Convert your RRSP to a Defined Benefit Pension when you retire (?)

I think that in the DIY investor world, the propensity to convert an RRSP to a RRIF is strong. The same is probably true for those who use an advisor as well. In fact, approximately 75% of RRSPs are eventually converted to RRIF (Registered Retirement Income Fund) accounts. The title of this post isn’t entirely accurate (you can’t actually convert your RRSP to a defined benefit pension plan per se), but you can convert your RRSP into a structure that mimics a Defined Benefit Pension Plan through the use of a life annuity.

Defined Benefit pensions are envied by some since you eliminate a lot of unknowns for your retirement income planning such as the risk of running out of money. The major counter argument is that with a RRIF account you can possibly increase the pot and potentially have a higher overall retirement income by earning a higher internal rate of return than is normally afforded by an annuity. As always, there is a tradeoff – you are trading the risk of running out of money for the chance at higher overall income stream.

For those who enter retirement with an RRSP, one of the RRSP maturity options is to convert to a Life Annuity. This is a guaranteed income stream for life. Essentially you trade a lump sum now for that guaranteed income stream which you will have until the day you die. An actuarial evaluation is used (you can only arrange a life annuity through an insurance agent/company) and as opposed to life insurance where you "lose" when you live too long, you "win" if you live longer than the mortality tables predict with an annuity.

Nonetheless, once you set up the life annuity you will now have an income stream for life – which will fully address the risk of running out of money. The internal rate of return for an annuity is very much based on the interest rate environment, and as such the return might not be up to par for some investors. However, if more people knew about this option I’m sure it would be more prevalent.

And of course, it would be wise to consider a combination of a life annuity and a RRIF account in tandem (the two are not mutually exclusive). You could figure out your absolute minimum income requirement and purchase an annuity to match that income requirement and use the balance of your RRSP for a RRIF account. Now you will have a minimum guaranteed income for life AND the chance of increasing your overall retirement income.