Plan to Retire in a Lower Tax Bracket
A few years before you retire, you’ll probably ask yourself if you’re on track to meet your retirement income goals. You’ve determined the amount of pre-tax income you’ll likely need and plugged the numbers into a retirement planning calculator. In many cases, the results might suggest that the savings amount needs to be increased or the retirement date should be postponed.
A different approach is to consider where you invest your money instead of just socking more away, or even worse, taking on more risk on your investments to achieve a higher return.
Your taxable income can be very different from the cash you receive.
These ideas are more effective if you start working on them about five years before your planned retirement date.
1. Have the right mix of investments
You are fully taxed at your marginal tax rate on income received from your pensions, RRIF withdrawals and interest, but only partially taxed on tax-efficient nonregistered investments and there’s no tax on TFSA withdrawals.
RELATED: Converting an RRSP into a RRIF
You goal should be to have your taxable income below the lowest Federal tax bracket ($47,680 in 2019). For example, if your pension payments come to $32,500 you can have up to $15,180 taxable income from your investments. If you have a substantial RRSP amount you may want to start contributing to a Spousal RRSP instead to reduce your minimum withdrawal amount.
Refunds from RRSP contributions could be invested in your TFSA. Fully taxed investments could also be transferred to your TFSA
2. Tax-efficient investments
Different types of income are taxed at different rates. You know that RRSP withdrawals and interest are taxed higher than capital gains and dividends from public companies.
Receiving dividends from a non-registered account can be a disadvantage if your income will be low (less than $25,000) because GIS will be reduced. The “gross up” can result in OAS claw back for higher income retirees.
The lowest tax rate at any income level is with deferred capital gains from tax-efficient equity investments. With a Systematic Withdrawal Plan (SWP) when you sell some of your funds they are a mix of capital gains and getting your invested money back.
3. Equality between spouses
When you understand how our tax system works, you begin to clearly see the importance of have two equal incomes in retirement. Always attempt to have an equal amount of assets between both spouses at retirement through Spousal RRSPs, TFSAs, and choosing which spouse should invest money in non-registered accounts.
Use your tax return as a guide
Your income is taxed using a combination of Federal and Provincial tax. The amount of tax you pay on the next dollar of income increases as you earn more money and enter the next tax bracket.
Take full advantage of the Basic Personal Amount. You want to make sure each taxpayer has at least this much income to their name each year.
Watch the clawback zones for the Age Credit and OAS. Both these benefits become available at age 65. The ideal objective is to split income so an equal amount is shared between both spouses to be below the clawback thresholds.
The bottom line
Retirement planning software tells you how much you need to save, but not where to save. In some situations, you may end up over-estimating how much you actually need to save, pay too much tax and take on too much risk in your investment portfolio.
A little planning ahead of time of how and where to invest will give you a lot more flexibility. Calculate multiple scenarios and then project them onto your tax return. You will be able to minimize the taxes you pay by determining the amount and type of income you take when you retire.
Obviously, the less tax you pay, the more you will have to spend.