RRIF or Annuity: How to choose

Annuities used to be the most popular option for mature RRSPs. Interest rates were high, and the RRIF was not the same creature it is today.

The payout schedule for RRIFs was based on the assumption of a high rate of inflation. Thus it left you with a smaller income in the early years of retirement, and more when you were older. Yet, in theory at least, you were less likely to need that income.

But now, there are improvements in the flexibility of the RRIF payment schedule. The result is fewer retirees selecting annuities. Most now choose RRIFs as their maturity option, or possibly a combination of the two.

As with so many aspects of a financial plan, there is no “right” or “wrong” choice. The point is to find the product that suits your needs.

Consider both options
Let’s look at the two options from the standpoint of the principal features of each. Here are some questions you can ask yourself to help make the choice best for your circumstances.

Do you need/want a guaranteed ince?
This is one of the biggest advantages of an annuity. You acquire a “life annuity” that guarantees payments to you until you die.

If you cannot or do not care for the responsibility for managing your funds in retirement, then this option gives you a certain peace of mind. You could even select an inflation protection option, if you’re concerned about future inflation.

If the funds that you have for retirement are limited, and preservation of capital is critical, then the security offered by a life annuity can beneficial.

What is your assessment of the trend for inflation?
If there is a downside to a guaranteed monthly annuity payment, it is the effects of inflation.

Anyone who lived through the 1980s remembers how inflation could erode the value of a fixed income. Inflation protection is a common option available with an annuity. But all protection comes with a cost.

Inflation protection is achieved by lowering the income you’d receive in the early years of the annuity, and increasing it in the later years. You won’t receive more money with this option.

Again, if capital preservation is important to you, this could still be the way to go.

However, a RRIF may offer better inflation protection, since you can continue to manage your investments yourself (or with the help of a professional).

A properly designed portfolio can give you a reasonable degree of both inflation protection and a reliable income.

The RRIF option is more appropriate if you have other assets you can rely on. Remember that the real issue is not to outlive your assets, and the income they generate.

Next page: Management of your investments

Do you want to continue to manage your investments?
Is investment flexibility important to you? RRIFs offer you a wide range of investment alternatives, just as RRSPs do. You can even open a self-directed RRIF if you really like to “go it alone”.

RRIFs allow you to invest in such items as Canada Savings Bonds, T-bills, qualifying bonds and mutual funds, shares listed on Canadian exchanges, Canadian mortgages, and so on.

But if all of this leaves your head spinning, and you do not want the burden of making investment decisions, the security of the annuity may be for you.

Do you want/need the ability to adjust your income annually?
RRIFs offer you the ability to withdraw funds from your plan whenever the need arises. This action should only be taken, however, after consideration of a number of issues.

  • Can the assets be turned into cash?
  • Are there penalties for doing so?
  • What taxes need to be paid on this lump sum withdrawal?
  • What will this consumption of capital do to your likely future income stream?
Only after these questions have been answered satisfactorily should you proceed with a large lump sum withdrawal.

Mind you, if you must make the withdrawal regardless of the above issues, it’s nice to know you can.

Be aware that some annuities can be collapsed, but there may be penalties for doing so. As always, investigate before you act.

Do I want/need to defer taxes on my income?
A RRIF offers a greater opportunity for tax deferral than do other maturity options. Assets in the plan continue to grow on a tax-protected basis. Subject to the minimum annual withdrawal limit, assets can stay in the plan for as long as you want.

There is a product (or a combination of products) that will suit you perfectly. It only requires that you accurately determine your wants and needs, and match those with the features of the products you are considering.