What is a LIRA and how should you invest in it?
Got a Locked-In Retirement Account (LIRA)?
On the cusp on getting a Locked-In Retirement Account thanks to your recent workplace changes?
What the heck is a LIRA and why does investing have to be a bunch of alphabet soup?
All great questions readers.
Thanks to more reader questions this winter, including a recent request for help, we’re going to provide an overview of this account and some considerations associated with investing inside this account.
First up, a LIRA primer:
- A Locked-In Retirement Account (LIRA) is similar but not the same as a Registered Retirement Savings Plan (RRSP). Sure, they are both designed for tax deferred investing (you can read up on RRSPs in my 101 post here) but a LIRA differs in how it originates. Most adult Canadians can open an RRSP any time. A LIRA is basically designed to hold pension money outside of a pension plan.
- LIRAs are typically established when you leave an organization and you want to take the pension money you’ve accumulated as part of that pension plan with you. If you have a LIRA or you were asked to establish a LIRA, chances are you were part of a company pension plan at some point.
- Recall there are two key types of pension plans – defined contribution and defined benefit. If you are fortunate to have a pension plan at work then I would encourage you to find out which one you can contribute to and all the rules associated with it!
- Unlike an RRSP, you cannot contribute/add new money to a LIRA – hence the name (Locked-In).
- Depending on the jurisdiction the pension was registered in, LIRAs can be managed federally or under provincially regulated pension laws.
- Like an RRSP though, a LIRA can hold you various investment products or securities such as GICs, cash, bonds, stocks, ETFs and more for long-term tax-deferred growth.
- You can’t make withdrawals from a LIRA, first it must be converted into a LIF. LIRAs can be converted to a LIF as soon as you reach age 55 and must be converted to a LIF by the end of the year you turn 71.
- Once a LIRA is converted to a LIF there is very little flexibility on annual withdrawals. This greatly reduces income flexibility in retirement (important for income tax planning and benefit claw back planning). Once converted to a LIF there is a minimum withdrawal and a maximum withdrawal based on your age and the size of the portfolio at the beginning of the year. These min and max withdrawals are slightly different depending on where the LIF is regulated, either provincially or federally.
- LIRAs can be unlocked in some circumstances. Certain provinces allow up to 50% of the LIRA to be unlocked after age 55 (that is the case in Ontario, in Alberta it will be age 50). Be mindful you have only 60 days to make any transfer after unlocking!
- Up to 100% can be unlocked if facing financial hardship or a shortened life expectancy. This can increase the flexibility on the timing of withdrawals.
LIRA to LIF Table:
Image courtesy of RBC.
Why I have a LIRA
When I left Toronto (and my employer at the time) to move to Ottawa in 2001, I was given an option to move the defined contribution pension money I accumulated with that employer to a LIRA (a few thousand bucks). I did so because I didn’t want to leave that money in that pension plan (who knows what might or might not happen to that privately-owned company?) and more importantly, I knew I knew I could take investing matters into my own hands using a self-directed LIRA account at my discount brokerage.
How should you invest in a LIRA – what are some good options to consider? Check out this reader case study:
Mark, I subscribe to your site and I enjoy reading about your personal finance journey and DIY approaches to investing. However, I work for a company that recently announced it is closing in May 2019. I would like to know what to invest in, given some of this pension money will need to be placed into a LIRA. I’m forty- eight years old so I still have a long ways to go before retirement, so I want this money to grow. I believe the LIRA amount will be close to $200,000 so it’s a lot of money. I definitely appreciate any insights – I know you can’t offer direct advice.
Keep up the great work!
Thanks for your question and yes, you are correct, I can’t offer direct advice but I can offer a take on what I would consider.
I also enlisted the help of Owen Winkelmolen is a fee-for-service financial planner (FPSC Level 1) and founder of PlanEasy.ca.
Mark to Reader:
I’m going to make the following assumptions with your LIRA. You:
- Have a modest-risk tolerance.
- Are willing to “stick to the plan” – not trade in and out of ETF(s).
- Have modest investment knowledge.
- What makes a great ETF?
Owning one of these all-in-one funds could provide you with one stop shopping (and longer-term growth) whereby you don’t need to worry about any asset allocation or asset location over time. The ETF, depending upon the risk tolerance you want to take, will do all the heavy lifting for you!
Alternatively, you could always build your own low-cost ETF portfolio – a mix from Canada, say one ETF for the U.S. market exposure, and potentially one ETF for international equity. Put equal amounts into each to make up 60-70% of your LIRA. Put the rest of your LIRA (30-40%) into a Canadian bond ETF. Simple enough but would take a bit more management though to re-balance the LIRA.
Personally, I would go for at least a “GRO” fund of 80% equities if your investing timeline in your LIRA is>10 years. Otherwise, dial it back.
There are other strategies and considerations for sure. I’ll let Owen who provides advice for a living discuss that in more detail. Owen?
Owen to Reader:
When it comes to retirement planning, it’s important to look at retirement assets across the entire investment portfolio and not just account by account.
Mark wrote about asset allocation above, that’s important, but asset location is very important too – that describes the tax impact of holding specific retirement assets in specific accounts (GICs, bonds, Canadian equities, US equities, international equities).
When considering asset location, it’s important to understand how investments will eventually be withdrawn from each account as well. Some accounts allow for a lot of flexibility on withdrawals (like RRSPs and TFSAs), while other accounts are very restrictive (like RRIFs and LIFs).
Because of the restrictive nature of the LIRA/LIF we shared above, one strategy to consider is to keep LIRA accounts as small as possible.
What I mean is, as long as the overall asset allocation stays on target across the portfolio, lower return investments like bonds and GICs can be held in the LIRA, while higher return investments (i.e., more equities) can be held in the RRSPs and TFSAs. Over time this allows the RRSPs and TFSAs to grow faster than the LIRA and helps to increase income flexibility in retirement (which could help avoid higher income tax rates and/or GIS (Guaranteed Income Supplement) & OAS (Old Age Security) claw backs).
Here is what I mean in a couple of charts just for illustrative purposes:
While Mark’s suggestion to keep things very simple is OK, placing specific assets in specific accounts requires a level of flexibility that all-in-one funds just don’t allow. Having this flexibility would require at least a simple portfolio of ETFs and/or low-cost mutual funds.
This does create some complexity because assets would need to be rebalanced as mentioned above across the entire portfolio at least annually. The benefit though is that the LIRA is much smaller in the future. By using a more specific asset location strategy the LIRA could be $163.7K smaller, and up to $378.7K smaller if 50% is unlocked and placed into an RRSP. As a result, the mandatory withdrawals will be smaller as well – providing potential tax flexibility in retirement – but the portfolio overall is the same size ($1.48 M).
On the flip side, sometimes “simplicity is the ultimate sophistication”. If simplicity means that an investor (you in this case) will stick to the plan, then holding the same investment, or investment allocation, in each account might be the best option. All-in-one funds like the ones from Vanguard, iShares and other companies, provide a simple and inexpensive way to create a highly diversified portfolio that automatically rebalances.
But, if you want to maximize your flexibility in retirement, minimize income tax, and minimize government claw backs, then it’s beneficial to look at your overall portfolio and retirement draw down plan when making investment decisions across different accounts.
Great stuff Owen. I want to thank Owen for walking through some options for this investor and more importantly, outlining how asset allocation and asset location can deliver portfolio flexibility.
Owen Winkelmolen is a fee-for-service financial planner (FPSC Level 1) and founder of PlanEasy.ca. He specializes in budgeting, cashflow, taxes & benefits, and retirement planning. He works with individuals and young families in their 30’s, 40’s and 50’s to create comprehensive financial plans from today to age 100.
Other reading with Mark and Owen:
Disclosure: My Own Advisor, and the financial expert above, has provided this information for illustrative purposes. This is not direct investing advice nor should it ever be taken as such. Assumptions above are for case study purposes only. If you have specific needs, please consider consulting a fee-only financial planner to discuss any major financial decisions.
Thoughts on the case study? Comments on the options? Let us know in a comment.