Tax Tip Thursday

We have been getting a lot of people asking about retirement income and order of operations and tax consequences.

 

The RRSP “tax trap”

I have spoken to many people over the years that do not believe in RRSP’s at all.  The feel that registered retirement savings plans (RRSPs) are a “tax trap.” The concern is that withdrawals later in life – or taxation at death – will push people into higher tax brackets and could lead to clawbacks of Old Age Security benefits during retirement.

These are serious considerations when planning for your retirement and you should understand the implications.

An RRSP gives you a deduction when you contribute and allows your investments to grow tax-deferred for decades. You are effectively investing pretax dollars. That is not a trap. It is a powerful investment tool. Yes, tax is eventually paid. The question was never if tax would be paid, but when.

It makes sense that tax should be owing either when you make withdrawals or when you pass the registered plan assets to the next generation. The good news? You can pay tax gradually as you withdraw funds – which you control (except for the minimum withdrawal requirement for registered retirement income funds).

Conversion to a RRIF

In the year that you turn 71, you MUST convert your RRSP into a RRIF – a Registered Retirement Income Fund.

There are no tax implications, stocks do not need to be sold.  Everything in your RRSP portfolio can be moved exactly as they are into the RRIF.

At that time, you can no longer make contributions to your RRSP (there are some opportunities to contribute to your spouses RRSP depending on the circumstances).

AND you MUST start drawing down your RRIF.  It is a pre-determined rate by the CRA and is not flexible.  It starts at just over 5% at 71 and then increases every year up to 20% at age 95.

You MUST give consideration to this as you age and contribute understanding that depending on the size of your RRSP, it could affect OAS.

Other considerations

If you have other “Cash” investments or TFSA’s, these can affect your decision making of how you take money out and of course the associated tax implications.

Specifically, TFSA’s come out tax free.  So they can often be treated as “bonuses” for yourself without causing you any additional taxes.

Depending on the type of investments in the Cash Investments, you could be receiving dividends and/or interest income which is all taxable.

You could also have growth stocks that do not payout dividends and/or interest income, but instead are taxable when sold.  These are the most tax efficient investments for you as the maximum income tax rates on capital gains is 26.5%

Structuring your investments and investment vehicles WILL make a difference in your retirement.

There are pros and cons to all investments depending on your goals, objectives and financial needs.

The real goal in retirement

People seem to fall into two camps when it comes to retirement income planning: One camp believes in “avoiding tax at all costs.” The other says, “just live your life.” I understand both views and think a prudent approach lies somewhere between.

The primary goal in retirement is to avoid running out of money. Yes, taxes are part of the equation, but sustainability of income and peace of mind matter more.

It is important to realize retirement can bring unpredictable shocks: long-term care costs, major home repairs, helping adult children, dental bills and market downturns.

you focus so much on saving taxes that you ignore the objective of saving and investing enough in the first place, your tax strategies won’t matter much. Being tax-aware is wise. Being tax-obsessed can be exhausting.

you understand the numbers, you can be confident you’re on track to have enough for your lifetime.  This is where The Mad Accountant can help you.

 The psychology of retirement

Many readers say they want to enjoy their early retirement years – the “go-go” years when health and energy are strongest. That makes sense. Spending is rarely flat in retirement. It often starts higher with travel and experiences, then tapers off later.

The hard part can be psychological. For decades, you have been a saver. Suddenly, retirement requires you to become a spender. That shift can feel unnatural, with the fear of depleting assets too quickly because markets fluctuate and life expectancy is uncertain.

Retirement is about more than spreadsheets. Work can provide identity, structure and purpose. When that disappears, some feel they are drifting. It is important to consider not just how you will fund retirement, but how you will live it.

The best strategy is to come up with a plan and then live it!

Review it each year at least for the first few years to see if you are staying on plan, need to make some adjustments or just keep going!

Come talk to us about your retirement planning! Make An Appointment today!

Disclaimer:

This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal or tax advice nor can it or should it be relied upon. All tax situations are specific to each individual. If you have specific tax questions you should book an appointment for a 1 on 1 consultation.