If you participate in a registered pension plan, and leave voluntarily or happen to be laid off, your company pension may be transferred to a locked-in retirement account. While a LIRA is like an RRSP, in that it will be a source of retirement income, it is more complex and subject to many more restrictions.
Unlike an RRSP, from which you can make withdrawals at any time, it is difficult to unlock the funds held in a LIRA, in whole or in part. There are some exceptions, though. But being able to do so means meeting a slew of conditions, which cannot be undertaken lightly.
"No one chooses a LIRA on purpose," observes Jamie Golombek, managing director, tax and estate planning at Toronto-based CIBC Wealth Strategies Group, a unit of CIBC. "It is an RRSP, basically. But on top of the RRSP rules, a LIRA is governed by locking-in provisions contained in various pension legislation, either provincial or federal." Most company pension plans are governed by provincial laws, although banks, airlines and railway companies are subject to federal rules.
One of the key differences, compared to RRSPs, is that you cannot make any personal contributions to a LIRA. "A pension plan provides a portability option which allows your pension contributions and those of your employer to be transferred to a LIRA, when you leave the company or retire," says Golombek.
Another key difference is that, because they are subject to pension rules, LIRAs provide you with creditor protection, says John Natale, assistant vice-president, tax, retirement and estate planning with Waterloo, Ont.-based Manulife Financial Corp. Moreover, it could be argued that LIRAs also protect people from themselves, and potentially depleting their assets prematurely. Says Natale: "These assets were intended to be used for retirement someday down the road."
While pension plans may appear alike, it's important to understand the difference between a defined-benefit (DB) plan as opposed to a defined-contribution (DC) plan. In principle, defined-benefit plans promise a pre-set level of retirement income. Defined-contribution plans offer no pre-set guarantees of retirement income. Under pension rules governing DB plans, says Natale, one must determine the maximum transfer value (MTV) or the amount you are allowed to transfer to a LIRA on a tax-deferred basis. "The commuted value may be more than the MTV."
If, for example, the commuted value was $500,000 and the maximum transfer value was $400,000, you could transfer up to $400,000 into a LIRA on a tax-deferred basis. But the excess of $100,000 would have to be taken into income. That could result in a fairly painful tax bite, depending on your marginal rate.
If you had contribution room in your RRSP, observes Natale, you could transfer the excess amount to your RRSP and get a deduction. "The problem is that people with a defined-benefit plan get what is called a pension adjustment each year for the value of the pension benefits earned. This reduces their annual RRSP contribution room. Most people, especially those with a fairly rich defined-benefit plan, have minimal RRSP room, if any."
The advantage of participating in a DC plan is that you don't have to be concerned with a potential taxable excess and can simply roll all the money into a LIRA. "You control the lump sum," says Natale. "It's not like a guaranteed retirement-income benefit payout, where you have to do a calculation to determine the commuted value." On the face of it, the DC plan appears to offer more control of your pension assets. But, Natale notes, it also means that the risk resides with you, as opposed to the employer who is required to stand behind a DB plan.
What are your options when you reach retirement and decide to convert your LIRA into an income stream? There are four, although some are restricted to certain jurisdictions.
Life annuity. Available in all jurisdictions. "It's the easiest way and provides you with income for the rest of your life," says Golombek. "But you don't have control over the investments."
Life income fund (LIF). This vehicle is similar to a registered retirement income fund (RRIF). It offers full control of the investments in the fund, though it is subject to annual minimum and maximum withdrawals.
Locked-in retirement income fund (LRIF). Similar to a LIF, but available only in Newfoundland and Labrador.
Prescribed registered retirement income fund (PRRIF). Similar to a LIF, but available only in Saskatchewan and Manitoba.
What happens if you want full or partial access to the LIRA, before reaching retirement age? In a number of instances, you can. But you will have to meet several conditions to do so, subject to the rules of the legislation governing your LIRA.
Small amounts. If you are 55 years old or older and have an Ontario LIRA, for example, you can withdraw in cash or transfer to an RRSP or RRIF the balance of the LIRA, provided that the assets of all of your Ontario locked-in plans amount to less than 40% of the year's maximum pensionable earnings, or YMPE. For 2016, the YMPE is $54,900, so your total locked-in assets must be less than $21,960.
Shortened life expectancy. While the rule varies by jurisdiction, you can get access to all or part of your LIRA, provided your physician certifies that you have an illness or physical disability that will shorten your life. Applicable withholding taxes will have to be paid.
Financial hardship. If you are in desperate straits and, for example, risk foreclosure on your home or eviction from rented premises, you may be able to access the LIRA, less any applicable withholding taxes.
Non-residency. If you are moving or have already moved to another country, you can access 100% of your funds.
50% unlocking. Depending on the jurisdiction, you can make a one-time lump-sum withdrawal of up to 50% of the funds in cash from your LIRA, subject to any withholding taxes. Alternatively, you could transfer it to an RRSP or RRIF.
Because of the complexity surrounding LIRAs, and the range of options, it's advisable to consult a financial advisor before deciding about the conversion options. "He or she can advise you, based on your income needs," says Golombek. "Does it make sense to convert a LIRA to a life annuity? It will give you certainty as to how much money you will receive each month. Or does it make sense to put a part into an annuity and another part into a LIF? The latter will give you the flexibility to manage some of your own money."
Manulife's Natale concurs. "There are a lot of nuances in this field. The rules vary by pension jurisdiction. If you are not careful, you may not be able to take full advantage of the options available to you."
