Canadians need to be more strategic in the decumulation stage of life to minimize their taxes.PeopleImages/iStockPhoto / Getty Images
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For many working Canadians, filing taxes is relatively straightforward: You get a T4 slip from your employer, maybe make a deduction for contributing to your registered retirement savings plan (RRSP), and perhaps claim the odd credit, depending on the current tax rules.
However, your tax picture can get more complex in retirement, given the new and varied income sources. These often include workplace pensions, RRSPs, registered retirement income funds (RRIFs), locked-in retirement income funds (LRIFs), Canada Pension Plan (CPP) and Old Age Security (OAS) benefits, non-registered investment accounts, and maybe some extra cash from part-time or occasional work.
“The more buckets you have, the more flexible you are in controlling your income levels … The key is figuring out which buckets to take money from and when,” says Brianne Gardner, financial advisor and co-founder of Velocity Investment Partners at Raymond James Ltd. in Vancouver.
She says Canadians need to be more strategic in the decumulation stage of life to minimize their taxes not just from year to year but for the longer term, while also factoring in tax changes. An example is the increase in the capital gains inclusion rate, proposed in the latest federal budget, which could impact business owners and people selling investment properties and businesses.
Ms. Gardner says she likes to start retirement planning about five years before a client retires, giving people time to make any necessary changes to their finances and consider any new and existing tax implications.
“Nobody has it planned out perfectly, but a rough idea helps us forecast ‘what-if’ scenarios and different tax planning strategies,” she says.
Owen Winkelmolen, an advice-only financial planner and founder of financial planning firm PlanEasy.ca in London, Ont., divides the planning into three age categories: pre-65, 65 to 70, and 72 and older.
“Your tax picture changes depending on your age, what income phase you’re in, and your income sources,” he says.
Below is a look at some of the tax considerations for retirees in each of these three phases.
The pre-65 phase
Many Canadians who retire before 65 receive income from workplace pensions, RRSPs and non-registered accounts (usually an investment portfolio).
Mr. Winkelmolen says drawing down non-registered assets first might seem like a good idea as dividends and capital gains typically earned in these accounts have lower tax rates than many other forms of income. But he says it could be more advantageous to mix withdrawals between lower-taxed non-registered assets and higher-taxed RRSPs to take advantage of the low marginal tax rates and avoid higher marginal tax rates later on.
Some retirees may also want to start withdrawing money from their RRSPs in this pre-65 stage so they’re not forced to withdraw more than they want when the account is converted to a RRIF at the end of the year in which they turn 71, risking higher tax bills and a clawback of OAS.
“We might do this kind of RRSP meltdown to take advantage of lower income tax brackets in that early retirement phase,” says Mr. Winkelmolen, adding it’s especially the case for people with a large amount of both registered and non-registered assets.
“Even though we’re technically triggering more taxes today, more strategic planning can help lower your overall lifetime tax bill. A little forward-thinking planning will help later on.”
Canadians who receive income from eligible pension plans – not including the CPP and certain annuities – are also eligible to receive a federal pension income tax credit for up to $2,000 of that income, translating into maximum annual tax savings of up to $300 (or $600 for couples), Mr. Winkelmolen notes. There are also provincial and territorial pension income tax credits.
For additional income, Canadians can also start taking their CPP benefits at age 60. However, the monthly payments will be lower than if they were delayed for a few more years, says Jamie Golombek, managing director of tax and estate planning at CIBC Private Wealth in Toronto. Canadians who take CPP before age 65 see their payments decrease by 7.2 per cent a year to a maximum reduction of 36 per cent if they start at age 60. That compares to an increase of 8.4 per cent a year if they delay until 65 or older, to a maximum of 42 per cent at 70.
“Our general advice is if you can defer, you should,” Mr. Golombek says, noting that CPP benefits are also taxable and need to be factored into the decision of what income to take when in retirement.
From 65 to 70
Once Canadians are 65, they have additional tax-saving opportunities, including the federal age amount tax credit and pension income splitting.
The age amount tax credit is a non-refundable tax credit available to individuals 65 and older. The federal age amount for 2023 is up to $8,396, which, combined with the pension tax credit, is about $10,000 a year, or roughly $1,500 in reduced taxes, Mr. Winkelmolen says. For a couple, that’s $20,000 in tax credits and $3,000 in reduced taxes. The amount someone can claim depends on their annual net income.
Canadians 65 and older can also take advantage of pension income splitting with their spouse or common-law partner to reduce their family tax bill, adds Mr. Golombek. He says couples can split income from a workplace pension or RRIFs (once the annuitant is 65), but not RRSPs.
“Some people might convert their RRSP to a RRIF earlier in retirement … because half of it can be transferred to the spouse’s return,” Mr. Golombek says.
He notes that pension income splitting doesn’t apply to CPP benefits. However, Canadians can apply for CPP sharing, which requires an application through Service Canada. Income splitting has to be handled annually on your taxes, while pension sharing is an election done once and then becomes automatic, with each spouse receiving a monthly payment for the shared amount. Both pension splitting and sharing may reduce a family’s overall tax bill because it shifts income from the higher-earning spouse to one with a lower income.
Canadians can also opt to start receiving their OAS benefits at 65 but, similar to the CPP, the benefits increase the longer you wait, up to 36 per cent if delayed until age 70.
Ms. Gardner often gets asked about the right time to take CPP and OAS benefits, especially if someone is at risk of having their OAS clawed back when their overall income is too high. (The threshold for the 2023 taxation year is net income of $86,912).
“Sometimes, it makes sense to defer their OAS payments if they’re in a high tax bracket at age 65,” Ms. Gardner says, but notes the decision depends on various other factors such as current and future expenses and income expectations.
72 and older
Once a retiree is 72 and older, their income options aren’t as flexible. Not only are they already receiving CPP and OAS benefits, but the mandatory RRIF withdrawals increase each year. It can be a problem for retirees with large RRIFs who haven’t pre-planned withdrawals before this phase.
“Some retirees can get stuck with a lot of taxable income, a lot of tax owing and sometimes even OAS clawback if these accounts are quite sizable,” Mr. Winkelmolen says. “You can get to the point at which you have a lot of income that you have little control over.”
It’s also an estate issue, he says, because when someone dies, all their registered investments are considered to have been withdrawn and are taxed at once – unless they have a spousal beneficiary.
Ms. Gardner says retirees should review their decumulation strategy annually to ensure it’s as tax-efficient as possible for the rest of their lives and supports beneficiaries.
“Intergenerational wealth transfers can sometimes trigger a lot of taxes if not planned and executed properly,” she says.
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Editor’s note: This article has been updated to clarify that an individual's registered investments are considered to have been withdrawn and are taxed when they die, unless they have a spousal beneficiary.