Many client-advisor relationships are focused almost exclusively on amassing wealth. It makes perfect sense – people want to preserve and grow their wealth in order to afford their preferred lifestyle and save for the future. However, once the future has arrived, it’s time to shift plans and think about maintaining that preferred lifestyle after one’s working years. Accumulating assets is very different than generating income in retirement, though both are critical to achieving your retirement dreams.
Retirement Income Planning is the intelligent dismantling of accumulated assets in a tax efficient manner. In order to minimize taxes, this process should begin many years before retirement, and could dramatically affect the use of registered products and determine when retirement, or semi-retirement occurs.
What you need to know
Retirement Income Planning requires some baseline information, some assumptions, and will generate a number of scenarios.
The goal is to reduce or defer taxes, provide income flexibility and stability, and avoid Old Age Security (OAS) claw backs.
Step 1 – Determine baseline income
“Fixed Income” has been used negatively, but in this case, it simply means: ‘what income will you receive in retirement that you cannot control?’
Fixed income includes company and private pensions. A recipient has only two choices: take a lump sum or receive a periodic payment for the rest of their life (not including any survivor benefits). For the purpose of Retirement Income Planning, we will assume that the periodic payment can be closely estimated and is based on years of service, amount of salary, and age.
For example, after 35 years of service an employee will receive 70% of the average of their best 5 years of compensation. If the best 5 years of compensation averaged $90,000, they would receive $63,000 per year in gross pension.
Step 2 – Determine when to take Canada Pension Plan benefits
For those who are ‘average’ - meaning those who will live to the average age - taking CPP early is not a smart financial decision. If you are in poor health, expect to have a shortened life expectancy, or are unable to work, then taking the CPP early might be the best decision. StatsCan has the average life expectancy for 65-year old Canadian men and women at 22 and 24 years, respectively. Therefore, you will collect CPP until age 87 or 89 if you start at 65. The penalties for taking CPP early don’t make sense for ‘average’ Canadians.
Once you have decided at what age you will take your CPP, we can layer that on top of any private pension you receive.
For 2017, the maximum benefit for those who take their pension at age 65 is $13,370.04 per year.
Step 3 – Project your RRIF income
This is often the most confusing part of the process for investors who have been taught to ‘contribute and never touch your RRSP savings’. Eventually, unless you withdraw everything from your RRSP, it will be converted into a Registered Retirement Income Fund (RRIF).
Depending on the age at which you make this conversion, specified annual minimum withdrawals must be made. The older you are, the larger the withdrawal percentages are. If you wait until age 71, which is the deadline to convert, then your RRSP will likely be at its highest level and the percentage required to be withdrawn will start at over 5%. A $500,000 RRSP, converting to a RRIF will generate over $26,000 in income.
Step 4 – Project your total Income
Depending on the province of residence, someone with these three income sources ($63,000 pension, $13,000 CPP and $26,000 RRIF) will be close to the highest income tax bracket, with very little relief. Also, this income will be treated at the highest level, with no 50% deduction for Capital Gains or Dividend Tax Credits.
It might make sense for some investors to stop contributing to their RRSPs to lessen the amount dropped into their RRIF, diverting savings to Tax Free Savings Accounts (TFSA) to lessen taxes and provide flexibility.
Additionally, the Old Age Security (OAS) claw back is a consideration for many. Once your income in 2017 reaches about $75,000, your OAS benefit begins to be reduced by 15% for every dollar you earn over $75,000. This effectively taxes income over this threshold by an additional 15% - not an insignificant amount!
Step 5 – Determine ways to reduce tax and increase income
This is where creativity becomes important. If you are doing well, and have invested intelligently, your pre-retirement tax bracket may be virtually the same as your post-retirement tax bracket. That is to say that between income generated from your savings, CPP and OAS, you are almost back at the same level of income as you were in your working years – the ideal situation.
The Bottom Line
Together we need to discuss your anticipated retirement date, and review any additional income you may receive as well along with assets you might accumulate (from inheritance or sale of real estate or business, for example). From there we will determine the most tax efficient way to ensure that your accumulated assets deliver the income that you need, providing flexibility for you and your family.