In Part 1 of this article series, we covered some of the more common Canadian investment accounts available: the basic (non-registered) investment account, Tax-free Savings Accounts (TFSAs), Registered Retirement Savings Plans (RRSPs), and Registered Retirement Income Funds (RRIFs).
In this Part 2, we take a look at three more registered Canadian investment accounts: Locked-in Retirement Accounts (LIRAs), Life Income Funds (LIFs), and Registered Education Savings Plans (RESPs).
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 is converted to a Locked-in Retirement Account (LIRA). Whether you keep everything in cash or invest the capital, the “pension” is housed in a LIRA account — another registered Canadian investment account type that holds 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. This means that the investor does not pay taxes on gains as long as they remain in the LIRA account. You will pay tax only when you withdraw income from the LIRA.
Furthermore, just as the RRSP converts to an RRIF, the LIRA converts to a Life Income Fund (LIF). The conversion happens automatically at 71 years of age. Withdrawals 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? Once a pension becomes a LIRA you can’t contribute any more money to that account. You also can’t merge various LIRA accounts. 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. It’s right in the name with “locked-in.” The earliest age you can access your funds is generally 55.
Life Income Fund (LIF)
If you have a LIRA, you must convert it into a Life Income Fund (LIF) in the lead up to retirement. A LIF is a registered account through which you’ll receive your pension funds as retirement income. You cannot contribute to it. It operates in a similar way as the RRSP-to-RRIF throughline.
Difference between LIF and RRIF
The major difference between the RRIF and the LIF concerns the rule around withdrawals. With RRIFs, depending on your age, you’re required to withdraw a certain percentage per year. LIFs, however, have both a minimum and a maximum withdrawal rate.
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 happen 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 RRIF will no longer be subject to the maximum withdrawal parameter.
The last registered Canadian investment 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 investment accounts, the focus of the RESP is not on retirement. Rather it’s intended as savings for a child’s future post-secondary education. Parents, grandparents, extended family, and family friends can all contribute to an RESP. The maximum lifetime contribution is $50,000 per child.
One of the advantages of the RESP is tax deferment. 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. This is another benefit since students tend to be in a very low bracket.
Furthermore, the RESP has a unique characteristic that 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.
There are two types of RESP accounts:
- Individual RESP accounts: You’ll open this account for one specific child. Anyone can contribute to this account and the maximum lifetime contribution to the account is $50,000.
- Family RESP account: You’ll open this account for all the children in the family together. 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?
There are three options available if your child decides against university or college.
For starters, you have the wait-and-see approach. Kids don’t always pursue higher education right away! RESPs remain active for 36 years. If they decide to live abroad for a while or need some time to figure out the path they want, the money will still be there when they loop back.
The available funds (and any interest) in the investment account can go to the RESP of a sibling, and CESG contributions go back to the government.
Finally, funds can go back to you/a parent. Withdrawing it outright will come with taxes, but if you have contribution room in your RRSP, this could be the best option. CESG contributions, of course, go back to the government.