Money Monday: What Is an RRIF?March 4th, 2013 by Michael Kwan
In Canada, you might come across GICs, for example, which are Guaranteed Investment Certificates. You are guaranteed a certain interest rate on your investment for the defined period of time for that GIC. And then there are RESPs (Registered Education Savings Plans) that you can use to save up for your child’s higher education.
But what about when you are planning for your retirement years? What is an RRIF and how does it relate to your retirement savings strategy?
Registered Retirement Income Fund
RRIF stands for Registered Retirement Income Fund. It is an investment vehicle that, as you can probably guess, generates income to help fund your retirement years. That seems reasonably straightforward, but then I started to wonder about how RRIFs relate to Registered Retirement Savings Plans (RRSPs). What’s the difference? Should I be investing in one over the other?
Both RRSPs and RRIFs are tax-deferred retirement plans. When you invest in RRSPs, you effectively reduce your net income for that year and, thus, reduce the amount of income tax that you have to pay. For example, if you earned $40,000 and invested $2,000 in RRSPs, you would effectively be taxed as if you earned $38,000 that year. The income only becomes taxable when you withdraw that money from your RRSP.
An RRIF is different. Whereas RRSPs and other retirement products are utilized during your working years to defer your income tax liability, an RRIF is used during your retirement years to defer the tax that you would have to pay if you withdrew all your savings from your RRSP.
Why Not Just Leave It in the RRSP?
The Canadian government allows you to use RRSPs as a tax-deferment strategy, but you are not allowed to leave that money in there forever. By the end of the year where you turn the age of 71, you must withdraw all your money from your RRSP. If you have a substantial amount of money saved up, you can see how this can a huge income tax liability… which defeats the whole purpose of you using RRSPs in the first place.
And that’s where RRIFs come into the picture. Rather than simply withdrawing all the money from your RRSP and depositing into a savings account (and thus having to pay income tax on all that money), you can transfer the funds to an RRIF instead. Investments that are held within an RRIF can grow in a tax-deferred way, just as they did inside of your RRSP. This way, you can slowly withdraw money from the RRIF rather than taking the huge lump sum all at once.
Can’t Leave It in the RRIF Either
This comes with a caveat. Just as there are maximums (as a percentage) set out for how much you can invest in an RRSP during your working years, based on the income you earning at the time, there are also minimums that must withdraw from your RRIF and this is a function of your age. The minimums are also defined as a percentage. Of course, you can take out more than the minimum, but you will be on the hook for the tax.
Given this, I won’t have to worry about RRIFs for a good number of years, but it’s good to have that basic background knowledge ahead of time.