Thursday, June 13, 2013

Unlocking Your Locked-In Life Income Fund

While I was still working, I was enrolled in a locked-in Defined Contribution pension plan.  On an annual basis, my employer contributed a preset percentage of my salary to a Locked-In Retirement Account (LIRA), which is basically a locked-in RRSP.  This amount reduced my RRSP contribution room for the year.  Once I retired, I transferred the accumulated money into a self-directed LIRA account at Scotia iTRADE, where we were managing the rest of our investments.  These funds were then used to buy more dividend-paying stocks, in line with the income generating strategy described in our book Retired at 48 - One Couple's Journey to a Pensionless Retirement.  However, at age 48, we would not be able to access this money for a while.

A LIRA has many more restrictions than a regular RRSP.  The earliest that a LIRA can be collapsed is age 55, and it must be converted into a locked-in income generating product such as a Life Income Fund (LIF).  The latest date to collapse the LIRA is the same as the RRSP–by the end of your 71st year.

The LIF not only mandates an annual minimum withdrawal, but also imposes an annual maximum withdrawal limitation.  This is to ensure that your pension lasts throughout your retirement years, rather than being squandered prematurely.  In my opinion, this is a "Big Brother" approach that feels unreasonably restrictive. I want to free up as much of the LIF money as soon as possible so that I can be in control of my own funds and make my own decisions.  Luckily there have been some recently added LIF rules that could help.

If your LIF is subject to Ontario laws, then rules have been introduced over the past few years which allow you to free up some of these locked-in funds.  However you need to be aware of them and take action promptly at the appropriate times in order to take advantage of them.   The two most relevant rules that apply to the most people are:

1. You can free up to 50% of the value of your LIF by submitting a request form to the financial institution managing the LIF.  The catch is that you must make this request within 60 days of creating the LIF.  You can request to either withdraw the money from the LIF or to transfer it into an unlocked RRSP or RRIF.  Choosing the withdrawal option could trigger a huge tax burden for the year, whereas transferring to the RRSP or RRIF would be tax-free since you are provided an contribution deduction slip which offsets the taxable income.  Unless you need all the money immediately, the latter seems to be the better strategy.   

If you hold stock within your LIF, you can provide instructions to transfer shares "in-kind" into the RRSP or RRIF.  This will save transaction fees of selling stock in the LIF and repurchasing it in the RRSP or RRIF.  It also will not disrupt any Dividend Reinvestment Plans (DRIP) that you may be registered in.

2. The small account rule indicates that once the combined value of all of your locked-in accounts is less than $20,440, you can submit another form requesting to unlock the rest of the money. 

The two steps can be executed sequentially.  If withdrawing/transferring 50% in step 1 brings the value of your LIF(s) down below the small account minimum, then step 2 can be executed to unlock the rest.  This means that LIFs in the range of around $41,000 or less can be totally unlocked within the first year.  If the value is more than that, then you need to set up the LIF to withdraw the maximum each year and wait for it to fall below the value of the small account rule.