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Unlock locked-in dollars for more flexibility

Here's a heartwarming story making the rounds on the Internet. It's about a Charlotte, N.C., lawyer who bought a box of rare cigars, then insured them against fire.

Within a month, having smoked every one of them, the lawyer filed a claim with the insurance company, stating that the cigars were lost "in a series of small fires." The insurance company refused to pay, so the lawyer sued -- and won! In delivering the ruling, the judge agreed that the claim was frivolous, but emphasized that the lawyer held a policy from the company that failed to define what is considered "unacceptable fire." The insurance company had to pay $15,000 (U.S.) to the lawyer for his bamboozle.

Get this. After the lawyer cashed the cheque, the insurance company had him arrested on 24 counts of arson, and he was convicted of intentionally burning his insured property. He was sentenced to 24 months in jail and a $24,000 fine. This story is so heartwarming because, in the end, the bad guy loses. Ah, if the story were only true (but it's not).

There's another familiar, yet true, story in which the good guy loses. It might even be your story. It's about a person who has saved for retirement for years only to find that he's not able to withdraw all that he wants from his registered plan. It's a locked-in plan. But his story has a good ending after all. He's discovered a way to unlock some of those locked-in dollars. Let me explain.
The problem

If you're an ex-member of a pension plan, it could be that you are currently the proud owner of a Life Income Fund (LIF) or a Locked-In Retirement Income Fund (LRIF). These are locked-in retirement plans. You see, when a person leaves her pension plan, it's a common occurrence for her to take the money earmarked for her in the pension plan and transfer those dollars to a locked-in plan. The money has to remain locked-in under pension legislation. This simply means that any withdrawals each year will be restricted to some maximum amount.

These plans also have a minimum withdrawal requirement each year.

Most of us want more flexibility than the locked-in plans provide.

If it were possible to take some of those locked-in dollars and move them to a non-locked registered retirement savings plan (for those under age 69) or registered retirement income fund (for those over 69) we'd benefit from more flexibility and control over the timing of our retirement income.
The solution

There's a method to accomplish some unlocking of your locked-in assets. If you're like many Canadians with a LIF or LRIF, you may not need to withdraw the maximum amount each year in order to meet your cash needs. In this case, the difference between the maximum you're entitled to withdraw and the actual amount you withdraw can be transferred on a tax-free basis to a non-locked RRSP or RRIF.

Suppose that, at age 55, you have $250,000 in a locked-in retirement account and transfer it to a LIF. At age 56, you'll be required to withdraw 2.94 per cent of the account as a minimum under Canadian tax law. You'll be restricted to a maximum withdrawal of 6.57 per cent under pension law.

Assuming you don't need the cash, you could withdraw the minimum amount (because you're required to) and then transfer the balance, up to the maximum, to a non-locked RRSP. In this example, 3.63 per cent (6.57 less 2.94 per cent), or $9,075, of your locked-in assets can be transferred to a non-locked RRSP on a tax-free basis in that year. All that's required is to file Form T2030 annually.

Doing this for just 10 years will result in transferring $108,770 to a non-locked plan. With the growth on that money at 8 per cent over 10 years, the total value you will have unlocked will be $153,860.

It's generally best to use a LIF rather than an LRIF for this strategy because the maximum withdrawal is always higher than the minimum with a LIF. This is not necessarily the case with an LRIF. Further, you'd be wise to base your withdrawals on the age of the younger spouse since this will reduce the minimum required withdrawal and allow you to unlock even more assets annually.
The candidates

Who is an ideal candidate for this strategy? Anyone who has significant assets in a locked-in retirement plan, wants the flexibility offered by unlocking those assets, is willing to make the minimum but less than the maximum withdrawal annually, and is of the right age to convert to a LIF or LRIF under pension legislation in their province. (This age is generally 55, but can vary; Alberta is age 50, and Manitoba, Quebec, and New Brunswick don't have a minimum age requirement.)
Tim Cestnick, CA, CFP, TEP is author of The Tax Freedom Zone and Winning the Tax Game 2003. He is managing director, Tax Smart Services, at AIC Ltd.

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