Funding Boomer retirements

Life goes by so fast. Believe it or not but the oldest of the Baby Boomers are set to turn 65 in 2011. This will trigger the beginning of a rising wave of retirements that will peak within the next two decades. This global trend towards retirement is even more significant in Canada where the average retirement age is currently 62.

With the move towards retirement, many of your clients will be looking to convert Registered Retirement Savings Plans (RRSPs) to Registered Retirement Income Funds (RRIFs) to help fund their retirements. When considering such a conversion, consider asking the following five questions which highlight tax and estate planning tips that can maximize the effectiveness of your clients RRIFs.

1) Should your client make one final RRSP contribution?

If your client is 71 and has unused RRSP contribution room, they can consider making one final RRSP contribution – particularly if they expect to be in a lower tax bracket in future years. Because individuals cannot contribute to RRSPs beyond age 71, this may be their final opportunity for a large tax deduction in one year. If your client is 71, does not have RRSP contribution room, but is still working, they can consider making an overcontribution to their RRSP in December of the year they turn 71. If the excess contribution exceeds $2,000, it will result in an overcontribution penalty for the month of December. However, because the client is still working, the penalty will cease in January of the following year when new RRSP room becomes available. The benefit of this strategy is that your client will be able to make use of RRSP contribution room that becomes available the year after they turn 71 – a benefit that may far exceed the 1% penalty tax paid for December, the month in which the overcontribution was made.

If your client is younger than 71, they can continue to contribute to an RRSP until the end of the year they reach 71 provided they have RRSP contribution room. Their contributions will create a tax deduction that can be used to offset any form of income, including part-time employment income. The earlier contributions are made, the longer RRSP assets can grow tax-deferred.

If your client is older than 71, has unused RRSP contribution room and has a spouse or common-law partner (CLP) who is younger than 72, they can contribute to a spousal RRSP. Contributions to a spousal RRSP will create a tax deduction on your client’s tax return. Provided withdrawals from the spousal RRSP take place three years after the contribution is made, the lower income spouse/CLP will be taxed on the withdrawal.

2) Whose age should be used to calculate RRIF minimums?

When setting up a RRIF, your client has the opportunity to calculate future RRIF payments based on their age or the age of a spouse or CLP. If the goal is to maximize the tax-deferral opportunity of their RRIF, it is generally best to calculate annual RRIF payments based on the age of the younger person. This results in smaller mandatory withdrawals and allows for a longer period of tax-deferral.

If your client does not require the cash received from mandatory RRIF payments, they can transfer their RRIF back to an RRSP if they are under the age of 72, or contribute their after-tax RRIF payments to a Tax-free Savings Account (TFSA) where future income would grow free of income tax. Contributions to a TFSA would require TFSA contribution room. Contributions to a non-registered investment account are also possible where tax-efficient dividends and capital gains can be realized.

3) Has your client named a beneficiary on their RRIF application?

Beneficiaries named on RRSP applications do not automatically carry over to RRIFs. If, at death, your client wants their RRIF assets to transfer directly to beneficiaries without flowing through their estate, your client should be sure to name their beneficiaries directly on their new RRIF application. Failure to do so may result in their RRIF assets passing through their estate where it may be subject to complex estate settlement matters and/or unintended distributions.

Estate administration fees may also apply. In Quebec, when the annuitant of a trusteed RRSP or RRIF dies, the proceeds of the plan flow through the deceased’s estate and is subject to the terms of the deceased’s will regardless of designations made on a plan application. Hence, the distribution of RRIF assets through the terms of a will continue to be of importance for RRIF annuitants that reside in Quebec.

If your client intends for their spouse or CLP to inherit their RRIF, you can highlight the option to name their spouse or CLP as either “successor annuitant” or “beneficiary” on their RRIF application. Assuming tax minimization at death will be a priority, the successor annuitant designation allows spouses and CLPs to receive the deceased’s RRIF based on the plan’s original terms and conditions. For example, if the deceased annuitant was receiving RRIF minimum payments based on the deceased’s age, the payments would continue to the spouse or CLP based on the deceased’s age.

If the deceased was younger than the surviving spouse or CLP, using the deceased’s age would result in smaller mandatory RRIF payments and a longer period of tax-deferred growth. Where a spouse or CLP is named beneficiary, future RRIF payments would be calculated based on the survivor’s age, which would mean larger RRIF payments if the spouse or CLP was older than the deceased.

4) Should your client request increased withholding tax on RRIF payments?

RRIF payments are generally subject to a withholding tax of between 0 and 31% depending on the amount redeemed. If your client will receive other forms of taxable income that are not subject to withholding tax at source (eg. capital gains from the sale of investments, interest payments or dividends), your client can consider contacting their RRIF issuer to request an increase in withholding tax on RRIF payments. By doing so, your client can prepay tax payable on other sources of income and reduce their balance owing when their tax return is filed at year end.

5) Can your client claim the pension credit for RRIF income?

If your client is 65 or older and receiving (or about to receive) RRIF income, they can claim the pension credit on their federal tax return for up to $2,000 of RRIF income provided the credit has not already been claimed for other eligible incomes (eg. payments from a private pension plan). A similar credit is also available provincially. The federal credit is worth $300, and can be used to offset tax payable on any form of income. The credit cannot be carried forward to a future year, so your client should claim it when available. If your client is under 65, the pension credit is available for RRIF income only if received as a consequence of the death of a spouse or common-law partner.

If eligible to claim the pension credit for RRIF income (ie. age 65 or older), your client can split the income with their spouse or CLP regardless of their spouse/CLP’s age. Since 2007, income eligible for the pension credit is also eligible for pension income-splitting. Where a spouse or CLP is in a lower tax bracket, an effective income-split will be achieved. Also, by transferring the RRIF income to a spouse or CLP (which is achieved simply by allocating the split on their respective tax returns – an actual cash transfer is not necessary), your client may be able to double the pension credit for their family provided their spouse/CLP is 65 or older.

A point of note, when splitting income, clients should be mindful of Old Age Security (OAS) clawback thresholds to ensure that income-sensitive OAS benefits are not reduced as a result of the split. For 2010, seniors can report a net income of up to $66,733 before OAS benefits are reduced.

While RRSPs don’t need to be converted to RRIFs until December of the year annuitants turn 71, many baby boomers will choose to convert earlier. Some will require the income to fund their day-to-day needs, while others will convert for tax or estate planning reasons (eg. to reinvest in a TFSA or avoid high tax rates at death). Regardless of the reason, with the number of baby boomers expected to retire over the next two decades, financial professionals have a wonderful opportunity to position themselves as valued partners in their client’s financial security. Assisting in the transfer of RRSPs to RRIFs is part of that process and an opportunity to highlight some key tax and estate planning concepts.

Wilmot George

Tax & Estate

Wilmot George, CFP, TEP, CLU, CHS, is vice-president, Tax, Retirement and Estate Planning at CI Global Asset Management. Wilmot can be contacted at wgeorge@ci.com.