Five tips to reduce your taxes in retirement

With people living longer – and the cost of living continuing to rise – it can be a challenge to make your retirement savings last as long as you need. What’s more, the major sources of retirement income are often taxed at the highest marginal rate. Here are five tips to reduce taxes – and maximize your retirement “paycheque”:

1. Consider how different types of investment income are taxed

Your investment income is taxed in different ways within a regular, non-registered account:

• Interest income from bonds or GICs is taxed at higher rates than dividend income or capital gains from stocks. Therefore, by selling investments that generate interest income (as opposed to selling investments that generate dividend income or capital gains), you’re depleting the capital which earns the higher taxed income.
• Preferentially taxed income like Canadian-source dividends can be a good source to draw from, as you’re already paying tax on it regardless. And if you are only using the income, you will not be drawing down on your capital, which may preserve future growth.
• Capital gains are taxed most favourably. As such, triggering gains in order to fund lifestyle expenses will allow you to have more after-tax income for spending.

2. Think about the order you draw from your income sources

What are (or will be) your retirement income sources? When – and in what order – should you start drawing income from them? You often have a choice, or at least a choice within certain parameters. And timing is important when it comes to maximizing your after-tax retirement income.

For example, if you’re in a high tax bracket, it generally makes sense to draw on your least taxed income sources first, where possible. For example, income from your RRIF is fully taxable at your marginal rate, whereas all income withdrawn from your TFSA is completely tax free. As a result, it can make sense to start drawing from your TFSA before withdrawing excess income from your RRIF.

And while you can’t completely control the timing of your RRIF income, you do have some flexibility. For example, you can wait to start receiving RRIF payments until the year in which you turn 71 – and then only take the minimum required amount. Choosing the minimum payment has the added benefit of leaving more of your assets to continue growing within your RRIF on a tax-deferred basis (you only pay tax when you withdraw from your RRIF).

The optimal order to draw on your retirement income sources depends on your individual circumstances. Ask your Investment Advisor for more information.

3. Maximize your registered plans

Registered plans such as your RRSP and RRIF offer some unique tax advantages. As mentioned, you can choose to wait to convert your RRSP into a RRIF until the year you turn 71. By doing so, you can give your RRSP assets more time to continue growing on a tax-deferred basis. Then, once you do convert your RRSP into a RRIF, consider taking only the minimum required RRIF payment. Again, that leaves more of your RRIF assets within the tax-deferred environment to continue accumulating.

And there are other ways to make the most of your registered plans. For example, interest income is fully taxable when earned within your regular, non-registered account. Consider allocating more of your interest-bearing investments such as bonds and GICs to your registered accounts instead. Then, allocate more of your tax-efficient investments such as dividend-paying stocks to your non-registered account. You’re able to claim a tax credit on eligible dividends, and only 50% of any capital gain realized on the sale of a stock is taxable – when earned in a regular, non-registered account.

And if it makes sense in your situation, consider maximizing your available RRSP contribution room as soon as possible, before you convert your RRSP into a retirement income source, such as a RRIF. In addition to being able to claim a deduction on your tax return, you also give those contributions that much more time to benefit from tax-deferred growth.

4. Split income with your spouse or common-law partner

Income splitting works best when you have one spouse in a higher tax bracket than the other. By allocating income to the lower-income spouse, they pay tax on that income at their lower rate. This effectively helps to reduce your combined taxes.

You and your spouse can split eligible pension income (which includes annuity and RRIF income, but not CPP/QPP) by making a joint election on Form T1032, Joint Election to Split Pension Income, when you file your annual tax returns.

Another way to split income is through a spousal RRSP. If you expect your retirement income to be higher than that of your spouse, consider contributing to a spousal RRSP in advance. The sooner you start, the more income you’ll be able to shift to your lower-income spouse by the time you retire. You receive the RRSP contribution tax deduction as usual to reduce your current taxable income. However, the eventual retirement income is taxed at your spouse’s lower tax rate.

Already retired? If you still have unused RRSP contribution room and your spouse has not yet reached the year in which they turn 72, you can continue to make spousal RRSP contributions even if you, yourself, are over age 71.

5. Maximize your TFSA

The TFSA is sometimes overlooked as a retirement planning tool. But it offers some great advantages, whether you’re already retired or still working on it. Unlike an RRSP, you (and every Canadian resident 18+) automatically receive new TFSA contribution room every year – regardless of whether you have earned income. You can invest in all sorts of investments and earn tax-free investment income. You can also make tax-free withdrawals – which makes a TFSA a potential source of tax-free retirement income.

Ask your Investment Advisor for more information about maximizing after-tax retirement income.