Forget your manners, mind your taxes
Albert Einstein once said: “The hardest thing in the world to understand is the income tax,” and I would say there are a lot of people who agree. Managing your taxes during your working years is relatively generic. However, as you transition into retirement, the tax planning process shifts onto withdrawing assets, and doing so in the most tax-efficient manner. To succeed in achieving tax efficiency in retirement, Canadians may need to make a minor “mind shift” here. Most are preoccupied with minimizing current taxes each year; however, this cannot be at the expense of your longterm objective for maximizing after tax income for your entire retirement, often estimated at 25 to 40 years. Decisions need to be made on how to properly allocate investments with a keen awareness of tax brackets and thresholds for future tax credits. Rising life expectancies, market volatilities, progressive inflation and, of course, unplanned expenses all pose serious threats to the ability of a retiree to manage their finances.
There are three main types of taxation to consider: interest income, dividend income, and capital gains. All are taxed differently, so this makes it easier to structure your portfolio more efficiently when you are creating your plan with your adviser. As a general rule, you want to place income that is going to be unfavourably taxed (interest income) into tax sheltered products such as TFSAS or RRSPS. Investment income that generates returns that receive more favourable tax treatments (dividends or capital gains) should be placed in non-registered accounts.
The next rule is to take advantage of government pensions and count them in first when estimating your annual withdrawals for your yearly income. We want to avoid clawbacks as much as possible, so it is imperative that you have a good understanding of your company pension, government pensions and/or anticipated investment income withdrawals for each year, to be clear on the taxation. Those individuals 65 or older can also take advantage of the Canadian Age Tax credit and the Pension Income credit.
Other ways to initiate good tax planning opportunities would be to utilize CPP/QPP pension sharing with a spouse or common-law partner if possible. You can also split employer pension plans and registered plans with a lower-income spouse or common-law partner to reduce marginal tax rates. Remember that with any registered plans, RRSP, LIRA or LIFS, you should try to hold them to their latest maturity (for example, age 71). Once registered funds are converted into an RRIF or LRIF, the prescribed annual minimum withdrawal requirement will ensure that you have income to report every year.
Tax efficiency in retirement should be something you regularly discuss with your adviser.