It’s common to focus on the money that’s coming in the door more than the money that’s going out, but it’s a good idea to pay attention to both, especially in retirement. Tax planning is one often-overlooked strategy to reduce retirement expenses and, unlike other expense reduction strategies, it doesn’t require you to make any changes to your lifestyle. The 5 retirement tax tips in this article will help you keep more of your money so you can live the retirement you’ve dreamed of.
TIP #1: Allocate your assets in a tax-efficient way.
In Canada, different types of income are taxed in different ways. Interest income is taxed in the most unfavourable way—it’s taxed just like employment income. Dividend income from Canadian companies and capital gains are taxed at a lower rate. Allocating your investment assets to different accounts based on how they’re taxed can reduce the taxes you pay. Investments that generate interest income should be held in registered accounts, such as an RRSP or TFSA, because they’re tax sheltered. Non-registered accounts should be reserved for dividend and capital gains income. If you want to know more about investment income in retirement, check out our Live off your nest egg page.
TIP #2: Use the TFSA.
As of 2009, Canadians have been able to contribute to a tax-free savings account, or TFSA. There are definite tax advantages to TFSAs for those who are retired compared to RRSPs. First, the income in a TFSA is never taxed. (When you start withdrawing from your RRSP, CRA will want its due.) Second, there’s no upper age limit for contributions. (The upper age limit for RRSP contributions is 71.) And third, every time you take money out of your TFSA, you’re creating additional contribution room in the year following a withdrawal). (When you withdraw from an RRSP that contribution room is lost forever.) If you have a large RRIF, one strategy is to withdraw funds from the RRIF, pay the required tax, and contribute them to your TFSA, where the funds can grow tax-free.
TIP #3: Delay taking CPP and OAS.
It’s tempting to fill out the forms the government mails you when you’re 64 and start receiving your government pension and Old Age Security payments at 65. After all, who wants to withdraw from their investments first, particularly if they’re performing well or, the opposite, doing poorly? The reality is that it could be beneficial from a tax perspective to convert your RRSP into an RRIF earlier and delay your CPP and OAS until age 70. You’ll get more each month from government sources by delaying, there will be less likelihood that your OAS will be clawed back because your income is too high, and you’ll have less money in your RRIF when you die, which will result in fewer taxes being paid by your estate.
TIP #4: Top-up your income in lower earning years.
Many investors enjoy the tax holiday they experience during the first few years of retirement, when their income is lower because they haven’t converted their RRSP to an RRIF and aren’t receiving CPP and OAS. If you’re in the lowest tax bracket during this time, it’s a perfect opportunity to withdraw money from your RRSP. Even though you’ll be paying some tax on the money, it will likely be at a lower rate than you’ll pay later in your retirement.
TIP #5: Have a plan for assets you won’t need.
A number of our clients feel very confident that they have more than enough income to look after their needs for the rest of their lives, even assuming the worst-case scenario for health, the best-case scenario for longevity and a few unexpected large expenses along the way. The question becomes, then, what do you do with these extra assets so your loved ones get the full benefit? One option is to take out a life insurance policy, so your beneficiaries receive a tax-free payment on your death. Another popular option is to gift some of the assets to family members or charities before you die. A financial advisor can help you evaluate whether you actually have surplus assets to share, and help you decide on the best way to share them.
These 5 retirement tax tips are just the start. In fact, tax planning in retirement can get quite complicated, especially once we move beyond generalities to the specific situation of a particular investor. If you'd like more tax tips or you're curious about whether your retirement accounts are set up for optimal tax-efficiency, let's talk.