Time flies when you’re saving money.  Lo and behold, you are turning 71 which is the deadline for converting your Registered Retirement Savings Plan (RRSP) into a Registered Retirement Income Fund (RRIF).

A portfolio strategy suitable for accumulating a retirement nest egg may be need to change when it is time to convert to a RRIF. 

Here, there and everywhere

When making annual RRSP contributions it doesn’t matter how many separate RRSP accounts you open.  The tax deduction applies regardless. 

When RRIF payments begin, the investor must withdraw a legislated minimum from the account each year.  If you have five different RRIF accounts, you will receive five separate monthly or annual deposits to your bank account.  In addition, you will have to make sure that there is sufficient liquidity in the account to fund the withdrawals.  That can be challenging if your RRIF is primarily invested in GICs. 

Keep your sanity by consolidating your various RRSP accounts into one RRIF account. 

RRIFs require a different portfolio strategy

Market volatility can significantly impact your retirement cash flow.  Unlike during the accumulation stage, the sequence of returns during the withdrawal phase can have a huge impact on how long the money lasts.  Withdrawing capital after a decline in the value of the portfolio results in a permanent loss of capital that cannot be recovered.  That is one of the reasons why a more conservative investment approach is sensible as you move into retirement. 

A  ‘cash wedge’ strategy is one way of reducing this risk.  Here is how it works:

1.  The cash wedge – One year’s worth of RRIF payments is invested in a conservative, liquid investment such as a high interest savings vehicle.  This part of the portfolio creates a secure base from which you draw your retirement cash flow.

2. Short-term, conservative investments – The second and third years’ projected withdrawals are invested in a low volatility investment, such as short term GICs or fixed income investments.  This part of the portfolio can generate a reasonable return and would be used to “top up” the cash wedge on an annual basis.

3.  Diversified asset mix – The remainder of the portfolio would be invested in a mix of investments suitable to the investor’s investment profile and risk tolerance.  This is the portion that would likely include some amount of conservative equity exposure.  Over time, and opportunistically, profits are moved from this part of the portfolio to the cash wedge and/or short-term portion of the portfolio.

4.  Repeat as necessary

Annuities are worth considering as well.  They aren’t for everyone, but can complement traditional investments in some cases.

It’s time to pay tax

The party’s over.  After receiving tax savings for contributions, and earning investment returns tax free for years, it’s time to pay the piper.  RRIF withdrawals are taxable at the top tax rates.  Here’s how to deal with the inevitable tax hit:

1.  Withhold tax even if you don’t have to – When you elect to receive only the minimum required payment from the RRIF, the RRIF trustee is not required to withhold income tax.  That could mean a nasty surprise when you file your tax return.  The better approach is the estimate your overall tax rate and request that the trustee withhold an appropriate percentage before depositing the net amount to your bank account.  If you over estimate your tax rate, you will get a refund when you file your tax return. 

2.  Split income – 50% of RRIF income can be split with a spouse.  Doing so may reduce the overall tax burden of the family.

3.  Minimize realizing income from non-registered investments – Some Canadians are finding that their RRIF withdrawals are resulting in Old Age Security (OAS) benefits being clawed back.  It may be possible to structure your non-registered investments in such a way as to minimize T3 slips, thereby recapturing lost OAS.  Income splitting can help here too.

If converting your RRSP to a RRIF is on the horizon, meet with your wealth advisor sooner rather than later to ensure that your portfolio strategy reflects that reality.

This information is of a general nature and should not be considered professional advice. Its accuracy or completeness is not guaranteed and Queensbury Strategies Inc. assumes no responsibility or liability.