Roy and Gail want to spend at least six months of the year abroad and wonder whether it would make sense from a tax point of view to take up residency elsewhere.Tijana Martin/The Globe and Mail
Now age 57, Roy and Gail have done remarkably well for themselves and are ready to retire from work early in 2023. Several factors helped them save more than most. They live in small-town Ontario where expenses are relatively low. They have no children. And they both have well-paying jobs, with Gail making $105,280 a year in government and Roy $90,750 in industry. Both have defined-benefit pension plans but only Gail’s is indexed to inflation.
Their main question: “How can we generate $120,000 a year after tax when we retire?” Roy asks in an e-mail. That’s more than they are spending now.
They want to spend at least six months of the year abroad and wonder whether it would make sense from a tax point of view to take up residency elsewhere. “If we leave Canada permanently, is it better to give up or keep our Canadian residency status for tax purposes?” Roy asks.
We asked Nushzaad Malcolm, a financial planner at Henderson Partners LLP in Oakville, Ont., to look at Roy and Gail’s situation.
What the expert says
Roy and Gail’s main focus is to ensure they have the cash flow to meet their lifestyle expenses, retire abroad comfortably if they decide to, and minimize taxes, Mr. Malcolm says.
To meet their spending goal of $120,000 a year, they have Gail’s pension of $72,250 a year, Roy’s pension of $20,000 a year, and non-registered investment income of $4,560 a year. To make up the shortfall, Mr. Malcolm suggests they withdraw $30,000 each from their RRSPs. These withdrawals will not be eligible for income splitting until age 65. To avoid withholding tax, they could convert part of their RRSPs to registered retirement income funds. RRIFs are only subject to withholding tax for amounts above the minimum.
“The gross income of $157,000 should provide for $125,400 net income after tax,” the planner says. After making contributions of $450 a month to their tax-free savings accounts, they will have $120,000 available to spend.
“The rationale for the early RRSP withdrawals is that they are in a reasonably low tax bracket – 20 per cent with the RRSP withdrawals – given that they achieve a near perfect income split,” Mr. Malcolm says. Gail can split up to half of her pension income with Roy any time after age 55. Their tax rate will be relatively low until they start taking Canada Pension Plan and Old Age Security benefits. “I would recommend delaying CPP and OAS till age 70, providing them with 10 years of relatively low tax brackets,” the planner says. “The delay also allows for a 42 per cent CPP increase and 36 per cent OAS increase before clawback.”
Because Roy and Gail have defined-benefit pensions to fall back on, they can safely maintain their mortgage until it is paid off, the planner says. He estimates it will be paid in full by the time they are age 69.
Not only can Gail and Roy comfortably meet their spending target, but at age 95, they are estimated to have $3.4-million in investment assets and a house worth an estimated $3.19-million, both in future value dollars, Mr. Malcolm says.
Next, the planner looks at whether they are holding their investments in the right accounts. For their TFSAs, Mr. Malcolm says Canadian mutual funds, interest bearing securities, exchange-traded funds and equities are ideal investments. “We would also suggest holding U.S. or foreign securities that pay little to no dividends and that provide their value through price appreciation,” he says. There is a 15-per-cent withholding tax on U.S. dividends on U.S. stocks held in a TFSA.
For RRSPs, “we recommend that they hold U.S. dollar-denominated funds listed on a U.S. exchange” because the dividends are not subject to withholding tax. Canadian-listed funds invested in U.S. securities have U.S. tax withheld on dividend distributions that cannot be recovered. There is no downside to holding Canadian mutual funds and ETFs invested in Canadian securities in an RRSP.
In their final year of employment (2022), Roy and Gail should focus on maximizing their RRSPs, Mr. Malcolm says. If they are working from home during the pandemic, eligible expenses should be claimed on Form 777 (“Statement of Employment Expenses”), provided that their employer has given them a signed Form 2200 (“Declaration of Conditions of Employment”).
As soon as they retire, they will begin drawing down their RRSPs. “A large RRSP balance could be a tax liability, especially upon the death of the surviving spouse, where the combined total of the RRSPs/RRIFs is fully included in income and taxed at the highest marginal tax rate of 53.53 per cent (federal plus Ontario),” the planner says. They should continue contributing to their TFSAs during retirement because they permit tax-free growth and are “a great estate planning tool,” Mr. Malcolm says. There is no tax on withdrawals and the account is not subject to probate fees if there is a named beneficiary.
Roy and Gail are considering moving abroad permanently, selling their house, and maybe visiting Canada during summer months. Their final question was about keeping or relinquishing tax residency in Canada. A tax resident of Canada is subject to Canadian tax on worldwide sources of income, whereas a non-resident is only subject to Canadian tax on Canadian-sourced income, the planner says.
To lose tax residency, they would have to stay outside of Canada for 183 days or more, cut significant residential ties with Canada, including selling their house, and be considered a resident of another country, the planner says.
As well, they will not be able to make any further TFSA contributions. They can still keep their TFSAs, and they will not be taxed on any future earnings or withdrawals. Second, given that their retirement income sources are based in Canada, they will be liable for withholding tax for non-residents. This is applicable to Canadian-sourced investment and pension income (excluding TFSAs).
Resident tax is progressive, being subject to increasing marginal tax brackets, whereas non-resident tax is generally flat at 25 per cent, Mr. Malcolm says. So in early retirement when their marginal tax rates are relatively low, being residents may be advantageous. As their income – hence their tax brackets – rise, surpassing the 25-per-cent flat rate, they’d be better off as non-residents. (Their income will rise when they begin collecting government benefits and making mandatory RRIF withdrawals.)
“Roy and Gail could strategize around this and delay a full move until mandatory RRIF drawdowns begin at age 71.”
Before they make a move, it will be critical for the couple to sit down with a tax professional and weigh the alternatives, Mr. Malcolm says.
Client situation
The people: Roy and Gail, both 57
The problem: Can they generate $120,000 a year after tax? Are their assets allocated to their various accounts properly? How can they minimize tax? Is it better to give up or keep Canadian residency status for tax purposes?
The plan: Begin drawing down their RRSPs in the low-income years before they start collecting government benefits. Continue contributing to TFSAs. Take advantage of splitting eligible pension income. Keep Canadian tax residency during early retirement, but consider giving it up during later retirement years.
The payoff: Clarity and tax savings during retirement
Monthly net income: $12,440
Assets: Principal residence: $1.5-million; bank accounts $51,500; non-registered $98,000; his RRSP $310,000; her RRSP $200,000; his TFSA $30,000; her TFSA $98,000; his deferred profit sharing plan $400,000; commuted value of his pension $303,155; commuted value of her pension $1,243,970. Total: $4.2-million
Monthly outlays: Mortgage: $2,280; property tax $420; water, sewer, garbage $10; property insurance $140; electricity $130; heating $200; maintenance $75; garden $10; transportation $975; groceries $600; clothing $50; charity $30; vacations $1,200; dining, drinks, entertainment $1,000; personal care $100; health care $120; communications $230; TFSAs $450; RRSPs $550; pension-plan contributions $1,000. Total: $9,570
Liabilities: Mortgage $300,000
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Some details may be changed to protect the privacy of the persons profiled.
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