Most Canadians are familiar with RRSPs and TFSAs, but there’s another registered vehicle for retirement savings that you may not know much about: locked-in retirement accounts. What is a LIRA account and why would you have one? Here’s what you need to know.
What is a LIRA?
A locked-in retirement account (LIRA) is a registered account for funds that used to be invested in a corporate pension plan.
When workers who are members of a corporate pension plan leave their employer for any reason, they can remain in the plan and receive a monthly pension income at retirement, or they can exit the plan and transfer the commuted value of the pension to a LIRA.
Similar to a registered retirement savings plan (RRSP), a LIRA can hold a number of investments, including GICs, stocks, bonds, mutual funds, index funds and exchange-traded funds. And, like RRSPs, the earnings on those investments grow tax-free while they remain inside the LIRA, and are fully taxable upon withdrawal.
In some provinces, LIRAs are actually called locked-in RRSPs, which a good way of thinking of them. That’s because unless there are extreme mitigating circumstances, such as shortened life expectancy, disability or financial hardship, the money invested in a LIRA is “locked-in” — meaning no funds can be added or withdrawn — until retirement.
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Difference Between LIRA and RRSP
As mentioned, the main differences between these two registered accounts are that LIRAs hold money transferred from a corporate pension and are locked until retirement, while RRSPs hold money you contribute directly and can be taken out at any time.
Of course, the flexibility of RRSPs can be a double-edged sword. On the one hand, investors may want to withdraw funds before retirement for a variety of reasons, such as to buy a home, pay for education or cover emergency expenses. On the other hand, if they tap into their RRSP money too often, they won’t have anything left at retirement.
The locked-in nature of LIRAs ensures that the money intended for retirement will not be used until retirement.
Here’s a more detailed breakdown of the similarities and differences between RRSPs and LIRAs, and the pros and cons for investors:
LIRA RRSP Investment options: Pro: Can choose own investments Pro: Can choose own investments Tax rules: Pro: Tax-sheltered growth on investments Pro: Tax-sheltered growth on investments Direct contributions? Con: Can't make contributions -- funds can only be transferred from a corporate pension Pro: Can contribute directly (18% of previous year's earned income up to $26,500 for 2019) Withdrawal rules: Con: Can't make withdrawals before retirement Pro: Can withdraw any amount at any time, subject to income tax Pro: Ensures an income at retirement, since money is locked-in Con: If you cash out, you won't have anything left at retirement Eligibility for incentives: Con: Not eligible for Home Buyers/ Lifelong Learning Plan Pro: Withdrawals made under the Home Buyers Plan or Lifelong Learning Plan are tax-free Rules and regulations: Con: Rules vary slightly from province to province Pro: Rules are consistent across Canada
How to best use your LIRA when you retire
Similar to RRSPs, a LIRA account must be converted to an income-generating vehicle by the end of the year you turn 71.
While an RRSP can be turned into a RIF (registered income fund) any time before age 71, a LIRA usually cannot be converted to an income fund until age 55 at the earliest (age 50 in Alberta). The options available at that point are to turn the account into a LIF (life income fund) or LRIF (locked-in retirement income fund), or to buy a life annuity.
A LIF or LRIF operates like a RIF, in that you can control the investments in your account and must withdraw a minimum amount every year. The minimum annual withdrawals are the same as with a RIF, and are based on your age and size of your account (see table below). Those withdrawals are included as taxable income on your annual tax return.
Unlike a RIF, however, a LIF/LRIF also has a cap on how much you can withdraw each year. These maximum withdrawal amounts are in place to make sure the money will last for the rest of your life and won’t run out early in your retirement.
2021 LIF/LRIF Withdrawal Limits
Age on Jan.1 Minimum Withdrawal Maximum Withdrawal Age on Jan. 1 Minimum Withdrawal Maximum Withdrawal 55 2.86% 4.33% 73 5.53% 6.66% 56 2.94% 4.38% 74 5.67% 7.01% 57 3.03% 4.43% 75 5.82% 7.42% 58 3.13% 4.49% 76 5.98% 7.89% 59 3.23% 4.55% 77 6.17% 8.43% 60 3.33% 4.62% 78 6.36% 9.07% 61 3.45% 4.70% 79 6.58% 9.82% 62 3.57% 4.78% 80 6.82% 10.72% 63 3.70% 4.87% 81 7.08% 11.82% 64 3.85% 4.98% 82 7.38% 13.19% 65 4.00% 5.09% 83 7.71% 14.96% 66 4.17% 5.21% 84 8.08% 17.32% 67 4.35% 5.35% 85 8.51% 20.63% 68 4.55% 5.51% 86 8.99% 25.59% 69 4.76% 5.68% 87 9.55% 33.85% 70 5.00% 5.88% 88 10.21% 50.39% 71 5.28% 6.10% 89 10.99% 100.00% 72 5.40% 6.36% 90 11.92% 100.00%
*Maximums are for federally regulated LIFs/LRIFs only. Maximums for provincially regulated funds are set by each province’s registered pension plan regulator. Note: No withdrawal is required in the year the LIF/LRIF is started. (Source: https://www.investingforme.com/withdrawals)
Another option open to retirees is to use the money in their LIRA to buy a life annuity contract, which would provide them with a guaranteed fixed income for life. In addition, in some provinces, half of the money in a LIRA can be transferred into an RRSP at retirement.
Locked-in retirement accounts are a valuable alternative for investors who decide to leave their corporate pension plan after a job change or layoff. Individuals can transfer the money within their pension to a LIRA, choose whatever investments they want, and watch their investments earnings grow tax-free.
Because funds in a LIRA account are locked-in, the money cannot be withdrawn early and spent on other priorities — ensuring Canadians have that money for its intended purpose: retirement. LIRAs, used in conjunction with RRSPs and TFSAs, can provide well-rounded investment income for Canadian retirees.