Retirement planning can seem extremely complex, with scores of complicated terms and acronyms.
But, like most things that are very complicated when you first look at them, they can become pretty straightforward once you understand the concepts.
This column will explain some basic concepts of tax planning and deferral, then get into the extra choices that business owners (and former business owners) have to make. Over the next several weeks, we will take a look at specific RRSP and TFSA considerations, but today will focus on overall strategies.
Certain types of retirement income are fully taxable, including OAS, CPP, pension income, RRSP, RRIF and LIF withdrawals and any ongoing employment or net self-employment and rental income.
Other types of income are tax-free. These include withdrawals from TFSA accounts, and withdrawals of capital from savings accounts, bonds and any other non-RRSP or RRIF investments. However, if any of these investments have gained in value, then half of the gain is taxable in the year the investment is sold or redeemed.
Other types of income can be considered partly taxable, or taxed at a lower rate. These include dividends on shares of publicly traded corporations or private corporations, and appreciated investments on which there are capital gains.
Private corporations might be operating companies involved in businesses or investment holding companies, which may be the result of a business owner selling the business.
A good basic strategy is to defer the taxable sources of income as long as possible, and instead draw on tax-free or partly taxable sources in the early years of retirement.
This means using non-registered savings and TFSAs instead of withdrawing from RRSPs and RRIFs (until forced to do this after age 71), and spending the dividends, interest and other taxable investment income sources on non-registered investments. These amounts are taxable whether spent or not, so they should be used for living, if the alternative is to draw on RRSP, RRIF or LIF.
The exception to the rule of avoiding taxable sources of income may be when you have an entitlement, like OAS, CPP or a company pension plan. Some of these payments will increase if deferred, so make sure you are clear on the formula. It might be worth your while to wait, especially if you plan to live a long time, but it does mean that your total value from these plans could be decreased if you pass away early.
Complicating things slightly is that every dollar of “net” income above $72,000 results in 15 cents of OAS being denied. Dividends add disproportionately to the calculation of net income, even though the actual tax on dividends is disproportionately low.
Owners of private corporations may have options for income splitting among family members, if they have set up their ownership structure properly. Generally, the best strategy is to pay dividends from these corporations in order to pay out the retained earnings over time. If the shareholder dies with large retained earnings balances in the corporation, this could result in double taxation.
The shareholder is deemed to have sold the shares on death, resulting in a capital gain. However, the retained earnings are still within the corporation, and a taxable dividend must be paid to the surviving shareholders if that value is to be removed and used. So consider spending that money before RRSPs and RRIFs.
Regarding RRSPs, there is no requirement to withdraw and pay tax until after age 71. By the end of the year in which you turn 71, you must convert your RRSP into an RRIF or annuity, and start taxable income in the following year. The minimum is 7.48% of the previous December 31 value, in your 72nd year.
There, that’s pretty simple, isn’t it? Actually, there is a lot more to know than I can put in a single column, so I encourage you to get some good advice to plan your retirement, and do some reading. I happen to have written a great book on all this stuff. J
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Dollars and Sense is meant as an introduction to this topic and should not in any way be construed as a replacement for personalized professional advice.
Please consult legal, tax and investment experts for advice on your unique situation.
David Christianson, BA, CFP, R.F.P., TEP, is a financial planner and advisor with Christianson Wealth Advisors, a Vice President with National Bank Financial Wealth Management, and author of the book Managing the Bull, A No-Nonsense Guide to Personal Finance.