How Can I Pay Less Tax at Retirement?

Withdraw from investments wisely

You need to properly plan the order in which you will withdraw funds from your investments, as this could mean you pay less tax.

There’s an unspoken rule that it’s best to start withdrawing from non-registered investments, then from your Tax-Free Savings Account (TFSA), then your Registered Retirement Savings Plan (RRSP) in order to keep your money sheltered from tax for as long as possible.

Since everyone is different and several factors can influence how much tax you pay, the best withdrawal plan can vary from one person to another.

In most cases, it’s advantageous to defer government benefits. Payments from the Canada Pension Plan (CPP) and Quebec Pension Plan (QPP) increase if you wait to take them. It’s important to think about whether it’s worth it in your individual situation. For example, it might not be the best option for you if you have a shortened life expectancy. Speak to your accountant or financial planner for help finding the best strategy for you.

In all cases, you need to think about tax brackets and the marginal effective tax rate (METR). The METR takes into account the impact of all social programs, such as OAS clawback.

Income splitting

One possibility is to split your income with your spouse. If there’s a disparity in income between spouses, it may be advantageous to transfer some income from one spouse to another. You can do this when preparing your tax returns or you can make an arrangement for your pension payments (such as with CPP or QPP). It’s a strategy that’s easy to set up and that could reduce your tax bill.

It’s possible to split income from employer pensions and registered retirement funds, such as a RRIF, when you file your taxes. You make a decision about splitting pension income when you file your tax return each year. It’s not permanent and the money is not really transferred from one spouse to the other. It’s possible to transfer up to 50% of this income. There are specific rules on the age when a couple can split these types of income, so speak to your advisor for more details.

When you choose to share government pension payments with your spouse, a real and permanent financial transfer takes place, and the money belongs to the receiving spouse. You must complete a pension sharing form. The total pension amount for both spouses is automatically divided equally based on the number of years you and your spouse lived together during your contributory period.

For example, two people who each earn $50,000 per year may pay less tax combined than one person who earns $100,000. In this case, 1 + 1 doesn't equal 2.

Take advantage of a spousal RRSP

Contributing to an RRSP on behalf of your spouse may help you reduce your taxes. The money that you contribute to your spouse’s RRSP belongs to your spouse. In the event of separation or divorce of a legally married couple, the law may go some way towards restoring a balance. However, the situation may be more complicated for common-law couples who separate. Depending on your province of residence, you could consider drawing up a contract along the lines set out in this article about cohabitation agreements, so as to protect your assets in various situations.

Your RRSP deduction limit statement shows your contribution room for a given tax year and the RRSP deduction limit for the same year. The deduction limit may be higher if you have made contributions but not deducted them. If your Notice of Assessment issued by the Canada Revenue Agency (CRA) says your RRSP contribution room is $10,000, that means you only have $10,000 to contribute to your RRSP and your spouse’s.

However, in some cases, this transaction can reduce your tax bill. How? Let’s look at two examples.

First of all, it allows you to get around the 50% limit on retirement income splitting. The receiving spouse can withdraw 100% of the money in their own name. There are no age restrictions, so they can even do it before they turn 65. The only general rule is to wait three calendar years before making the withdrawal, otherwise the contributing spouse will be taxed on it. Although the contributor contributes to the RRSP on behalf of their spouse, they benefit from the tax deduction at the time of their choosing.

Here’s another scenario. Let’s say you have unused RRSP contribution room but can’t make any more contributions because of your age (December 31 of the year you turn 71 is the latest you can contribute to your own RRSP). You can, however, contribute to your spouse’s RRSP, provided that they aren’t 71 yet.

Use all available tax credits and deductions

We can’t list all the possible tax credits and deductions that you may be entitled to once you’re retired. They vary depending on your situation and your province of residence. Here are some offered by the federal government:

• The age amount
• The pension income tax credit
• The home accessibility tax credit
• The medical expense tax credit (medication, hearing aids, etc.)

Get the most out of your RRSP and RRIF

An RRSP lets you build savings for retirement sheltered from taxes. When you need to withdraw funds for your retirement, you convert it into a Registered Retirement Income Fund (RRIF). You can think of it as a continuation of your RRSP.

You have until December 31 of the year you turn 71 to convert your RRSPs into RRIFs. The amounts in the RRIF are also tax-sheltered. Only the amounts withdrawn during the year become taxable for that tax year. Remember that you must withdraw a minimum amount from your RRIF each year, based on a percentage set by the federal government.

However, there is nothing preventing you from converting it before the end of the year you turn 71 to reduce your taxes. The idea is to withdraw the money when your taxable income is lower. Try to level out your taxable income over time. In addition, to guard against the risk of outliving your savings, it’s usually advantageous to delay receiving government benefits (QPP, for example) so that you can enjoy higher payments of these indexed pensions for the rest of your life. Drawing down your RRSP/RRIF early can help to make up the shortfall in income while you’re waiting to take your government pension.

For example, for the first few years, you could withdraw $20,000 per year from your RRSP/RRIF. Then, when you turn 70, you could combine $14,000 from QPP with $6,000 from your RRSP/RRIF. This means that your tax bracket won’t change.

Make the most of your TFSA

The tax-free savings account can be a very useful tool for retirement, especially if it’s used as part of a wider strategy to cut your taxes.

The TFSA is advantageous because withdrawals aren’t taxable, so they won’t affect your eligibility for social programs (think about METR).

You can start contributing to a TFSA at age 18, and it’s in your best interest to do so because this investment tool can really enhance your tax strategy at any age. Because you never have to pay tax on the returns generated by the money invested in your TFSA, this can, in some cases, make a TFSA even more beneficial than an RRSP. An RRSP is less beneficial if your METR is lower at the time of the deduction than when you are taxed on the withdrawal.

It’s important to remember that everyone’s situation is different. Our specialists can help you find the strategies that are best for you. We’re here to answer your questions.