A longer life expectancy and all-time low investment returns have created the perfect storm for retiring Canadians, as their life savings are put at risk of running out. The issue lies in outdated rules regarding Registered Retirement Income Funds (RRIFs), according to a new report released by the C.D. Howe Institute. For two-thirds of Canadians without a workplace pension plan, RRIFs will be vital to providing income in retirement, but current withdrawal rules mean seniors run the risk of depleting their funds in their 90s, when they need it most for health and general care.
What is a RRIF?
A RRIF is like your own personal pension plan and is an extension of the RRSP.
While your RRSP is used to save for retirement during your working years, your RRIF is used to drawdown those savings as income in retirement.
“If you think of an RRSP as a bucket of tax deferred money, a RRIF is simply a bucket with a hole in it,” says financial educator Jim Yih, owner of Retirehappy.ca. “The hole forces to you withdraw money and any withdrawals are taxable.”
RRIFs are a lot like RRSPs – they provide tax – deferred growth, allow you to choose from different investments, and are regulated by the government – but there’s one key difference. With an RRSP, you can make annual contributions as long as you have earned income and contribution room left.
However, with a RRIF, you’re not allowed to make contributions – instead you must make annual minimum mandatory withdrawals.
“The investment options for the RRIF are the same investment options for the RRSP,” Yih says. “The only difference in theory is the hole. The hole has to be a minimum size (hence the minimum income). The hole can be as big as you want (you can take more income than the minimum) but it can’t be smaller (except if you have a younger spouse, you can use the spouse's age to make the hole smaller).”
Why RRIF withdrawal rules are outdated
With baby boomers aging en masse, there’s never been a greater urgency to update RRIF withdrawal limits.
Today there are approximately 203,000 Canadians in their 90s – that number is expected to triple in 25 years. The C.D. Howe Institute says the annual minimum mandatory withdrawals for RRIFs no longer make sense. Under existing rules, seniors must make annual withdrawals that increase with age all the way up to 20% at age 94.
RRIFs are supposed to give retirees a steady source of income, while allowing governments to recoup deferred tax revenue. While minimum withdrawal rules may have made sense in 1992 when they were introduced, times have changed, argues the report.
"Longer lives are a good thing. Lower yields ... may not be good but they are a reality," the authors say. "Good or bad, when combined with out-dated drawdown rules, modern longevity and investment returns spell trouble for holders of RRIFs (registered retired income funds) and similar accounts."
Raising the age for mandatory RRIF withdrawal
Raising the age for mandatory withdrawal or making required amounts smaller would greatly reduce the risk of seniors running out of savings, according to the report. The government has already raised the eligible age for seniors to start collecting Old Age Security (OAS), so why not RRIFs? The report’s authors even go as far as suggesting phasing out the mandatory minimum withdrawals altogether.
Low savings still the main concern
Although updating RRIF withdrawal limits will help seniors, it won’t solve Canada’s looming retirement crisis.
“Revision to the RRIF withdrawal rules would not create more savings but would still be of some assistance by guiding retirees towards better preservation of their savings for their longer term care needs, enabling RRIF savings to be used as a form on longevity protection,” says Alexandre Laurin, associate director of Research at the C.D. Howe Institute.
What about the TFSA?
Although the Tax Free Savings Account (TFSA) contribution limit is expected to be increased to $10,000 annually, the think-tank still believes it makes sense to update RRIF withdrawal minimums.
“More TFSA room would be welcome. However, RRIF withdrawal minimums, especially if and when used by retirees as their guide, are still too high,” argues Laurin. “Sure it is possible to re-invest the after-tax proceed of RRIF withdrawals, but why make it so complicated for seniors wanting to protect against the risk of living long?”