(As published in LIfeStyles 55+ July 2012)
During our peak earning years, our tax strategy was to defer taxes (through RRSPs) in order to put more income into savings, which also got tax free growth. Part of this tax deferment strategy was to shelter income subject to the highest marginal tax rate (MTR) when we would expect to be taxed at a lower MTR when our incomes were less during retirement. We tend to continue this deferment strategy in retirement, using non-registered savings to supplement pensions so that we “defer” RRSP withdrawals that would be taxed. Often this is continued to our 71st birthday when we are required to begin minimum annual withdrawals as a RRIF; even then we limit withdrawals to the minimum to defer paying any more than the least possible tax.
As discussed last month, Revenue Canada is going to tax you eventually. All registered money and capital gains on assets like the family cottage become income on your expiry date (except for transfers between spouses). One reason for RC’s patience is that all that income realized at the end will put much of your estate into the highest MTR (currently 46.4% in MB). I guess CRA is practicing deferment on getting your taxes so that they get more from you at the higher rate!
So the first step in tax planning in your retirement is to plan how to withdraw your registered money, even if it is taxable. Whatever is left after taxes will be non-registered money and safe from Revenue Canada. You will need to consult your accountant to calculate how much you can take out each year while still minimizing the MTR you end up paying. One key after age 65 is to keep your taxable income below the level where OAS is clawed back. The claw back together with your higher MTR may result in an effective MTR greater than 50%! Currently, this number is just over $65,000 a year; with pension splitting, you should be able to divide (the second D of tax planning) your family income pretty evenly. As that is taxable income, your gross family income will be in the order of $150,000 (if you are enjoying more than that you are likely paying someone a lot more than I charge). Say your taxable income is $50,000 each, that would allow you to withdraw some $15,000 each or $30,000 total without triggering OAS claw back and still keep you to a MTR of about 35% (instead of 45% if left registered till death).
So make a $15,000 (each) withdrawal on January 1st. After the 20% withholding tax, you net $12,000. (At a 35% MTR, you will have to pay another $2250 by April 30th of next year.) So what should you do with your $12,000? (assuming you are still living comfortably on the$50,000 net you had before). I often recommend investing in a Segregated Fund. As I mentioned in June, a Seg Fund is an insurance product that can serve as a tax shelter because of the unique treatment of insurance in the tax law. By the same principle as a lottery ticket that is purchased with after tax income, insurance benefits flow directly to the beneficiary, escaping the delays (and fees) of probate, and even provides protection from creditors.
One illustration I recently prepared withdrew $10,000 a year from an RRSP or RIFF of $100,000. After six years, the client had $100,000 of non-registered after tax money, versus the $54,000 after tax value of the $100,000 RRSP when they started. After twelve years when the RRSP was fully withdrawn the non taxable investment was then worth $140,000, a nice gain on what was only worth $54,000 after tax. If circumstances are appropriate to use leverage to start the Seg Fund at $100,000, the value after 12 years was $240,000, which could provide a supplemental tax free income of $1500 a month, without ever using up the capital. But we are out of space again so we will have to wait till next month to explore how you convert your RRSP to income for life without using up the principal, or paying tax .