Maintaining your lifestyle in retirement and paying less tax

Tony Maiorino:

The common question we hear from retirees is, how do I make my life savings last? It’s a valid concern. We’re facing rising costs, longer life expectancies, and markets that can change direction overnight. But while many people focus on budgeting or reducing costs, they often overlook the importance of investment returns and one of the biggest drains on retirement income, taxes. Look, the good news is there are many powerful ways to reduce your tax burden and keep more money available for both your daily life needs and your future needs. It’s time to understand how to make our retirement dollars work harder, and reducing unnecessary tax. Hello, I’m Tony Maiorino and welcome to RBC Wealth Management Canada’s, Matters Beyond Wealth. With me today is Prashant Patel, vice president of High Net Worth Planning at RBC Family Office Services. For over three decades, Prashant has been assisting high net-worth families with tax, estate, and retirement issues. Prashant, thanks so much for being here with me today to talk about the ways to manage retirement income and why this matters beyond wealth.

Prashant Patel:

Thanks, Tony. It’s a pleasure to be here.

Tony Maiorino:

So before we dive into some specific strategies, I’m just curious, what are the main issues that you’re seeing retirees face when it comes to maintaining their lifestyle? I know you work with lots of families. Is it rising costs, market uncertainty, or is it just something else?

Prashant Patel:

Yeah, that’s a great question. I mean, definitely rising costs and market uncertainty and volatility are two of the bigger challenges that retirees are facing today in their deaccumulation phase of their life. But there are other things that also come to mind, such as, you know, what if there’s a possibility of a prolonged low interest rate environment which impacts the fixed income returns of our retirees? What about higher-than-expected medical costs, you know, as we age? And definitely people are living much longer these days. And also a lot of parents, you know, they want to give to their children with a warm hand, rather than a cold hand. So they want to support their children during their lifetime with certain gifts, you know, helping with the down payment on a home purchase, wedding costs, starting a business, et cetera.

So, you know, if we kind of step back, I would say kind of one of the best ways to plan for these potential risks and challenges and start mapping out your retirement income plan is to go through a financial planning process with a professional that has access to a team of specialists. Now, a financial plan or a financial projection can help you model your retirement income sources and investment in assets that create that retirement pay cheque for you after your salary from your employer stops. So if a financial plan typically starts with a base scenario based on your current net worth, expected income and expenses and assumptions for inflation and investment returns.

But one of the real powers and benefits of financial plan is that you can modify the base scenario by doing some sensitivity analysis with alternative scenarios which capture some of these potential retirement challenges. For example, an alternate scenario can include, you know, what if your expenses increased by twenty-five percent or your investment returns were lower than expected for a prolonged period? Or what if you live to a hundred? You know, fun fact for everyone. There are over twelve thousand people in Canada over the age of one hundred, and it’s the fastest-growing segment in Canada we have. So that’s pretty incredible. So by changing some of these assumptions and doing alternate scenarios, you can see the impact on your ability to maintain your retirement lifestyle and then make adjustments if needed.

Tony Maiorino:

I love the financial planning component because I think a lot of people are familiar with planning for retirement. They get their financial plan done in understanding how to get to retirement, but not enough people understand that financial planning in retirement is also really important, and there are different aspects to that. And I know that we’ve seen many retirees are surprised when they go through that process that their tax bill in retirement might actually be higher than expected, even though they’re no longer drawing a salary. So from RRSP or RRIF withdrawals to pension income, different sources of income are taxed differently. What are some of the considerations around tax that Canadian retirees should be aware of?

Prashant Patel:

The typical retirement income sources that retirees receive, like you mentioned, RRSP, RRIF payments, pension, interest income, fully taxable at ones marginal tax rates with no preferential tax treatment like there is for capital gains or Canadian dividend income. And during retirement, you’re not making RRSP contributions. Likely you’re going to have less tax deductions. So all of your income is going to be taxable. Furthermore, if your annual net income exceeds ninety-three thousand dollars, then your old age security is going to start to be clawed back. The other thing retirees need to be aware of is if you have considerable investment income in retirement outside of your RRSP and TFSAs, you could be subject to quarterly tax instalments since investment income is not subject to tax at source. This is a surprise for many retirees, as they likely never had to pay quarterly tax instalments to CRA during their working years since their income was primarily salary, which was subject to tax at source by their employer on their pay cheque.

Tony Maiorino:

I know you love the Benjamin Franklin quote, there’s nothing certain in life but death and taxes, but there are ways to minimize the impact of taxes. What are some of the effective tax strategies for retirees that you would recommend?

Prashant Patel:

You know, one of the most popular strategies is income splitting with your spouse, which can go a long way in reducing taxes in retirement.

Tony Maiorino:

So that’s really interesting. Can you maybe give us a bit of a detailed example of the tax savings that you’re talking about?

Prashant Patel:

So let’s take an example of a couple, and they are looking for two hundred thousand of before tax retirement income. But in this case, all of that two hundred thousand, let’s say, was taxed in only one spouse’s name. In that case, the tax bill would be about sixty-five thousand dollars. Now, this is going to vary by province. Now, if they were to income split and split that two hundred thousand equally between both spouses, and each spouse earns one hundred thousand dollars, then the combined tax bill is going to go down to forty thousand dollars because each spouse has their graduated tax rates to take advantage of. That’s a tax savings per year of twenty-five thousand dollars. Now, just to make sure everyone’s aware to income split with a spouse, you need to consider the spousal attribution rules, which can prevent income splitting. So it’s important to work with a qualified tax advisor here. Furthermore, the tax numbers that are quoted assume that all of the income is taxed at marginal tax rates like interest income with no tax preference.

So now another way to reduce tax from retirement if you had investments outside of your RRSP or RRIF is to earn dividends from Canadian public companies and capital gains as this type of income is taxed lower than your typical retirement income sources like interest income, dividends from foreign companies, pension, RRIF withdrawals. So back to my example, and if we kind of take this to an extreme and say that both spouses now have one hundred thousand of income each. But in this case, all of their income is comprised of only Canadian public company dividend income. Then the total tax bill would go down from forty thousand down to eighteen thousand per year. Very significant tax savings. But keep in mind, investments earning Canadian dividends or capital gains carry higher risk than more conservative fixed income investments earning interest income. So this needs to be considered with your investment professional based on your risk tolerance.

Tony Maiorino:

Yeah, and I think that that’s a really important point that you don’t want to be focused solely on tax, or you don’t want to be focused solely on cost, or you don’t want to be focused solely on performance. It’s a combination of those things that really is what can help drive this in a positive way for you. So income splitting sounds like it’s a great idea. Can we look at couples who have pension income and how does income splitting work and benefit for them?

Prashant Patel:

Yeah, pension income splitting is a very simple way to reduce tax for retirement. And the spousal attribution rules that I mentioned earlier do not apply to pension income splitting. There are generally three ways to pension income split with your spouse. One is if you’re receiving an employer pension from a defined benefit pension plan, then up to fifty percent of that pension can be split with your spouse, regardless of your age. If you’re receiving a RRIF or a LIF payment, then you can also split fifty percent of that payment with your spouse. But in this case, you have to be at least sixty-five years of age. Note that RRSP withdrawals for someone sixty-five or over do not qualify for pension income splitting. It must be from a RRIF or LIF. And finally, if you and your spouse are at least sixty and receiving CPP/QPP, then you can split up to fifty percent of your CPP/QPP pension, depending on the years you and your spouse were living together. Note that splitting of your employer pension and the RRIF and the LIF payments is automatically done on your tax returns, whereas for the CPP/QPP splitting, you have to apply for that.

Tony Maiorino:

Let’s take a second and pivot here. I want to talk about TFSAs for a moment. Some retirees might not realize that they can still contribute to a TFSA after retirement. Can you maybe take a minute to just help us understand how a tax-free savings account could be effectively used in a person’s retirement strategy? Because I think there’s some value there that lots of people maybe don’t take enough time to think about.

Prashant Patel:

Yeah, I mean, obviously, TFSAs are a very popular savings vehicle. And in retirement, you can continue to contribute money to a TFSA up to your contribution limit. There is no age seventy-one limit like there is for RRSP contributions. With TFSAs, you can contribute for life. Although TFSA contributions are not tax deductible, remember that all of the income and capital gains earned in a TFSA grow tax-free. And of course, any money withdrawn from the TFSA is also tax-free. So to the extent that you’ve got excess cash flow, surplus monies contributing to your TFSA annually during your retirement will continue to maximize your tax-free growth. And furthermore, any of the withdrawals you make from your TFSA during retirement have no impact on any income-tested government benefits like old age security or guaranteed income supplement or the age credit.

Tony Maiorino:

Okay, that’s fantastic. So let’s quickly imagine I’m in retirement, I’ve done my planning, and I find that I have a surplus. I have more money than I’m going to need to meet the objectives that I’ve set out for myself and my partner in retirement. Should I invest the surplus? Should I make a gift to a family? Should I look at other ways of minimizing tax on those monies going forward? So depending on what I’m looking to do, what are some of the tools that you would recommend someone in that situation, dealing with a surplus, what are some of the tools that would help work for them for a smarter, more efficient retirement?

Prashant Patel:

You know, in addition to maximizing TFSA contributions, you know, there’s a couple of interesting ideas and concepts that I’d like to share here. More and more individuals with surplus funds are depositing funds to a tax-exempt permanent life insurance policy like whole life or universal life as another asset class as part of their overall investment portfolio. Now, these policies have both an insurance component and an investment component, and all the earnings within these policies grow on a tax-free basis and one hundred percent of the death benefit is tax-free.

So again, back to the financial plan concept, it can help you determine if you will likely have some surplus funds. They will not be spending during your lifetime, but rather transfer that to your beneficiaries like your children. And if that’s the case, it may not make sense to expose these surplus funds to high taxation during your entire lifetime. And that is where the insurance becomes fairly attractive. And another tax-effective option using surplus funds, if you have charities or causes you want to support, is to donate some of those funds directly to a charity or your own charitable foundation during your lifetime. Now, the charitable foundation concept has become fairly popular in recent years, and RBC Wealth Management has the ability to set up a turnkey off-the-shelf foundation, also referred to as a donor-advised fund with no setup costs and a minimum initial donation of twenty-five thousand.

Prashant Patel:

From a tax standpoint, the donation tax credit can be used in the current year or in five following years. Furthermore, it’s become very popular to donate publicly traded stock in a gain position in kind directly to a charity or even your own charitable foundation instead of donating cash. As in this case, the capital gain on the stock that’s donated in kind is exempt from tax. And you would also receive a donation receipt equal to the fair market value of the stock donated.

Tony Maiorino:

Okay, well thank you for that. Those are some great strategies that I think people can absolutely look at. You know, we’ve covered a lot of ground today and some of the things you’ve said are quite complex. If you hope listeners remember one thing from our conversation today, what would that thing be? What would you want our listeners to remember?

Prashant Patel:

You know, retirement planning, as you said, can be complex with many moving parts and as mentioned earlier, many potential challenges that one will face. So rather than leaving our listeners with just one takeaway, I’d like to offer my top three. Firstly, it’s important to work with a professional that has the tools and resources on his or her team to offer financial planning or retirement planning services. As mentioned in many cases, this typically starts with preparing a comprehensive financial plan or financial projection and running a base scenario. And then doing some sensitivity analysis with the alternate scenarios that I mentioned earlier. Secondly, not all forms and sources of income are created equally, as they all have different tax treatment and tax planning considerations. And if you think about it, all the different sources  we’ve got – RIF payments, TFSAs, pensions, life annuities, government CPP, pension, interest income, capital gains, dividends, and the list goes on and on. So it’s important to understand this and work with a qualified advisor to help you sort out that complexity and understand how to efficiently draw upon or see these different sources of income to meet your retirement goals in the most tax-effective manner. And last but not least, is to keep an open mind to unique and different strategies and concepts that may enhance your retirement income, reduce taxes, and pass on wealth to the next generation in a more tax-effective manner. You know, this can include certain strategies as family income splitting, you know, using life insurance as another asset class, which most people don’t think of life insurance in that way, and possibly setting up a charitable foundation to leave that lasting legacy. You may not end up implementing some of these strategies, but it’s prudent to review them, understand the pros and cons and see the numerical analysis so you can make an informed decision.

Tony Maiorino:

Thanks so much, Prashant. Thank you for joining us. Thank you for your guidance today and helping us better understand how to make our retirement dollars work harder while reducing unnecessary tax costs and why this matters beyond wealth.

Prashant Patel:

Thank you, Tony.

Tony Maiorino:

You can find out more about Prashant Patel and the strategies that we discussed today at rbcwealthmanagement.com. If you’ve enjoyed this episode and you’d like to help support the podcast, please share it with others, post about it on social media, or leave a rating and a review. Until next time, I’m Tony Maiorino. Thank you for joining us.

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