What is a locked-in retirement account (LIRA)?
A Locked-In Retirement Account (LIRA) is a special type of registered retirement savings account in Canada designed to hold pension funds for individuals who have left their employer and are not yet retired. It’s a safeguard, locking in pension funds until retirement age, ensuring these funds are used as intended—to provide income during one’s later years.
LIRAs prevent the premature cash-out of pension assets, mandating that the benefits accrued in the account remain untouched until the account holder reaches a certain age, typically anywhere from 55 to 65. Once an individual reaches this age, the LIRA must be converted into a life annuity, a Locked-In Retirement Income Fund (LRIF), or a Life Income Fund (LIF), which then provides regular retirement income.
Benefits of having a LIRA
The primary benefit of a LIRA is the preservation of pension funds for retirement years, ensuring a stable and secure source of income when income from work ceases. It’s a crucial tool for long-term financial planning, offering several advantages:
Tax-deferred growth
One of the substantial benefits of a LIRA mirrors that of Registered Retirement Savings Plans (RRSPs); the investments within a LIRA benefit from tax-deferred growth. This means the investment income generated—whether it’s interest, dividends, or capital gains—doesn’t get taxed as long as it remains within the account. This tax-advantaged status allows your savings to compound more rapidly over time, devoid of the immediate tax implications that diminish growth in non-registered accounts.
Protection from creditors
An often-overlooked advantage of a LIRA is its protection from creditors. For individuals facing financial hardships or business risks, knowing that their retirement funds are safeguarded is invaluable. While the degree of protection can vary between provinces and territories, generally, funds held in a LIRA are not accessible to creditors, ensuring that your retirement savings remain intact regardless of financial downturns or personal liabilities.
Control over investments
Despite the locked-in status and contribution limits, LIRA holders can significantly manage their investment choices within the account, aligning with their risk tolerance, preferences, and retirement objectives. This flexibility lets individuals choose from various investment options like stocks, bonds, ETFs, and mutual funds to tailor their retirement strategy as they approach retirement.
Income splitting
Converting a LIRA into a LIF or a life annuity at retirement introduces financial strategies like income splitting, which for couples, can notably lower their tax burden by distributing retirement income more evenly, especially when one partner’s income is significantly higher.
Who should consider a LIRA
Not everyone will find themselves in a position to consider a LIRA, but for those who do, it can be an invaluable component of retirement planning. You might consider transferring your pension funds into a LIRA if:
- You’re changing jobs: If you switch employers and are part of a pension plan, you can often transfer the accrued value of your pension into a LIRA.
- You’re leaving your job: Whether due to resignation, termination, or retirement, if you’re departing from your position and have a pension plan in place, a LIRA can secure those funds until retirement.
- You’re seeking to manage your pension investments: If you prefer to have more control over how your pension funds are invested, a LIRA gives you the flexibility to choose your investments while maintaining the tax-advantaged status of these funds.
- You’re consolidating retirement accounts: For those with multiple small pension entitlements from different employers, consolidating those funds into a single LIRA can simplify management and potentially improve investment outcomes.
Requirements and eligibility criteria
To open a LIRA, you must have pension funds from a previous employment that you wish to transfer. The eligibility for opening a LIRA typically hinges on these conditions:
- You are leaving a job with a pension plan and want to retain control over your pension funds.
- You have received or are eligible to receive a lump-sum payout from your pension plan, which needs to be preserved for retirement.
How to open and invest in a LIRA
Step 1: Select a financial institution
First begin by choosing a bank, credit union, or investment firm that offers LIRA accounts and aligns with your investment preferences. Consider factors such as investment options, fees, and the level of customer service.
Step 2: Gather documentation
Prepare the necessary documentation from your previous pension plan indicating your eligibility for a lump-sum transfer. This typically includes your pension plan statements and officially drafted correspondence from the pension provider outlining your options.
Step 3: Complete the application
Work with your chosen financial institution to fill out the LIRA application form. This process includes specifying the investment options for your LIRA funds, based on the offerings available through the institution.
Step 4: Execute the transfer
Coordinate between your pension plan administrator and the financial institution to transfer your pension funds directly into your new LIRA. This will typically include a transfer request form that outlines the amount being transferred and confirms the locked-in status of the funds. Once the funds are transferred, you will choose how they are invested within the LIRA, adhering to any investment restrictions imposed by the account trustee and relevant legislation.
Restrictions on withdrawals
One of the defining features of a LIRA is its stringent restrictions on withdrawals. Unlike typical retirement savings accounts where holders may access funds at their discretion, a LIRA’s primary purpose is to ensure that pension funds are preserved to provide income during retirement. Hence, the funds in a LIRA cannot be withdrawn until the account holder reaches a certain age, usually between 55 and 65, depending on the jurisdiction. Upon reaching this age, and up until age 71, the holder must convert their LIRA into a retirement income vehicle, such as a Life Income Fund (LIF) or a locked-in annuity, to start receiving retirement income, rather than opting for a lump-sum withdrawal.
Some exceptions to these withdrawal rules may apply in specific circumstances, such as financial hardship, medical expenses, or shortened life expectancy, though these exceptions vary by province.
Tax implications and penalties for early withdrawals
Withdrawing funds from a LIRA before retirement age, when allowed by specific circumstances, can have considerable tax implications. Typically, any withdrawn amount will be taxed as income at your current marginal rate. Additionally, early withdrawals could be subject to penalties or fees, both from the government and the institution holding the LIRA.
Pros and cons of a LIRA
Pros of a LIRA | Cons of a LIRA |
Tax-Deferred Growth: Like other retirement savings plans, a LIRA allows your investments to grow tax-deferred, enhancing the compounding effect over time. | Liquidity: The primary drawback of a LIRA is the lack of access to your funds until retirement age. Except under specific circumstances, you cannot withdraw funds early, making it less flexible than other types of accounts. |
Security: A LIRA locks in your pension funds, ensuring they are used for their intended purpose: providing income in retirement. | Complexity: The rules surrounding LIRAs, including contributions, withdrawals, and conversions to income-generating products, can be complex. This makes it essential to work with a financial advisor to navigate these rules effectively. |
Control: Although you can’t make additional contributions to a LIRA, you do have control over how the funds are invested, within certain guidelines. | Risk of Mismanagement: Poor investment choices within a LIRA can impact the available retirement income, underscoring the importance of informed decision-making and possibly, professional guidance. |
How does a LIRA fit into your retirement planning?
A Locked-In Retirement Account (LIRA) is a pivotal component of retirement planning for many Canadians, particularly those who have accumulated pension funds from previous employment. Understanding how a LIRA can complement your retirement strategy will not only help in maintaining financial stability in your later years but also in maximizing the potential income from your retirement savings.
Options upon Reaching Retirement Age (LIFs, Life Annuities)
As you approach retirement, it’s crucial to consider how your LIRA will transform into a reliable income source. Two primary options are available:
- Life Income Funds (LIFs): A LIF is a retirement income vehicle that allows you to retain control over the investment while receiving regular income. The funds remain invested, and you can decide on how to allocate them based on your risk tolerance and financial needs. However, there are minimum and maximum withdrawal limits set by legislation to ensure that your retirement savings last throughout your retirement.
- Life Annuities: Purchasing a life annuity means converting your LIRA into a guaranteed income stream for life. This option provides financial security and peace of mind, knowing exactly how much you will receive regularly, regardless of market conditions. However, once purchased, the decision is irreversible, and you lose control over the invested funds.
Differences between LIRAs, RRSPs, and TFSAs
When planning for retirement, Canadians have several powerful tools at their disposal, including Locked-In Retirement Accounts (LIRAs), Registered Retirement Savings Plans (RRSPs), and Tax-Free Savings Accounts (TFSAs). Each of these accounts plays a unique role in retirement planning, offering different advantages, restrictions, and tax implications. Understanding these differences is key to building a comprehensive and effective retirement strategy.
Locked-In Retirement Accounts (LIRAs) | Registered Retirement Savings Plans (RRSPs) | Tax-Free Savings Accounts (TFSAs) | |
Summary | LIRAs are specifically designed for transferring pension funds when you leave an employer. The primary characteristic of a LIRA is its “locked-in” nature, which restricts access to the funds until retirement age. This design ensures that pension funds are preserved to provide a steady income in retirement. | RRSPs allow Canadians to save and invest funds on a tax-deferred basis. Contributions to an RRSP reduce your taxable income. Unlike LIRAs, RRSPs offer more flexibility in terms of withdrawals, with options like the Home Buyers’ Plan (HBP) and Lifelong Learning Plan (LLP) allowing for tax-free withdrawals under certain conditions. | Introduced in 2009, TFSAs offer a flexible savings option for Canadians, allowing contributions, growth, and withdrawals to be tax-free. Unlike RRSPs, contributions to a TFSA do not reduce your taxable income, but the major advantage is that earnings and withdrawals are not taxed. TFSAs also do not have restrictions on the use of funds. |
Access | Restricted: Funds cannot be withdrawn until retirement, except under specific circumstances. | Flexible: Funds can be withdrawn at any time, with taxes deferred until withdrawal. | Flexible: Funds can be withdrawn at any time, tax-free. |
Purpose | To hold and protect pension funds until retirement. | To save for retirement, with the flexibility to withdraw funds for specific purposes like buying a home or education. | To save for any purpose with flexibility and tax-free growth. |
Tax Treatment | Tax-deferred growth; taxes are paid upon withdrawal. | Contributions are tax-deductible, reducing taxable income; withdrawals are taxed as income. | Contributions are not tax-deductible, but withdrawals and investment growth are tax-free. |