“Timing your Income and Planning at the Margin”

During your working life, you may have had one or two sources of income with limited ability to manage the timing of cash flows. In retirement, you have access to numerous income sources with a high degree of flexibility. 

In this article, we will first highlight the flexibility of various sources of income and then use a simplified case study to illustrate how we might structure a tax-efficient retirement income plan. 

TIMING OF RETIREMENT INCOME 

The income sources listed below are in order of low flexibility to high flexibility. We take into consideration both the timing and taxable nature of these cash flows. 

Pensions (Taxable income) Old Age Security: Payable at age 65, or able to defer up to age 70. If you were born in 1962, your OAS payments commence at age 67. For birthdates between 1959 - 1962, there is a transition period to age 67. If you were born in 1958 or later, OAS commencement has been changed to age 67. If you were born in 1957 or earlier, OAS payments may commence at age 65.  (Editor's note: OAS eligibility was reversed back to 65 in 2016)

Canada Pension Plan: Payable as early as age 60 and can be deferred up to age 70. 

Defined Benefit Employer Pensions: Typically can either front-load income through a "bridge benefit" or short-term annuity, or defer collecting the pension income within certain age limits. 

Registered Retirement Savings (Taxable income) RRSPs and RRIFs: RRSP lump sum withdrawals are available anytime; conversion from RRSPs to RRIFs is required in the calendar year you turn 71, with the first income to be withdrawn in the year you turn 72. Converting to an annuity is another option. 

Other savings that could be used for retirement income (partial or no taxation) Open Account or Non-Registered:  This is “tax-paid” capital that can either generate current income in the form of interest and dividends; be invested to limit current income or used for capital withdrawals. An annuity is another option for open account savings. 

Corporate Investments: Only when money is paid out to you from a company, typically in the form of dividends, will there be a taxable event personally. 

Tax-Free Savings Accounts (TFSAs): This is the most flexible and tax-efficient pool of capital as there is no taxable event when the funds are withdrawn from the plan. The limitation is the amount you are able to contribute to a TFSA from one year to the next. 

MARGINAL TAX RATES MATTER 

If we have the opportunity to position your financial portfolio more efficiently without compromising your asset allocation, it would be logical to overlay a tax strategy on top of your investment strategy. 

For planning purposes, we focus on the applicable tax on your last dollar of income, known as your marginal tax rate. 

There are various tax thresholds where tax rates jump but none is more impactful than at about the $71,000 level where Old Age Security clawback commences. Essentially, for every dollar of net income over $71,000, a 15% clawback of OAS is applied, which is another form of taxation. The OAS benefit is reduced to zero when your net income equals or exceeds approximately $116,000 per year. 

CASE STUDY 

The following is a simplified planning scenario to demonstrate how we might put in place a tax effective strategy. Please note that is for illustrative purposes only. By simplifying, we are overlooking a number of important planning considerations. 

Profile: Single, age 66 and newly retired.

Income Required: $56,000 after tax, or about $70,000 before tax income. 

Available Pensions: $30,000 annually before tax (CPP, OAS and Employer pension combined). 

RRSP Portfolio: $500,000. 

Open Investment Account: $500,000 recently inherited a portfolio generating approximately $5,000 interest income, and $5,000 in dividends each year. 

Tax-Free Savings Account: $35,000. 

SOLUTION 

In this scenario, we would suggest the client commence receiving the three sources of pension income now forming the first layers of retirement income. The second layer would be formed by converting the RRSP to a RRIF and targeting to generate about $35,000 per year. The third layer of income would be derived from the Open Account in the form of interest income, which is approximately $5,000. Total estimated gross income: $70,000.

Since the income target has been met, the dividend paying component of the Open Account might be repositioned to purchase securities that do not generate dividends in order to avoid OAS clawback. This component of the portfolio would grow and accumulate. The TFSA is too small to provide meaningful income so it would be positioned for accumulation and growth. Annual contributions would be funded out of the Open Account. 

Strategic planning for retirement income should start well before retirement to increase your financial flexibility and ensure you have the most tax efficient plan available to you.