Understanding tax-efficient growth

In last week’s column, I talked about the critical importance of tax planning in the investment management process and how many investment advisors are not providing this key component in client’s plans.

Email me if you missed it and would like a copy.

Last week’s article focused on the tax efficiency during the accumulation phase, and I wanted to follow up by talking a little more about the second piece which is the retirement income side.

Ensuring that your investments grow in the most tax efficient manner will allow you to build up the largest nest egg possible, but what happens when it’s time to start drawing money out?

Many investors end up drawing randomly from their various sources including government benefits (CPP &OAS), private pensions, RRSPs, TFSAs and other asset bases. The timing and amounts drawn from each source needs to be carefully considered to reduce your overall tax bill and put the most after-tax money in your pockets to fully enjoy your retirement.

For example, I recently met with a retired couple who had a combination of RRSP and non-registered assets at a bank and their ‘advisor’ had them drawing down on their RRSP assets at roughly 20 per cent per year while taking minimal amounts out of their non-registered account. The net result was that they were paying some pretty big tax bills each year unnecessarily. A simple rebalance of where they drew monthly income from cut their tax down considerably and helped to ensure that their retirement funds last.

Deciding where to pull retirement income from is a lot more complex than most people think as each person’s situation is different.

There may be situations where using up all of the RRSP assets first might make sense and for others, delaying as long as possible is better.

A good retirement plan will consider OAS and other government benefit claw-backs, expected future income levels, dependent requirements and estate plans in addition to just looking at annual taxation rates.

Another great example of efficient retirement tax planning is the utilization of the T-SWP strategy.

Let’s assume that a retired couple with no children has no pension or RRSP assets but $2 million sitting in a non-registered account that earns 8 per cent per year. Their T-SWP portfolio would allow them to draw 8 per cent per year ($13,333 per month) in retirement income that would be considered entirely return of capital so would not be taxable.

In addition to the non-registered income coming in, they also receive full CPP and OAS since they have no claw-back. Their CPP/ OAS provides roughly $20,000 per year of income each, which should be entirely offset by their basic exemptions and a few write-offs.

Now, of course, since the above couple is drawing down entirely on capital invested, their “book value” is shrinking and their investment account is going to be mostly taxable capital gains down the road.

Fortunately, this couple already planned to donate their estate assets when they pass on to their favourite charity and their investments can be gifted “in kind” at fair market value (their estate will receive a tax receipt for the full market value) and the charity will not need to pay any taxes on the capital gains when they sell the investments. Net result? The couple pay no tax in retirement and enjoy the full value of their retirement savings and then their chosen charity receives the full proceeds of their estate instead of a much smaller after-tax amount.

The above scenarios are again only a few examples to highlight just how important tax planning is in the overall investment management process.

If your retirement plan doesn’t include some detailed structure around the tax management side of things, you really don’t have a plan at all.

Brett Millard is the owner of SPEIR Wealth Management in Kelowna. Reach him at brett@speirwealth.com.