When is the ideal time to convert a portion of RRIFs to payout annuities?
Annuities can be a smart choice for investors seeking a guaranteed income stream and protection from market exposure
Date: December 8, 2017
It's no secret that when a client prepares to retire, they need to start shifting their thinking from accumulation to how they will drive income throughout their retirement.
As part of the transition, most people convert some or all of their RRSP (registered retirement savings plan) into RRIFs (registered retirement income funds).
In Canada, it is mandatory to either withdraw all of the funds from an RRSP or convert the plan to a RRIF or life annuity, or a combination of the two, by the end of the year in which an individual turns 71. If funds are simply withdrawn from an RRSP as a lump sum, the entire amount is fully taxable. RRIFs (like RRSPs) allow for tax-deferred growth, but unlike RRSPs, investors must make minimum withdrawals from their RRIFs each year, and these withdrawals are considered taxable income.
As clients make their way through their retirement years, a key question is worth considering: When does it make sense to convert RRIFs to payout annuities?
The concept of the payout annuity is simple … a lump sum investment is exchanged for a stream of guaranteed income payments. But there are differing advantages between payout annuities and RRIFs, says Patricia Michon, assistant vice-president of guaranteed wealth product management at Sun Life Financial.
"RRIF assets can offer the liquidity that a payout annuity can't," says Ms. Michon. "However, the payout annuity provides guaranteed income for life; there are no guarantees that a RRIF will last as long as you live."
She also notes that a payout annuity fully protects retirees from market exposure or interest rate fluctuations. If one is looking for inflation protection, fixed indexing is available. In many cases, the guaranteed income from a payout annuity can provide higher income than a RRIF.
Ms. Michon says retirees may want to consider converting a portion of their RRIF assets to a payout annuity when it's clear that they won't need to access the principal of the investment and they have a desire to create a guaranteed income stream for life. Payout annuities can be used to create a foundation to help cover fixed expenses in retirement, such as accommodation (rent, utilities, assisted living, etc.), food and prescription medications. But while payout annuities can be an important part of a retirement plan, Ms. Michon notes that most plans are likely to use more than one income vehicle to meet clients' needs, and could have a mix of RRIFs and annuities.
"Annuities are more predictable, and can be a good choice for people who don't like mutual funds," says Jim Yih, a personal finance author and educator who also runs the website Retirehappy.ca. He says that if people are trying to choose, they should weigh the added flexibility and risk of the RRIF against the safety and predictability of the payout annuity, and determine which is the best fit.
When it comes to the tax implications of converting RRIFs to payout annuities, the impact is minimal. The income from a RRIF is fully taxable, as is the income from a payout annuity purchased with registered assets.
Another major consideration is whether there may be implications for retirees' eligibility for government programs such as Canada Pension Plan (CPP), Old Age Security (OAS) and Guaranteed Income Supplement (GIS). The amount of income flowing from the payout annuity could be higher or lower than the RRIF, which may impact eligibility for OAS and GIS. However, there are no issues for CPP eligibility, as that program is not income-tested.
Advisors may face misconceptions about payout annuities when discussing them with clients.
Ms. Michon says the biggest myth is that if investor client dies earlier than expected, a large portion of the premium used to buy the annuity will be lost. The first way to avoid this is by choosing a joint life annuity, she says. This ensures the income continues when one annuitant dies, though income does stop when the second annuitant dies. The second way to avoid losing the premium is by selecting a guaranteed period during which time a death benefit is paid to a beneficiary if the annuitant dies during that period.
Some advisors may think that when interest rates are low, it's a bad time to buy a payout annuity.
"Interest rates are a factor, but they aren't the only factor," says Ms. Michon.
She points out that age is also important to keep in mind. Specifically, the older an individual is when they buy, the less important interest rates become. As well, leaving investments in other vehicles may expose clients' assets to harmful market volatility, reducing the amount available for income in retirement.
|Retirement anxiety? How to reduce the risks||Advice in the digital age — where do you fit in?|