Changes in the 2008 federal budget have made it easier for Canadians to dip into their locked-in life income funds. But although the rules governing federally regulated LIFs are loosening, the rules governing their provincially regulated counterparts vary widely.

Until now, former employees of federally regulated companies or agencies, whose pensions fall under federal regulation, were out of luck if they wanted access to their locked-in LIFs.

Even in cases in which the individual was facing monumental medical costs, the funds remained inaccessible. In anything but the direst cases — in which the client had a disability that would surely lead to death, for instance — there was nothing federal planholders could do to unlock some of the money.

Now, following in the footsteps of several provinces that liberalized their LIF-unlocking rules years ago, the federal government allows individuals to access funds from federal LIFs under three conditions: small balance; financial hardship; or using a one-time 50% unlocking provision.

> Small Balance. Individuals aged 55 and older can now wind up their plans if their federal LIF is worth less than the small-balance limit. The limit is not a fixed figure; it is 50% of yearly maximum pensionable earnings (YMPE), says Alan Roth, senior manager of tax services with Grant Thornton LLP in Markham, Ont. In 2008, the YMPE is $44,900, so the small-balance limit is $22,450.

Clients can choose to take the cash — and pay taxes on it — or transfer the funds to another tax-deferred plan, such as an RRSP or RRIF. Clients can then discuss with their advisors how much they will need in any given year and go over the tax consequences of their choices.

> Financial Hardship. Clients have to meet one of two conditions in order to qualify for the financial hardship provision.

The first is low income, which is calculated as anything less than 75% of the YMPE. In 2008, then, individuals would have to earn less than $33,675 to qualify, says David Ablett, director of tax and retirement planning with Investors Group Inc. in Winnipeg.

The amount planholders are eligible to withdraw is subject to an additional formula: 50% of YMPE (or $22,450) minus two-thirds of expected annual income.

Also under the financial hardship provision is an exception for those who have significant medical or disability expenditures. In this case, the client can gain access to his or her locked-in funds if the client can prove, with certification by a Canadian doctor, that he or she spent 20% of income in any given year on medical or disability costs.

“Up until these rule changes, the only way you could get special amounts would be if you had a life-threatening disability,” says Ablett. But an illness can be just as devastating financially. He knows of situations in which people have been evicted from their homes. “Yet they had this money sitting there, untouched.”

Paperwork for this provision can be intimidating, says Ablett, who suggests advisors help clients with the completion of the form. He also recommends reminding clients that these monies are taxable.

> One-Time Unlocking. The one-time 50% unlocking provision will probably affect the largest number of Canadians. It allows individuals aged 55 and older to transfer up to half of their LIF holdings to a tax-deferred vehicle, with no maximum withdrawal limit.

The first step for LIF holders is to transfer their plans to the new restricted life income fund. Clients have 60 days after that transfer to decide whether they want to transfer up to half of their RLIF to an RRSP or RRIF.

When the 60 days are up, says Jamie Golombek, managing director of tax and estate planning with CIBC Private Wealth Management in Toronto, the RLIF reverts back to the normal options available under the old LIF, subject to the same minimum and maximum withdrawal limits.

There’s really no downside to taking full advantage of this provision, says Ablett: “Our recommendation always is: ‘Why don’t you transfer the full 50%? It’s not taxable immediately and then all that money is available to you if you need it. But you can theoretically leave that RRSP intact right until the end of your 71st year’.”

There is, however, an important factor to consider before unlocking client funds: creditors.

@page_break@“One good feature of having these locked-in plans is that they’re creditorproof,” Roth says. That’s not the case once the funds are pocketed or transferred out of a LIF to another investment vehicle. Planholders must be aware of this distinction. In fact, he adds, they have to sign an attestation that shows they’re aware they will lose protection from creditors if they choose to unlock their LIF plans.

Who is affected by these changes to federal LIF-unlocking rules? Although pension legislation is a provincial responsibility — and every province has its own rules when it comes to unlocking provisions — a good number of LIFs fall under federal jurisdiction.

If a company’s operations are regulated by the federal government, its pension plans are federal, explains Ablett. For instance, airlines, banks and companies in broadcasting, telecommunications, interprovincial transportation and shipping are all federally regulated, so their pension plans fall under federal regulation.

Pension assets of employees who work and live in the Yukon, Northwest Territories or Nunavut are also subject to federal rules when it comes to LIFs. And until Prince Edward Island comes up with its own legislation, companies with head offices on the Island must follow the federal rules.

There is significant variation across the country when it comes to unlocking provincial LIFs. “They haven’t all moved the same way,” Golombek says.

Saskatchewan, for instance, has allowed LIF holders to unlock a full 100% of their LIFs at age 55 and put the funds into what it calls “preferred” RRIF since 2002. Ontario, on the other hand, set its unlocking rate to just 25% this year.

“A lot of people are upset that it isn’t more,” Golombek says. But, he admits, provincial governments have the responsibility to strike a balance to ensure that their residents have enough retirement income.

Some advisors claim that some Saskatchewan residents have irresponsibly blown all of their unlocked cash. That may well be the case, but the Saskatchewan government sees the funds as belonging to the individual, making it his or her choice.

Besides, Ablett is not sure Canadians are that irresponsible. “Canadians are smarter than that,” he says. But he agrees that the different rules can make for a confusing landscape: “It is frustrating to not have uniformity of treatment of people across the country.”

Neither Nova Scotia nor Quebec, for example, offers a one-off unlocking provision, but each has a temporary income provision. These provisions allow planholders under age 65 to withdraw more from their LIFs than the rules would normally allow. Amounts are determined by a schedule in each province.

The temporary income provision offers a way for planholders to get more income to cover the gap between early retirement and pension age, according to Ablett.

Manitoba used to have such a provision, but it was dropped when the province introduced its 50% unlocking rule. IE