required to withdraw from the LIF is $29,100. The maximum amount that you will be permitted to withdraw is $48,550.

CONCLUSION

Depending on your situation, some of these vehicles may be more or less relevant to your retirement. That said, for most of us a significant part of our retirement income will depend on them, so it’s important to understand how they work.