Planning strategies for Registered Retirement Income Funds

by Invesco Tax & Estate team, Invesco Canada

The 25 per cent reduction in mandatory Registered Retirement Income Fund (RRIF) minimums for 2020 was one of a handful of tax relief measures the Canadian federal government implemented as part of its COVID-19 economic stimulus. The government has made similar changes in the past, with the RRIF minimums temporarily reduced by 25 per cent in 2008 amid the global financial crisis. RRIF minimums also came into focus in 2015, with the government lowering the prescribed factors it uses to calculate minimum withdrawals. Reducing RRIF minimums is aimed at increasing financial longevity for individuals in retirement who are living longer. The government has also changed the age at which Registered Retirement Savings Plans (RRSPs) mature several times over the years. Originally set at age 71, it changed to age 69 in 1996 and changed back to age 71 in 2007.

What has changed in 2020?

The federal government has reduced mandatory RRIF minimums by 25 per cent for 2020. This change also applies to locked-in plans, such as Life Income Funds (LIFs) and Locked-in Retirement Income Funds (LRIFs). Unlike in previous years, if an annuitant has already received an amount in excess of the reduced minimum, he or she cannot recontribute the difference between the reduced and unreduced minimum to the RRIF. Built into the changes are the following exceptions:

• RRSP and RRIF spousal attribution only applies to excess amounts withdrawn above the unreduced minimum
• Withholding tax only applies to excess amounts withdrawn above the unreduced minimum
• For non-residents, the calculated periodic pension payment (PPP) is based on the unreduced minimum

In the current environment, seniors are looking for strategies to help them get the most out of their RRIF investments, in addition to lowering their overall tax bills. When an RRSP matures, conversion to a “traditional” RRIF is not the only option. In fact, it may make sense to purchase an annuity with some or all of the RRSP/RRIF proceeds to help mitigate longevity risk and offload investment risk to a financial institution. Here are some additional planning strategies to consider.

1. Choose to reduce RRIF minimum for 2020: If the client’s finances allow it, contact the financial institution and reduce withdrawals to match the new RRIF minimums. This reduces the tax impact of withdrawals and permits more capital to remain invested. Recall that if the unreduced minimum amount has already been paid, there is no opportunity to recontribute the amount above the reduced RRIF minimum to the plan.

2. Invest the withdrawn RRIF minimum: After the year the RRIF is established, the annuitant must withdraw the annual mandatory RRIF minimum and report it as taxable income. If the annuitant does not need some or all of the RRIF minimum, those funds may transfer from the RRIF to a non-registered account, or to a Tax-Free Savings Account (TFSA) subject to available TFSA contribution room. It is possible for the capital to remain invested in the underlying funds, while satisfying the requirement to recognize the RRIF minimum as taxable income in the year. Annuitants under age 72 can transfer all or some of a RRIF withdrawal to an RRSP and reduce the RRIF minimum for future years.

3. 3. Lower the RRIF minimum by using a spouse’s age: When setting up a RRIF, an annuitant can base the RRIF minimum calculations on either his or her own age, or on the age of his or her spouse or common-law partner. To maximize the amount that can continue to grow on a tax-deferred basis in the RRIF, many annuitants choose to base the calculations on the younger spouse’s or common-law partner’s age, as the RRIF minimum factors increase with age. The annuitant must make the election to use a spouse’s or common-law partner’s age before the first RRIF withdrawal.

If a RRIF already exists and the annuitant wants to use his or her spouse’s age to calculate the RRIF minimums, the annuitant is generally permitted to transfer funds to a new RRIF and use the spouse’s age. Discuss details of this type of transfer directly with the financial institution.

4. 4. Make spousal RRSP contributions and withdrawals: Retirees often continue to pursue gainful employment well beyond the traditional retirement age of 65. Employment income continues to generate RRSP contribution room, even if the retiree can no longer hold an RRSP for himself or herself. However, if the spouse is under age 72, the retiree can contribute to a spousal RRSP and receive a corresponding deduction against the contributor’s income. Note that income attribution to the contributor spouse applies if the annuitant spouse makes a withdrawal before the end of the second calendar year following the spouse’s contribution. For example, a contribution made in January 2020, though deductible by a spousal contributor for the 2019 tax year, occurred in the 2020 calendar year. As a result, a withdrawal from the spousal RRSP before 2023 results in the application of the attribution rules. If that same contribution had been made in December 2019 instead, a withdrawal could occur in 2022 without triggering the attribution rules. These attribution rules apply to spousal RRIFs as well, except on mandatory RRIF minimum withdrawals.

As part of the 2020 changes, spousal attribution only applies on amounts above the unreduced RRIF minimums.

5. Make final RRSP contributions at age 71: Contributions to an individual RRSP can only take place up to December 31 of the year in which an individual turns 71. For individuals who continue working into their early 70s, this age limit complicates the act of making a final RRSP contribution, as RRSP contribution room for a given year is not credited until the following year. One approach is to make the final contribution in December of the year the RRSP annuitant turns age 71, suffer the 1% over-contribution penalty for that month, then be back on-side in January when the room is credited to the annuitant. If the annuitant has a younger spouse, another option is to contribute to a spousal RRSP in the new year, after the contribution room is credited to the annuitant.

6. Use pension income-splitting for RRIF income: Since 2007, RRIF annuitants age 65 or older could split up to 50% of their RRIF income (and other eligible income) with a spouse or common-law partner. There are four principal benefits of pension income-splitting:

• Bracket management: Shifting income from a high-tax-bracket pensioner to a lower-tax-bracket spouse can reduce net taxes paid; keep in mind that this obviously increases the transferee spouse’s income, potentially triggering clawbacks or “bracket creep”
• Old Age Security (OAS): Shifting income may reduce the income of a pensioner in the clawback range for OAS
• Age amount (income tax credit): Shifting income may reduce the income of a pensioner over age 65 in the clawback range for the age amount; keep in mind that this may also result in a clawback of the receiving spouse’s age amount
• Pension amount (income tax credit): Shifting income allows the receiving spouse (over age 65) to access or increase a claim for the pension amount (federal claim of $2,000 at 15%)

7. Implement RRIF estate planning: A directly named successor annuitant RRIF designation may allow the continuation of the RRIF in the hands of the surviving spouse or common-law partner with the added advantages of easier administration, probate tax savings and a lower tax compliance burden. The successor annuitant merely steps into the place of the deceased RRIF annuitant and the plan continues with the surviving spouse or common-law partner as the new annuitant. The process is very different (from both an administrative and tax perspective) from naming the spouse or common-law partner as beneficiary directly on the plan or through the will. Note that a successor annuitant or primary beneficiary designation on a RRIF is not allowed for Quebec residents and can only be made in the will.

For more information regarding your clients’ RRIFs and reducing withdrawals to the new minimums, please contact us.

This post was first published at the official blog of Invesco Canada.