Manage the Tax You Pay on Retirement Income

Income tax is without a doubt life’s single greatest expense.  It’s quite shocking to see just how much of the total amount of your hard-saved money will disappear in tax.  If you are a typical retiree with an annual retirement income of $60,000 and a 20% average tax rate, over 25 years of retirement you could easily pay $300,000 or more in personal income taxes.

20 – 40% of your pension plan or RRSP/RRIF value may disappear in taxes, either in the years you are drawing money from them, or in your final estate.

How to pay less tax

There are several ways to pay less tax on your retirement income.  It all comes down to understanding:

  • How different types of income is taxed
  • The marginal tax rates for your province
  • The claw-back zones
  • Tax credits available to you

Plan your income sources pro-actively, layering withdrawals from your different investment plans to prevent “tax bracket creep.”

Here’s an example using 2018 federal tax rates:

Peter’s taxable income is $60,000 from his pension, government benefits and investment withdrawals.  He will pay 15% tax on the first $46,605 of income, or $6,990.75 and 20.5% on the remaining $13,395, or $2,746 for a total of $9,736.75. If Peter withdraws the $13,395 from his Tax Free Savings Account (assuming those funds are available), he will have $2,746 more to spend.

This is a very simple illustration, but you get the idea.  Also keep in mind that each province also has its own tax rates.

Income splitting with your spouse

Do you and your spouse have relatively equal incomes now that you are retired?  Remember, two smaller incomes will always pay less tax than one larger income.

How old are you?  Depending on your sources of income you will be able to spit up to 50% with your spouse.  Pension plan money can be spit with a spouse at any age.  CPP can be split once both of you begin to draw benefits.  Withdrawals from a RRIF or LRIF or LIF can only be split once the owner of the plan reaches age 65.

By splitting income with your spouse, you can take full advantage of certain credits and reduce OAS claw-backs.

Tax credits

A tax credit is a calculation that directly reduces the amount of tax paid.  Be familiar with the tax credits available to you.  If you are losing any of your credits, you should look for ways to rearrange your income so you can maximize these benefits.

These are the most common:

  • Basic personal amount. All tax filers receive this.  If one spouse doesn’t have any income (or it’s less than the personal amount) a spousal credit will be added to your personal amount.
  • Age amount. This is available if you are 65 or older with income up to $36,976.  After that amount it is reduced by 15% and eliminated at $85,863.
  • Pension income amount. If you receive pension income, the first $2,000 is tax-free for each spouse.
  • Canada caregiver credit. For those who take care of an adult who is infirm and dependent on you and resides with you.
  • Disability tax credit. You need to apply for this credit and it requires certification from a medical practitioner.
  • Medical expenses. It’s often best to claim this amount on the return of the lower income taxpayer unless they are not taxable.
  • Charitable donations. You may carry forward donations for five years if that will result in better tax treatment.

The bottom line

How much after-tax income do you need to live on?  Your tax return will influence how and when you draw your income.

Take a look at your tax picture before the end of the year based on expected income and deductions.  This can give you important insight into ways you could reduce your tax payments for the current year and give you time to make any necessary changes.





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4 Responses

  1. Paul says:

    “If Peter withdraws the $13,395 from his Tax Free Savings Account (assuming those funds are available), he will have $2,746 more to spend.”
    Seriously? Peter’s income goes from $60,000 to $73,395 gross income, and his tax bill goes from $9736 to $20.385?

    • Marie Engen says:

      Hi Paul. I’m not really sure what you mean. The amount taken from Peter’s TFSA becomes part of his $60,000 income – not in addition to. He pays tax on the amount up to the top of the (federal) marginal rate ($46,605) and the remainder is tax free.
      Someone who is “topping up to bracket” also has to take into account provincial marginal rates (which are different for each province) when using this withdrawal strategy.

      • Paul says:

        Hi Marie,
        Thanks for the clarification. It was unclear to me that the TFSA funds were part of the original $60,000, rather than in addition to it.

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