Understanding Locked-In Accounts
Employed: Defined Contribution Registered Pension Plan
Let’s suppose the following scenario: You are in your mid-40s and have worked for one employer for the entirety of your working career. Throughout, your employer had provided its employees a defined contribution registered pension plan which was based on mandatory 4% contributions by the employee and matching 4% contributions by the employer. Over the period of your career, you had amassed a pension balance of $200,000.
Over the years, however, you had gained some skills learned on the job and through ongoing training. You had started doing some work on the side and it was getting to the point that you would soon be making more on your own than with your employer. So, you decided to take the leap and go full-on self-employed.
Self-Employed: What About the Pension Plan?
What to do with that pension, though? Your employer offered you the option of staying with the pension plan as a “terminated member” or you could transfer it to an outside investment firm as a Locked-In Retirement Account (LIRA). Those were your only two choices. And you found out that you couldn’t withdraw any of the money until you were at least 55.
Locked-In Plans Before Retirement
Just like you decided to make the leap to becoming self-employed so that you could control your own employment, you decided that you want to control the pension you had built up, too. You decided to transfer your pension plan into a LIRA at a discount broker and manage the investments yourself.
Locked-In Plans After Retirement
Your self-employment venture has been a success. Your income was better than you would have gotten while employed and you have been consistently able to maximize your contributions to your personal Registered Retirement Savings Plan (RRSP) and your Tax-Free Savings Account (TFSA). You have managed your LIRA well, too, and over the subsequent 20 years or so, the balance has grown to $700,000. Now you are 65 and you wonder what to do with it.
One option is to take all $700,000 of the LIRA assets and use it to buy an annuity from an insurance company. Essentially, you have turned your LIRA into a pension plan that will pay out a regular monthly stream of income until you die.
Insuring Your Annuity
One thing to consider is that the monthly payments are fully insured against the insolvency of the insurance company up to a maximum of $2,000 per month via Assuris. If your annuity pays greater than $2,000 per month your payment is only guaranteed up to 85%. In that case, to retain your full payment, you may want to split your lump sum among two or possibly three different insurance companies so as to retain full insurance coverage.
Life Income Fund
As the LIRA corresponds to the RRSP except that the former comes from pension funds, so the Life Income Fund (LIF) corresponds to the Registered Retirement Income Fund (RRIF). In other words, just as a common choice of RRSP holders is to convert their RRSPs to a RRIFs, so it is for LIRA holders to convert those accounts into LIFs.
There are some differences, however.
Earliest Age to Convert
The year after you convert an RRSP to a RRIF, you must begin making prescribed payments from the account based on your age and the account balance. However, there is no minimum age limit to open a RRIF and transfer part or all of your RRSP into the new account. If you have been very successful at “F.I.R.E.” (Financial Independence, Retire Early), maybe you have amassed a multi-million-dollar RRSP by the time you are 40. Go ahead and start drawing it down if that makes sense.
Not so with the LIF. Across Canada, the earliest age at which you can transfer your LIRA into a LIF and start making withdrawals is 55. The one exception is Alberta, where it is age 50. Note, however, that if your pension were administered under federal jurisdiction, then even a resident of Alberta would have to wait until age 55.
Latest Age to Convert
In this case, there is no difference between RRSPs and LIRAs. In the year that you turn 71, you must open a RRIF in the case of RRSPs, or open a LIF in the case of LIRAs, and transfer the assets held in your RRSP/LIRA to your RRIF/LIF. In my experience, if you do not take the necessary action yourself, the investment firm where you hold the account will open the account and transfer the assets on its own, as the firm has a legal obligation to do so.
A LIF is a new account so there is new paperwork to complete. One thing to remember, then, is to name your beneficiaries as those named in your LIRA will not necessarily carry over. Also, if you are managing your investment accounts on your own, if you have not done so previously it would be wise to provide your investment firm with your Power of Attorney documents. As we age, the odds increase of losing the capacity to manage our financial affairs.
Minimum and Maximum Withdrawal Amounts
RRIFs and LIFs share the same minimum withdrawal percentage, which is based on your age. That percentage is then multiplied by the balance in your account at the end of the previous year. If you had turned 65 in the previous year, you would have a 4% withdrawal minimum withdrawal requirement. If your account balance at year end was $500,000, you would have to withdraw a minimum of $20,000.
LIFs are different than RRIFs, however, in that they have maximum withdrawal limits. A RRIF is made up of contributions personally made, which government legislation recognizes. Therefore, if you want to draw down the entirety of your RRIF within five years, that’s your right. In the case of a LIF, however, since its source of funds was from a pension plan, there is an expectation that it provide income for the entirety of your retirement years.
The following table, from RBC Wealth Management, provides the minimum and maximum withdrawal rates.
You will want to attend to the footnotes in this document as there are some exceptions to the maximums, notably in Saskatchewan and Manitoba.
Throughout, this has been a discussion of locked-in accounts, that is, assets that were once part of a pension plan but that have now been transferred outside of the plan and into an investment firm, whether with an advisor or at a discount broker. Essentially, the locking-in aspect means that the assets within the account will continue to be treated as a pension, intended for funding your retirement. This means that you cannot withdraw funds from it to help you put together a down payment on a house via the Home Buyers’ Plan or help with your education expenses as one might with the Lifelong Learning Plan.
There are, however, certain circumstances that allow for unlocking.
If the accumulated value of the locked-in plan is below 20% of the Year’s Maximum Pensionable Earnings (YMPE), you may be able to unlock the remainder of the plan. Depending on the jurisdiction, there may be additional, more flexible rules. In 2021, the YMPE is $61,600. Twenty percent is equal to $12,320. If your locked in account is less than that, you can unlock it entirely by transferring it to an RRSP. At that point, it can be withdrawn when you want.
Among the reasons that will allow you to claim financial hardship in order to unlock your account are: you need money to cover medical expenses; you are late on your rent or mortgage and are in danger of eviction/foreclosure, you need to come up with a deposit (e.g., first and last month’s rent, damage deposit, etc.) to enter into a residential rental contract; and/or you have low income that is below a specified threshold. The percentage you are allowed to withdraw can be as high as 50% of the YMPE ($30,800 in 2021).
Shortened Life Expectancy
If a physician certifies that you have a shortened life expectancy due to a physical or mental condition, you may be able to withdraw the total value of the locked-in account balance.
If you have ceased being a resident of Canada for at least two years, you may be able to unlock the total value of your account.
If a spousal rollover is applied, your locked-in plan will typically transfer to your surviving spouse’s RRSP or RRIF. If there is no spouse, then the balance will go to your estate. Either way, the locked-in plan is fully unlocked upon death.
One-Time 50% Unlocking
This rule depends on the jurisdiction of your pension plan/LIRA.
Federal: If you are age 55 or older, you are allowed a one-time opportunity to unlock 50% of your locked-in account’s value and transfer that portion to a RRSP or RRIF. This has no impact on your RRSP’s contribution room.
Alberta: The rules are similar to the federal rules except that this unlocking provision extends to as low as age 50.
Manitoba: Similar to the federal rules, one-time 50% unlocking is available for those aged 55 or over. The money will go into a prescribed Registered Retirement Income Fund (pRRIF) which, like the regular RRIF, is not locked in and does not have a maximum withdrawal amount.
New Brunswick: You may make a one-time withdrawal from a LIF of the lesser of three times the annual amount or 25 per cent of the balance in the LIF.
Ontario: The unlocking rules are similar to those of plans under federal jurisdiction.
Prince Edward Island: The province lacks pension legislation. By default, therefore, federal rules apply, allowing one-time 50% unlocking at age 55 or older.
Saskatchewan: Like Manitoba, Saskatchewan has a prescribed Registered Retirement Income Fund (pRRIF). However, unlike Manitoba, at age 55 or greater you can convert 100% of your LIRA into the pRRIF, thereby eliminating the maximum withdrawal limit.
British Columbia, Newfoundland and Labrador, Nova Scotia, and Quebec do not have pension legislation allowing for unlocking based on age alone.
After reading this and thinking that you would love to avoid these restrictions as much as possible, there are at least two other things to consider:
- Generally, you must obtain your spouse’s consent to unlock your pension/locked-in funds; and,
- There is creditor protection of assets held inside a pension plan or locked-in account that may not apply to the same extent in an RRSP or RRIF.
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.