10 Strategies to Pay Less Tax in Retirement

Are you approaching retirement or have you recently retired? Maximizing your retirement income may be an important aspect of enjoying and making the most of this new phase of your life. However, a large portion of your major sources of retirement income may be taxed at the top marginal tax rate with no preferential tax treatment. This is likely to be the case if you depend on sources of retirement income such as employer pensions, Registered Retirement Savings Plans (RRSPs), Registered Retirement Income Funds (RRIFs), Canada/ Quebec Pension Plan (CPP/QPP) and interest income. Fortunately, there are several approaches you may want to consider to maximize your after-tax retirement income.

?

Strategy 1 – Spousal RRSPs

If you project your retirement income to be higher than that of your spouse, one of the simplest ways to equalize your future retirement income is by making contributions to a spousal RRSP. The sooner you start, the more income you’ll be able to shift to your lower-income spouse’s spousal RRSP by the time you retire.

?

Strategy 2 – Order of asset Withdrawal

In order to optimize your after-tax retirement income, it’s important to determine where to withdraw assets from first to cover any income shortfalls you may have after receiving government and employer pensions. The appropriateness of each withdrawal source will be dependent on your asset types and mix during retirement.

Generally, if you’re in a high tax bracket, it makes sense to withdraw assets that attract the least amount of tax first. If your spouse is in a significantly lower tax bracket, consider withdrawing their taxable assets before yours (and your non-taxable assets before your spouse’s).

Unsure of which assets to withdrawal first? Ask us for our recommendation!

?

Strategy 3 - Tax-preferred investment income

Since the preferential tax treatment of Canadian dividends, capital gains and return of capital is lost when earned in and withdrawn from an RRSP/RRIF or locked-in account, the following can be considered when determining your ideal investment allocation with respect to tax characteristics between accounts.

Consider holding your fixed-income or interest-bearing investments, such as bonds and GICs, in your registered accounts (RRSP/RRIF and locked-in) and holding your equity investments, such as common stocks, preferred shares and equity mutual funds, in your non-registered account.

?

Strategy 4 — Pension income splitting

If you’re in a higher tax bracket than your spouse, you may be able to reduce your family’s total tax bill by allocating up to 50% of eligible pension income to your spouse. Keep in mind, however, that only certain income is eligible to be split with your spouse. The age of the primary recipient of the income is a factor in determining whether income is eligible for splitting.

?

Strategy 5 — CPP/QPP sharing

Although the CPP/QPP pension is not considered eligible pension income for the purpose of pension income splitting, you may achieve tax savings by sharing your CPP/QPP with your lower-income spouse. This may be a particularly viable strategy if you have a spouse with a limited working history and thus made limited contributions to the CPP/ QPP. This may lower your family tax bill and help to increase your age credit, as well as reduce OAS clawback where applicable

?

Strategy 6 — Spousal loan

Generally, you achieve no tax advantage when you simply give funds to your lower-income spouse to invest — this is because of “attribution”. The Canada Revenue Agency (CRA) attributes any investment income earned on these gifted funds back to you, as if you had earned it yourself. This is where the spousal loan strategy may help you reduce your taxes payable.

By making a bona fide loan to your lower-income spouse at the CRA prescribed interest rate, you can avoid triggering the CRA’s income attribution rules. Your spouse must make the annual interest payments. The prescribed rate in effect at the time your loan is established remains in effect for the lifetime of the loan. Your spouse can then invest the loan proceeds, and the investment income and capital gains earned will be taxed at your spouse’s lower rate.

?

Strategy 7 — Effective use of surplus assets

If your financial plan determines that you have surplus non-registered assets that you’ll likely not need during your lifetime, even under very conservative assumptions, then consider directing these excess assets to other more effective uses such as: tax exempt life insurance, lifetime gifts, establishing a family trust for adult children or grandchildren beneficiaries.

?

Strategy 8 — Prescribed life annuity

If you’re retired, a conservative investor and not satisfied with your fully taxable cash flow from traditional non-registered fixed-income assets (e.g. GICs and government bonds), consider using some of these fixed-income assets to purchase a prescribed life annuity. The prescribed life annuity will provide a guaranteed income stream for your lifetime with the advantage of partial tax deferral

?

Strategy 9 — Tax-Free Savings Account (TFSA)

In retirement, you continue to be able to contribute money to a TFSA, up to your contribution limit. Although TFSA contributions are not tax-deductible, remember that the income and gains generated in the TFSA grow tax-free. Additionally, any money withdrawn from a TFSA is not taxable.

?

Strategy 10 — Minimum RRIF/LIF/ LRIF/PRIF withdrawal planning

If your spouse is younger than you, you may be able to base your minimum annual RRIF/LIF/LRIF/ PRIF withdrawal on your spouse’s age in order to minimize the amount of the annual withdrawal, thereby keeping more assets in the registered environment to grow on a tax-deferred basis.

You can also wait to convert your RRSP/LIRA/Locked-in RRSP to a RRIF/LIF/ LRIF/PRIF as required by the end of the year in which you turn age 71, but don’t make your first withdrawal until the end of the year in which you turn age 72; this may allow for increased tax-deferred growth.

?

Summary

Although the majority of retirement income sources are taxed at a high rate with no preferential tax treatment, there are some common strategies that may help you to maximize your after-tax income in retirement. Give us a call today to see if any of the strategies discussed in this newsletter can help you.