Submitted by Sara Worley & Brendan Donahue
Investment Advisors, Manulife Securities Incorporated
Just as there are different stages in a person’s working years, there are different stages in retirement. When a person reaches age 72 there are very few things that can be done to affect their taxable income. There are, however, a few strategies that younger retirees should explore to ensure they take advantage of all tax-savings opportunities available to them as they approach age 72.
Pension Income Tax Credit
The Pension Income Tax Credit is available to all Canadians with qualified pension income. This credit makes the first $2,000 of qualified pension income tax-free.
Those who don’t have an employer-sponsored pension plan can create their own pension income. This can be done in the year the person turns 65 by converting all or a portion of their Registered Retirement Savings Plan (RRSP) to a Registered Retirement Income Fund (RRIF) and deregistering at least $2,000 from the RRIF each year.
The transaction will be subject to withholding tax upon deregistration; however, the credit is applied on one’s tax return. This is a simple way to get a little money out of an RRSP tax-free.
As of the 2007 tax year, Canadian residents have been able to split up to 50 per cent of eligible pension income with their resident spouse or common-law partner. This tax move is available to all Canadians who receive qualified pension income and works best if spouses are in different tax brackets.
No funds are actually transferred using pension splitting. It is simply a method for reducing the taxable income of one spouse by allocating income, on the tax return, to the other, lower-taxed spouse.
Early RRSP withdrawals
The year a person turns 71 their RRSPs must be converted into RRIFs. The following calendar year, they must begin withdrawing from their RRIFs at a rate determined by the government. This can cause tax problems for people with higher taxable income, as their RRIF income might be taxed in higher bracket than their other income, or their Old Age Security (OAS) benefits might be clawed back. Because of these potential consequences, all young retirees should explore the possibility of deregistering some of their RRSPs before age 72.
To see if early deregistration would be advantageous, try an income projection. This can be done by calculating all forms of taxable income now and at other points in retirement where one’s income might change, such as ages 65 and 72. Ask yourself, How will all my pensions, government benefits and RRIF minimum withdrawals affect my taxable income down the road? Could my tax situation be maximized by early de-registration?
Retirees who are de-registering funds from their RRIF for tax purposes alone might consider transferring funds in-kind to another investment account instead of taking the funds in cash. This manoeuvre can save trading fees if the person wants to continue owning the same investments.
Is GIS an option?
The Guaranteed Income Supplement (GIS) is an income-tested pension program offered by the federal government. For 2019, individuals earning less than $18,600 and couples earning less than $24,576 of combined taxable income, excluding OAS benefits, qualify for some GIS.
Some people find themselves in a unique situation where they are able to restructure their finances to receive GIS. The strategy could involve deregistering one’s RRSPs prior to age 65 and investing the proceeds in a TFSA, or deregistering RRSPs before life expectancy in order to capture GIS later in life. If you think this might be an option for you, speak with your financial advisor.
While there is no way to avoid taxation completely, people in the early stage of retirement have many options available to them which could significantly lower their tax bill now and in the future. Be sure to ask your financial advisor and accountant about all the options available to you.