Strategic Tax and Cash Flow Planning Through Your Investment Life Cycles

The working chapters of your life are often called the “accumulation” stage of life, as you are working hard and saving to build up a nest egg for your retirement years. For many Canadians in the accumulation stage of life, tax planning is pretty straight forward – it involves ensuring you maximize your RRSP and TFSA contributions, take advantage of the First Home Savings Account (FHSA), contribute to an RESP if you have children, utilize loss carryforwards and claim credits.

As you approach retirement, we coin this your “pre-retirement years”. Your wealth accumulation has been successful, and it is the most important time for strategic tax and cash flow planning. With many clients we find the pre-retirement years start around age 50.

Upon retirement, you enter into what is referred to as the “decumulation” stage of life because you start to draw down your nest egg to supplement other income sources to provide the cash flow you need to fund your retirement lifestyle. With careful planning, there are more opportunities to save taxes as you enter this stage.

It becomes important to analyze not only where you should draw funds from to meet your cash flow needs, but when you should withdraw the funds, taking into consideration your time horizon and estate goals. The age you choose to retire at, as well as your current age, can also impact your tax considerations.

Retiring Before You Turn 65

We typically find most individuals retire around the age of 60. In this stage, one has more varied sources of income, which creates some flexibility from a tax planning perspective.

Individuals in this stage often rely on income from a company pension, their non-registered investment accounts, or their RRSPs. It is often assumed that during this phase, it is best to preserve one’s RRSP and focus on making withdrawals from their non-registered assets, as this allows the investments within their registered accounts to continue to grow on a tax deferred basis.

However, a more detailed analysis may indicate that making withdrawals from a combination of one’s non-registered account and one’s RRSP may be more advantageous over the long-term, as their income will be taxed at a lower marginal tax rate now instead of at the highest marginal rate down the road. Earlier withdrawals from an RRSP will also help to reduce the mandated minimum RRIF withdrawals starting at age 72, which may help avoid an OAS claw back.

For married couples, the more detailed analysis will also consider the income levels of both partners in determining which account to draw the funds from.

Are there instances where it makes sense to apply for CPP before age 65 even though it results in a lower monthly payment? See our blog When Should I Apply for CPP? – Mirador Corporation for a more detailed discussion.

Ages 65 – 71

This is the phase when you will have the most flexibility in determining your income levels, so prior tax planning can make a significant difference.

Starting at age 65, individuals with eligible pension income are entitled to claim a $2,000 pension tax credit. Eligible pension income includes company pension and withdrawals from one’s RRIF, but does not include regular RRSP withdrawals or CPP benefits. As a result, a tax planning opportunity that may make sense in this phase is to convert a portion of your RRSP to a RRIF before the mandated age of 71 to take advantage of the pension tax credit.

In addition, starting at age 65, couples can opt to split eligible pension income with their spouse. This means that converting a portion of one’s RRSP to a RRIF early has the added benefit of having up to 50% of the RRIF income taxed in the lower spouse’s hands. It also makes them eligible for the pension tax credit, so the overall tax bill for the family will be reduced.

It is important to consider OAS during this phase. OAS benefits start at age 65, but individuals may choose to start receiving OAS as late as age 70 (with the benefit increasing up to 36% if you wait the extra 5 years). Early withdrawals from one’s RRIF may provide the cash flow you need to fund your retirement lifestyle without OAS, allowing you to defer to age 70 and take advantage of the increased benefit. It may also reduce your minimum RRIF payments down the road, reducing your risk of an OAS claw back.

As each family’s circumstances are different, a detailed cash flow analysis and tax planning will determine whether it makes sense for you to convert a portion of your RRSP to a RRIF early, and if so, how much or whether it makes sense for you to delay starting CPP or OAS. With over 30 years of experience, Mirador can help you navigate through this.

72+ Years

Once you reach 72 years of age, there is less flexibility in your income. You will be receiving CPP and OAS as you cannot defer this past age 70. In addition, you will now have mandatory annual withdrawals from your RRIF, which increase each year.

If you have a significant RRIF, you may find yourself in a high tax bracket with significant taxes payable each year, which may also result in a claw back of your OAS. If you are single, the challenge may be compounded when you pass away, as the market value of your RRIF at the time of your passing must be brought into income, leaving your estate with a significant tax bill.

If your spouse is the beneficiary of your RRIF, then the tax can be deferred until your spouse’s passing. However, this will mean that the spouse’s future minimum annual RRIF payments will be higher, creating more taxable income and possibly shifting them to a higher tax bracket.

If you are not already in the highest tax bracket, one planning opportunity that may exist in this phase is to estimate your total taxable income towards the end of each year. If, after including your minimum RRIF payment, your total taxable income is still in one of the lower tax brackets, it may make sense to withdraw an additional amount from your RRIF because it will be taxed at a lower rate than your estate will pay down the road.

As you can see, it’s important to do more strategic tax planning as you move through the investment life cycles to help lower the overall lifetime tax bill for you and your family. Mirador can help! With decades of experience helping hundreds of clients and by utilizing advanced financial planning software we can help you navigate through your pre-retirement and retirement life cycles. We will work closely with your tax advisors to help ensure you make the right decisions to minimize your overall tax burden wherever possible.