Some of you might be familiar with locked-in RRSP or RRIF accounts, otherwise known as LIRAs, LIFs, LRIFs, PRIFs and probably a few other choice names as well. These are basically RRSP or RRIF accounts that are locked-in so that the owners can’t get access to the money until retirement age. Even in retirement, the withdrawal amounts are limited.
The idea behind locking in the money is to protect the account owners from prematurely draining their retirement accounts and burdening government support programs such as GIS, in their old age.
How do you end up with a locked-in RRSP?
Employees who work for a company that offers a defined benefit pension plan (such as the government), will build up pension credits over time. If the employee should leave the job, they have a choice of:
- Leave their accumulated pension credits in the pension plan and collect a pro-rated pension at retirement age.
- Transfer the “commuted” value of their pension credits to a locked-in RRSP account which is called a LIRA (Locked-In Retirement Account)
If they are close to retirement age, option 2 is usually not available.
Contributions to a defined benefit plan need to be locked-in
If you are an active non-retired member of a defined benefit pension plan, you make contributions to the pension plan. The money you contribute is locked-in. You can’t withdraw it unless you leave the company and are eligible to transfer your pension credits out.
Money in a pension plan must be locked-in because of something called mortality credits
For an excellent description on mortality credits, please see the Oblivious Investor article on annuity payouts.
Very simply put – In order to run a pension plan properly, the administrators need to have some assurance that the money in the plan won’t be arbitrarily withdrawn by members. This is similar to buying an annuity. Once you buy – you can never undo the purchase. To do be able to do so would make it impossible to manage the annuity properly.
If an employee leaves the company and transfers their pension credits out – there is no necessity to keep the money locked in. Because it is not part of a pension plan, mortality credits and any other pension-related reasons for locking in, no longer exist.
What if the money is unlocked and the former employee spends it all?
One might make arguments that the accounts should be locked-in to protect the investor from themselves. If the accounts are unlocked, the investor might cash out and not have enough money for retirement.
But what about regular RRSP accounts? Are they locked-in? Should the government make all rrsp accounts locked-in so that the investors are “protected” against themselves?
I don’t think so either. And it doesn’t make sense to me that people who make contributions to an RRSP account have complete freedom over their money, whereas someone who contributed to a DB pension plan and then converted it to a locked-in RRSP account (LIRA), does not have complete freedom over their money.
Both investors might have contributed the same amount, over the same time period and ended up with the same investments in very similar retirement accounts. But one can withdraw any amount from their account anytime, the other can’t.
Employee chooses between annuity (pension) or RRSP
When an employee leaves a pension, they make their decision to keep the money in the pension plan and collect a pension later, or they choose to remove the money from the pension plan and make themselves responsible for the money.
This choice is similar to a retired person who has to choose between using some or all of their investment portfolio to buy an annuity (guaranteed income), or keep the money in their RRSP or RRIF account. If they choose the annuity, the money is used to buy an irreversible annuity which will have guaranteed income for life. If they choose to keep the money, they will be responsible for looking after the administration of the retirement account as well as withdrawals.
If the employee chooses not to remain in the pension plan, they should be able to transfer their pension money into a regular RRSP, where they will have full control over the investments as well as withdrawals.
Locked-in retirement accounts should be under federal rules
One last item, while I’m on the topic – Why, oh why are the locked-in retirement rules under provincial jurisdiction? The rules for withdrawals are different for every province. This is silly. If you have a TFSA or an RRSP – it doesn’t matter where you live, the rules are the same. Locked-in retirement accounts should also have the same rules, regardless of which province the locked-in money originated from.
Or better yet – just eliminate locked-in retirement accounts!
Want to learn more about RESPs? Buy The Book:
The RESP Book: The Simple Guide to Registered Education Savings Plans
Everything you need to know about RESPs.