As the baby boom generation ages, members of that generation must switch their focus from the accumulation of retirement savings to creating a structure which will ensure a steady flow of income throughout that retirement. Those individuals face a particular deadline when their 71^st birthday arrives, as they must, by December 31^st of that year, collapse their RRSP and convert it into a source of retirement income.

The decision to be made is an important one which, once made, can’t be undone. In addition, such decision involves a number of factors which are either unknown, or beyond the control of the individual, or both. And, to add to the pressure, the choice made will affect the individual’s finances for the remainder of his or her life

While the actual decision is a complex one, the options available to a taxpayer who must convert an RRSP are actually quite few in number — three, to be precise. They are as follows:

• collapse the RRSP and include all of the proceeds in income for that year;
• collapse the RRSP and transfer all proceeds to a registered retirement income fund (RRIF); and/or
• collapse the RRSP and purchase an annuity with the proceeds.

It’s not hard to see that the first option doesn’t have much to recommend it. Collapsing an RRSP without transferring the balance to a RRIF or purchasing an annuity means that every dollar in the RRSP will be treated as taxable income for that year. In many cases, that will mean losing nearly half of the RRSP proceeds to income tax. And, while any amount left can then be invested, tax will be payable on all investment income earned.

As a practical matter, then, the choices come down to two: a RRIF or an annuity. And, as is the case with most tax and financial planning decisions, the best choice will be driven by one’s personal financial and family circumstances, risk tolerance, cost of living, and the availability of other sources of income to meet that cost of living.

The annuity route has the great advantages of simplicity and reliability. In exchange for a lump sum amount paid by the taxpayer, the annuity issuer agrees to pay the taxpayer a specific sum of money on a periodic basis (usually once a month) for the remainder of the annuitant’s life. Annuities can also provide a guarantee period, in which the annuity payments continue for a specified time period (5 years, 10 years, etc.), even if the taxpayer dies during that time. The amount of monthly income which can be received depends, of course, on the amount paid in, but also on the gender and, especially, the age of the taxpayer. Currently, the annuity rate for each $100,000 paid to the annuity issuer by a taxpayer who is 71 years of age is about $586 per month for a male taxpayer and about $533 per month for a female taxpayer (the actual rate is set by the company which issues the annuity and will vary somewhat from company to company). Those rates do not include any guarantee period.

For taxpayers whose primary objective is to obtain a guaranteed life-long income stream without the responsibility of making any investment decisions or the need to take any investment risk, an annuity can be an attractive option. There are, however, some potential downsides to be considered. First, an annuity can never be reversed. Once the taxpayer has signed the annuity contract and transferred the funds, he or she is locked into that annuity arrangement for the remainder of his or her life, regardless of any change in circumstances that might mean an annuity is no longer suitable. Second, unless the annuity contract includes a guarantee period, there is no way of knowing how many payments the taxpayer will receive. If he or she dies within a short period of time after the annuity is put in place, there is generally no refund of amounts invested — once the initial transfer is made at the time the annuity is purchased, all funds transferred belong to the annuity company. Third, most annuity payment schedules do not keep up with inflation — while it is possible to obtain an annuity in which payments are indexed, having that feature will mean a substantially lower monthly payout amount. Finally, where the amount paid to obtain the annuity represents most or all of the taxpayer’s assets, entering into the annuity arrangement means that the taxpayer will not be leaving an estate for his or her heirs.

The second option open to taxpayers is to collapse the RRSP and transfer the entire balance to a RRIF. A RRIF operates in much the same way as an RRSP, with two major differences. First, it is not possible to contribute funds to a RRIF. Second, the taxpayer is required to withdraw an amount from his or her RRIF (and to pay tax on that amount) each year. That minimum withdrawal amount is a percentage of the outstanding balance, with that percentage figure determined by the taxpayer’s age at the beginning of the year. While the taxpayer can always withdraw more in a year or make lump sum withdrawals (and pay tax on those withdrawals), he or she cannot withdraw less than the minimum required withdrawal for his or her age group.

Where a taxpayer holds savings in a RRIF, he or she can invest those funds in the same investment vehicles as were used while the funds were held in an RRSP and those funds can continue to grow on a tax-sheltered basis, in the same way as funds in an RRSP. While the ability to continue holding investments that can grow on a tax-sheltered basis provides the taxpayer with a lot of flexibility, and the potential for growth in value, those benefits have a price in the form of investment risk. As is the case with all investments, the investments held within a RRIF can increase in value — or decrease — and the taxpayer carries the entire investment risk. When things go the way every investor wants them to, investment income is earned while the taxpayer’s underlying capital is maintained but, of course, that result is never guaranteed.

On the death of a RRIF annuitant, any funds remaining in the RRIF can pass to the annuitant’s spouse on a tax-free basis. Where there is no spouse, the remaining funds in the RRIF will be income to the RRIF annuitant in the year of death, and any balance after tax is paid will become part of his or her estate, available for distribution to beneficiaries.

While the above discussion of RRIFs versus annuities focuses on the benefits and downsides of each, it is not necessary (and in most cases not advisable) to limit the options to an either/or choice. It is possible to achieve, to a degree, the seemingly irreconcilable goals of lifetime income security and the potential for capital (and estate) growth. Combining the two alternatives — annuity and RRIF — either now or in the future can go a long way toward satisfying both objectives.

For everyone, in retirement or not, all spending is a combination of non-discretionary and discretionary items. The first category is made up mostly of expenditures for income tax, housing (whether rent or the cost of maintaining a house), food, insurance costs, and (especially for older Canadians) the cost of out-of-pocket medical expenses. The second category, discretionary expenses, includes entertainment, travel, and the cost of any hobbies or interests pursued. A strategy which utilizes a portion of RRSP savings to create a secure lifelong income stream to pay non-discretionary costs can remove the worry of outliving one’s money, while the balance of savings can be invested through a RRIF, for growth and to provide the income for non-discretionary spending.

Such a secure income stream can, of course, be created by purchasing an annuity. As well, although most taxpayers don’t necessarily think of them in that way, the Canada Pension Plan and Old Age Security have many of the attributes of an annuity, with the added benefit that both are indexed to inflation. By age 71, all taxpayers who are eligible for CPP and OAS will have begun receiving those monthly benefits. Consequently, in making the RRIF/annuity decision at that age, taxpayers should include in their calculations the extent to which CPP and OAS benefits will pay for their non-discretionary living costs.

As of September 2019, the maximum OAS benefit for most Canadians (specifically, those who have lived in Canada for 40 years after the age of 18) is about $614 per month. The amount of CPP benefits receivable by the taxpayer will vary, depending on his or her work history, but the maximum current benefit which can be received at age 65 is about $1,155. (Where receipt of either benefit is deferred past the age of 65, those amounts go up.) As a result, a single taxpayer who receives the maximum CPP and OAS benefits at age 65 will have just over $21,000 in annual income (or about $1,770 per month). And, for a married couple, of course, the combined total annual income received from CPP and OAS is just over $42,000 annually, or $3,500 per month. While $21,000 a year isn’t enough to provide a comfortable retirement, for those who go into retirement in good financial shape — meaning, generally, without any debt — it can go a long way toward meeting non-discretionary living costs. In other words, most Canadians who are facing the annuity versus RRIF decision already have a source of income which is effectively guaranteed for their lifetime and which is indexed to inflation. Taxpayers who are considering the purchase of an annuity to create the income stream required to cover non-discretionary expenses should first determine how much of those expenses can already be met by the combination of their (and their spouse’s) CPP and OAS benefits. The amount of any annuity purchase can then be set to cover off any shortfall.

While the options available to a taxpayer at age 71 with respect to the structuring of future retirement income are relatively straightforward, the number of factors to be considered in assessing those factors and making that decision are not. All of that makes for a situation in which consulting with an independent financial advisor on the right mix of choices and investments isn’t just a good idea, it’s a necessary one.