Tax Planning for Retirement

An efficient retirement tax planning can lower your tax outgo and ensure you get the most out of your savings. Since there are many ways to withdraw from various retirement savings, it’s important you create a strategy that perfectly fits your needs. We’ve put together this guide to help you find out everything you need to know about tax planning for retirement.

Key Takeaways:

• Withdrawing funds from retirement accounts in the correct order can reduce your overall tax burden in retirement
• Splitting your pension income with your spouse or common-law partner can put you in a lower tax bracket
• Unlike RRSPs, TFSAs have no age limit for contributing and offer tax-free withdrawals, making them a tax-efficient place to save money after retirement
• Passing along some of your surplus gifts to your children while you’re alive can reduce your tax burden

Why Does Tax Planning Matter in Retirement?

Being tax efficient matters in any stage of life, but it may matter most once you retire, which is when you want to maximize your savings to ensure they last as long as you do. Optimizing non-taxable retirement sources and managing taxable retirement sources in a way that you stay in the lowest possible tax bracket can help minimize your tax liability post retirement.  

Non-taxable retirement sources

These are sources that you don’t have to report on your tax return. Examples include:

• Tax-Free Savings Account (TFSA)
• Inheritances
• Withdrawals from non-registered accounts
• Guaranteed Income Supplement (GIS) payments

Taxable retirement sources

These are ones which you need to report on your tax return. Common examples are:

• Canada Pension Plan (CPP)
• Registered Retirement Savings Plan (RRSP)
• Annuity
• Old Age Security (OAS) pension
• Employment income

Understanding your tax bracket

Before you start tax planning for retirement, it’s is important find out the tax bracket you will fall into post-retirement. Your tax bracket will depend on the income you generate from various sources, such as OAS, Annuities, RRIF, RPP, etc.

If you fall into top of a tax bracket and require more income, consider using saving vehicles that do provide tax-free withdrawals, such as the TFSA. Another option is to access non-registered assets. However, keep in mind that capital gains realized on some of these investments need to reported on your annual tax return.  

On the other hand, if you fall into the lower end or the middle of a tax bracket, accessing funds from taxable sources, like LIFs and RRIFs, is a good idea.

If your net annual income exceeds the threshold amount, you will have to return part or your entire OAS pension. Allocating a portion of your retirement income to spouse if he or she is in a lower tax bracket can lower your tax bracket and allow you to keep the entire OAS pension.

5 ways to pay less taxes in retirement

No-one wants to pay taxes in excess of their liability to the Canadian Revenue Agency at any stage of life. It is particularly important to make sure you are not overpaying in retirement when you are living off your investments and savings. Here are five tax-saving strategies to ensure you aren’t paying too much tax in retirement.

1. Invest in RRSPs and TFSAs

Investing in RRSPs and TFSAs help you save for retirement and lower your tax bill. RRSPs allow you to shelter your savings from tax, whereas TFSAs let you withdraw funds without paying tax.

If you earn a higher income than your spouse, contributing to their RRSP can help reduce your family’s overall tax bill. These plans let spouses split income more evenly and in turn provide tax advantages to families during retirement.

2. Split your pension income

If your tax bracket post retirement is likely to be considerably higher than your partner, splitting your pension income could offer substantial tax savings. Couples can split up to 50% eligible pension between themselves, provided they meet certain criteria.

Here’s a real-life example: Meet recent retirees Susan and Sam, both aged 66 years. While Sam has a monthly work pension of $3,400 and a yearly income of $61,000 in retirement, Susan’s monthly pension and total post-retirement income are $2,100 and $26,000, respectively.

Since Susan is in a lower tax bracket than Sam, the couple can benefit from splitting their pension incomes. Depending on their age and other factors, Sam can share 50% of his pension income with Susan for income tax purpose. Doing so can allow Sam to reduce his taxable income without bumping Susan into a higher tax bracket.

3. Buy an annuity

Worried that your retirement savings won’t last? If so, consider buying a life annuity using some of your savings. With a life annuity, you receive a lifetime of tax-effective retirement income. In contrast, a term-certain annuity, pays you a fixed income for a specific period, like 20 years. Both types reduce the amount of tax payable each year since they amortize the invested amount over the life of the annuity. Taxes will be different if you purchase an annuity using non-registered savings versus registered savings.

4. Order of withdrawal

All retirement saving vehicles work the same way. Some are less flexible and tax efficient than others. In most situations, withdrawing from the least flexible and tax efficient accounts first — such as Life Income Fund (LIF) and Registered Retirement Income Fund (RRIF) — before dipping into other sources could prove to be a real tax saving.

5. Lifetime gifts

Passing along some of your surplus gifts to your children and grandchildren earlier, while you’re alive, can help your reduce tax burden post-retirement. If you have surplus gifts that you don’t require in retirement and that you will be eventually passing to your loved ones, it makes no sense to expose the income from these assets to higher tax rate.

TFSA for your retirement

Putting your assets in a TFSA instead of a non-registered account makes financial sense since any income earned in a TFSA isn’t taxable, even when it is withdrawn. Tax-free capital gains make a TFSA an ideal place to save money for emergencies or park excess RRIF money.

If your spouse or common-law partner has unused TFSA contribution room, you can give them money to contribute to their own TFSA.

RRSP for your retirement

It’s often a good strategy to maximize RRSP or RRIF withdrawals early in retirement, especially if you are planning to delay OAS or CPP benefits. OAS benefits are subject to claw back if your net annual income is above a certain threshold. Therefore, when the time comes to draw OAS benefits, you don’t want to be reporting higher RRIF withdrawals, as then you will have to return part or all of your OAS benefits.

Another benefit of withdrawing higher amounts from your RRSP in the first few years of retirement is that it will reduce the minimum withdrawal amount from your RRIF in the later years.

If you have to withdraw more than the minimum amount from your RRIF in a year, put the excess amount in a TFSA. Have already maxed out your TFSA? You can give the money to your spouse to contribute to their own TFSA. While you will be paying tax on the withdrawn amount now, you will be able to access it and any capital gains generated on it tax-free later.

How to withdraw money from various retirement accounts?

• RRSP: Your RRSP matures on December 31 of the year you turn 71. At that time, you’ll have three options to access the money stored in the RRSP. The tax implications depend on the option(s) you choose: some text
  • Receive a lump-sum amount on maturity
  • Convert your RRSP into a RRIF
  • Purchase an annuity

If you convert to a RRIF, you will have to take out a minimum each year. There’s no maximum annual withdrawal limit, but if you withdraw more than the minimum amount, you will pay withholding tax.

• LIF – You must withdraw a minimum amount each year. Unlike a RRIF, a LIF has a maximum annual limit.
• Non-registered accounts – You can take out as much as you want; there’s no minimum or maximum annual limit. Any capital gain or loss generated needs to reported on the tax return.

Conclusion

An efficient withdrawal plan for retirement savings can minimize your tax burden and ensure you won’t outlive your savings.

Withdrawing retirement savings funds in the correct order, sharing your pension income with your partner, using TFSAs in retirement for putting excess money, and passing some of your surplus assets to your heirs while you are alive can all go a long way in reducing your tax liability.

Looking for more retirement planning advice? Reach out to a Dundas Life licensed financial advisor today.

Frequently Asked Questions

How do I pay less tax in retirement?

If you want to reduce the taxes on your retirement income, consider investing in RRSPs and TFSAs, gifting some of the surplus assets while you’re alive, opening an RRSP for your partner, sharing pension income with your partner, and buying an annuity.

When should I start planning for retirement in Canada?

The earlier you start saving for retirement, the longer your money can leverage the power of compound interest and grow.

What are some tax-advantaged retirement savings accounts in Canada?

The RRSP, TFSA, and RPP are some of the most popular tax-advantaged retirement savings accounts in Canada. These accounts offer various benefits, making it easier for you to save money for retirement. For example, every dollar you put into your RRSP account cuts down your taxable income for that year, meaning you will pay less tax.

Additionally, your RRSP contributions and any capital gains you realize on them grow tax-free until you withdraw them. TFSAs, in contrast, offer not only tax-free growth but also tax-free withdrawals. In other words, you will not be paying tax on capital gains generated in the plan.

What is the Old Age Security (OAS) pension, and how is it taxed?

The Old Age Security (OAS) pension is a monthly benefit available to seniors aged 65 or older who meet the residence and legal requirements. The OAS payments are taxable and the amount of tax you pay depends on your annual income. If your annual income is greater than a certain amount, you must return part or all of your OAS pension.

Are there any specific tax credits or deductions available for retirees in Canada?

Yes, there are several tax credits and deductions available to Canadian seniors. Some common ones include:

• Age Amount Tax Credit
• Home Accessibility Tax Credit
• Pension Income Tax Credit
• Medical Expenses Tax Credit
• Disability Tax Credit