By Ilona Biro
Want to get the most retirement income from your savings? You’ll need a tax-aware strategy.
Congratulation! You have thoughtfully planned for your retirement, and you are well on your way to achieving your savings goals. However, planning for savings is only one of two parts of preparing for retirement. The other part is planning how much money you will have available for your expenses. In other words, you need to develop a strategy that will allow you to derive the highest possible retirement income from your savings.
How? ‘Or’ What? Including taking into account taxes, that is, looking at your retirement income plan from a tax perspective.
First, taxes work a little differently in retirement. Like employment income, most sources of retirement income are taxable. This includes benefits from the Canada Pension Plan (CPP)/Quebec Pension Plan (QPP), Old Age Security (OAS) and your employer’s pension plan, as well as income from annuities and pensions. Registered Retirement Income Funds (RRIFs) – but not withdrawals from your Tax-Free Savings Account (TFSA). However, if your retirement income exceeds a certain level, the government will ask you to return some or even – if your income is high enough – all of your OAS benefits. Also, as a general rule, after December 31 of the year, you turn 71, you will no longer be able to reduce your taxable income by contributing to a registered retirement savings plan (RRSP).
The way you pay taxes also changes in retirement. As long as you work, your employer probably withholds tax “at source” – directly from your pay before it goes into your bank account. On the other hand, once you are retired and no longer receive a paycheck, you have several options for paying your taxes:
You can arrange to have tax deducted at source from amounts you receive from your employer’s plan, CPP/QPP and OAS.
Tax on your investment, rental, self-employment income or certain retirement benefits may be paid in periodic instalments.
You can wait until you prepare your tax returns to determine how much you owe. However, be aware that if you owe more than $3,000 in federal tax ($1,800 for residents of Quebec), the Canada Revenue Agency (CRA) will require you to make periodic instalments. For provincial or territorial tax, thresholds vary depending on where you live.
Fortunately, you can take advantage of withdrawal strategies and retirement-related tax deductions to keep as much of your money as possible.
Strategy #1: Strategic Withdrawals
Like many people, you will likely have several sources of retirement income. In addition to CPP/QPP and OAS, this can include employer-sponsored pension plans, annuities, RRIFs, TFSAs, rental properties, or guaranteed interest products such as GICs. To pay as little tax as possible, you can plan the order in which you will earn income from these sources and how much you will take from each.
Remember that your situation is unique. Often, sound advice can make all the difference. An experienced advisor can do the calculations under different scenarios to determine the best withdrawal strategy for you. For example, your advisor can help you decide when to start receiving income from CPP/QPP and private pension plans and how to make withdrawals from your taxable investments.
If you have multiple taxable investments, proportional withdrawals could be beneficial: you could withdraw a set amount from each source based on its share of your total savings. Often, this strategy makes it possible to spread out and reduce the tax impact of withdrawals, thus making your savings last longer. Again, your advisor can help you make an informed choice.
Strategy #2: Income splitting
Couples can split up to 50% of their eligible retirement income as long as the team member transferring income to the other is at least 65 years old during the year. This can result in significant tax savings if one member of the couple has a much higher income than the other. Also, the split percentage does not have to be the same every year. This gives you some flexibility. Don’t forget to get independent tax advice to make sure you’re splitting your income the right way.
