Note: This article is part of Morningstar's January 2016 Five keys to retirement investing special report.
The money in your workplace registered pension plan belongs to you. However, it is normally not accessible until retirement. Even if you lose or quit your job, most if not all of the cash will be out of reach. Instead, the money stays in your former employer's pension plan and you will receive a specified pension when you reach retirement age.
Alternatively, you can choose to have the commuted value (the present value of the pension entitlement earned during your employment) transferred into a locked-in retirement account (LIRA). No further contributions can be made to the LIRA. Generally, the money must remain in the LIRA, where it grows tax-free. When you reach retirement age as defined by regulation, or by age 71 at the latest, you convert the LIRA funds into a pension-like income.
A LIRA offers greater control of retirement savings than a workplace pension. You decide how to invest the money. You may be able to unlock a portion of the funds before retirement. You can choose (within prescribed limits) when to begin drawing an income from your LIRA, and how much to take.
When it comes time to draw an income from your LIRA, you have three options: transfer the money to a life income fund (LIF), use the funds to purchase a life annuity, or do a combination of both. Note that no matter which option you choose, if you have a spouse or common-law partner you must convert your LIRA to a jointly held investment unless she waives her claim.
(Locked-in retirement income funds, available in Manitoba and Newfoundland and Labrador, and prescribed registered retirement income funds, available in Saskatchewan and Manitoba, are provincial variations of the LIF concept.)
A LIF is similar to a registered retirement income fund (RRIF). The income from these accounts is taxable. Both have the same annual minimum withdrawal requirements that increase with age, but a LIF also has a maximum annual withdrawal limit. On an ongoing basis, the LIF assets must be managed, and the LIF could be fully depleted before you die. Any LIF assets remaining after your death form part of your estate. You can keep a LIF for the rest of your life, or convert it to a life annuity later on.
Setting up a LIF is relatively easy. You open a LIF account and then arrange for the assets in the LIRA to be transferred to the LIF. It is often possible to move the holdings in kind, so there is no need to sell existing investments before the transfer. This process works most smoothly if the LIF is opened at the same financial institution that holds your LIRA.
A life annuity provides the annuitant with a regular defined, guaranteed income, which is taxable, for the rest of her life. An annuity is irrevocable. Once purchased, there are no further decisions to make regarding investments or withdrawals. It is an effective way to address longevity risk, which is the risk of running out of money in retirement. However, by choosing an annuity, there will usually be no funds left for your estate.
Your LIRA investments must be sold to raise the cash to buy a life annuity. To maximize your investment returns and avoid having to sell at market lows, the selling should begin well in advance of the annuity purchase date.
A life annuity is an insurance product and must be purchased from a licensed life insurance agent or broker. A career agent is employed by a life insurance company and sells only his firm's annuities. An independent broker will shop the market to find the best annuity rate that is currently available.
"The process for buying a life annuity is the same, whether the funds originate from a LIRA or RRSP," says insurance broker Rino Racanelli of www.backtobackannuities.com. "You work with the broker to flesh out the annuity details such as payment frequency and guaranteed payment period. The broker then obtains quotes from several life insurance companies and you decide which one is best. The broker arranges the annuity purchase and the transfer of your LIRA funds."
It takes approximately three weeks to set up the annuity and start receiving income, Racanelli says. The timing largely depends on how quickly the institution holding the LIRA transfers the funds to the annuity provider.
The details on drawing income from a LIRA depend on the jurisdiction where the originating pension plan is registered. The plans of federally regulated employers (e.g., banks, federal civil service and telecommunications companies) are governed by federal pension regulations and funds are held in what is known as a locked-in retirement savings plan (LRSP). Otherwise, the rules of the province or territory where the income was earned and the company is registered apply. The financial institution holding your LIRA will be able to tell you which jurisdiction governs it.
"Consumers find the large amount of information on LIRA regulations confusing," says Stephen Wilton, an investment-fund specialist at FTC Investor Services. "For example, the minimum annual LIF payout rate is the same across the country, but the maximum rate varies by jurisdiction. You can begin to draw an income stream at any age from a federal LRSP or a Manitoba, Quebec or New Brunswick LIRA. However, you must wait until age 50 if your LIRA is registered in British Columbia and Alberta. In Saskatchewan, Ontario, Nova Scotia and Newfoundland and Labrador, the minimum age to begin drawing income is 55."
LIRA funds may be accessible before the standard retirement age under special circumstances such as reduced life expectancy, financial hardship, a small balance or non-residency in Canada. Again, the precise rules of access vary by jurisdiction.
Pension regulations may also specify other ways to unlock at least some LIF funds. For instance, in Ontario after transferring LIRA funds to a LIF account, you have 60 days to withdraw in cash or transfer up to 50% of the value of the LIF to your RRSP or your RRIF. This effectively unlocks the money because there are no limits on withdrawals from an RRSP or RRIF.
What should you do with your LIRA? It all depends on your personal circumstances. If the LIRA balance is too small to provide a pension, you may be able to withdraw the entire amount and close the account. If longevity runs in your family, buying a life annuity means that your income stream will not expire before you do. If you are in poor health, a LIF may be the best way to preserve some assets for your estate.
When considering what to do with a LIRA, consulting an accredited financial planner with retirement-planning expertise and no vested interest in a particular LIRA conversion strategy is a wise course of action. She can advise on the regulations that apply to your LIRA and how to best integrate the LIRA into your overall financial plan.