In Part 1 of this article series, we covered some of the more common Canadian investment accounts available: the basic (non-registered) investment account, the Tax-free Savings Account (TFSA), the Registered Retirement Savings Plan (RRSP), and the Registered Retirement Income Fund (RRIF).
In Part 2, we’ll discuss three more registered investment accounts: Locked-in Retirement Account (LIRA), Life Income Fund (LIF), and Registered Education Savings Plan (RESP).
Locked-in Retirement Account (LIRA)
Canadians are changing jobs and companies much more frequently than in the past. One of the consequences of this trend is the treatment of pensions. When you decide to leave your company what happens to your pension? Most often, the pension benefit earned with your ex-employer will be converted to a Locked-in Retirement Account (LIRA). Regardless of whether you decide to keep everything in cash or invest the capital, or which company you hire to manage this portion of your portfolio, the “pension” will be housed in a LIRA account. The LIRA is simply another registered account type that will hold the underlying investments. Think of the LIRA as a close cousin to the RRSP (Registered Retirement Savings Plan), but with its own unique set of rules.
Similarities between LIRA and RRSP
Very much like the RRSP account, the LIRA is an account type that houses the underlying investments. Investments within a LIRA account grow tax-free, meaning that the investor does not pay taxes on gains as long as they remain in the LIRA account. Taxes are deferred in this case, just like with an RRSP account and you will be taxed only when you withdraw income from the LIRA.
Furthermore, just as the RRSP converts to a RRIF, the LIRA converts to a Life Income Fund (LIF) and the conversion is done automatically at 71 years of age, with withdrawals that must begin, at the latest, at age 72.
Now let’s turn to the several important differences between RRSPs-LIFs and RRIFs-LIFs.
Differences between LIRA and RRSP
The first important difference between an RRSP and LIRA account is that once a pension is converted to a LIRA you can’t contribute any more money to that LIRA account. You also can’t merge various LIRA accounts. Each pension turned to LIRA will be kept separately. As a result of this rule, depending on how many times you change employers, you may end up with several LIRA accounts over the years.
Another difference concerns early withdrawals. While you have the option to withdraw cash from an RRSP account before retirement (and suffer hefty withdrawal taxes), no such option exists with the LIRA account. The LIRA is “locked-in” until retirement. The earliest age at which funds can be accessed is generally 55.
Life Income Fund (LIF)
Difference between LIF and RRIF
The major difference between the RRIF and the LIF concerns the rule around withdrawals. The RRIF is restricted by a minimum withdrawal amount per year, where depending on your age you must withdraw a certain percentage per year (formula can be found here). The LIF, however, is constrained by both a minimum and a maximum withdrawal rate (the table can be seen here).
Lastly, one important option available to investors is that once the LIRA is converted to a LIF, you can “unlock” 50% of the assets within the LIF and move the funds into an RRSP or RRIF. However, this must be completed within 60 days of converting the LIRA to a LIF account. Investors will generally take advantage of this option if they’re looking for more flexibility. The funds transferred to an RRSP or a RRIF will no longer be subject to the maximum withdrawal parameter.
The last registered account we will look at is the RESP. The RESP differs in its intended use and treatment from the other registered accounts.
Registered Education Savings Plan (RESP)
Unlike the other registered accounts, the focus of the RESP is not on retirement. Rather it’s intended for parents (or grandparents, or friends) who wants to save for their children’s future post-secondary education. The maximum contribution is $50,000 per child.
One of the advantages of the RESP is tax-deferred income. Similar to the RRSP, taxes are not paid until the funds are withdrawn from the account. Since the child (student) is the beneficiary of these funds, the withdrawals are taxed at their tax rate — another benefit since students tend to be in a very low bracket.
Furthermore, the RESP has a unique characteristic which adds to its desirability. It allows for the ability to collect the Canada Government Education Savings Grant (CESG). The government matches 20% of the contributions made to the RESP account up to the maximum of $500 per year, and a lifetime grant of $7,200, per child. An RESP savings calculator can help estimate future education costs and how they will be covered.
RESP accounts can be set up in two ways:
- Individual RESP account: opened for a specific child. Anyone can contribute to this account and the maximum lifetime contribution to the account is $50,000.
- Family RESP account: opened for all the children in the family together, and can be used by any of the children in the future. Only the parents and grandparents of the beneficiaries can contribute to the account, and the maximum lifetime contribution to the account is $50,000 per child.
What happens if your child does not pursue post-secondary education? The available funds can be transferred to a sibling. Or, if that is not an option, the people who contributed to the RESP can transfer the funds to their personal RRSP account tax-free. Plus, the CESG contributions must be returned to the government.