Managing income streams tax efficiently
Many people on the cusp of retirement are wondering whether they’ll outlive their retirement nest egg. Even those with hefty savings tucked away in Registered Retirement Savings Plans and Tax-Free Savings Accounts have expressed their concerns to me about becoming destitute in advanced old age and have thus decided to delay CPP and OAS payments while putting off RRSP maturity until the very last possible day of the year in which they turn 71. Is this really necessary? When should you turn on the retirement income taps, and how long will your money really last?
It’s true that people are generally living longer. Better living standards, improving health care, and advances in pharmaceuticals have all contributed. According to Statistics Canada, between 1921 and 2005, average life expectancy at birth rose substantially in Canada, from 59 to 78 years for men and from 61 to 82 years for women. That’s an average, of course. Any retirement residence will tell you they have a high proportion of residents, mainly women, well into their 90s. Interestingly, the age gap between men and women was less than two years in 1921. But that gap steadily widened over the next 50 years to more than seven years in 1976, but gradually narrowed to fewer than five years by 2005.
And longevity is increasing. Those advances in medical science and healthcare I mentioned continue stretch average life expectancy. For example, at the top end of the scale, the number of centenarians is growing every year. The 2011 Canada census counted 5,825 people age 100 years and older, compared with 4,635 in 2006, and 3,795 in 2001.
Basically, people are living 20 to 30 years after age-65 retirement.
But very often, with advanced biological age comes both physical and mental infirmity. While some nonagenarians enjoy full mental and physical vigour (for their age), they tend to be the exception. Most will need to rely on third-party care of one kind or another, and here’s where retirees express the most concern.
As you age, costs of care rise, and the question of long-term care can become a problem. Will you be able to afford to stay in your home? Will the income from your savings and pensions cover your expenses? So how do you start enjoying your retirement while still providing for care in later life?
Layering assets for income
Retirees who have a long-established financial plan and have saved and invested through their careers probably now have assets that can be layered to produce both enough income and enough growth to see them through their old age. There are a few basic principles to be aware of.
Be tax efficient. The rule of thumb is that in most cases, you should start withdrawing from your non-registered funds first and then deplete your RRSPs and TFSAs. Other people may also have an employer pension plan that may provide an additional income stream.
Should you delay CPP and OAS? Some retirees consider deferring Canada Pension Plan benefits until age 70, thus increasing the ultimate monthly CPP payment received. Likewise, some may wait to convert their RRSP into a Registered Retirement Income Fund (RRIF) or an annuity until the year they turn 71, when conversion is mandatory and minimum withdrawals are based on a formula set by the government.
However, that could put some retirees into an even higher tax bracket down the road. Consider a couple who have each accumulated about $500,000 in their RRSPs. If they were to start withdrawing monies from a RRIF at 71 and the RRSPs were earning a 5% return indexed at 2.5%, they would each need to withdraw about $36,900 annually. If they each have annual pension income of, say, $30,000 and CPP of $13,000, they would have a gross family income of about $160,000. And they’d have to pay some fairly serious tax on that, to say nothing of having their OAS clawed back to zero.
So in this case, they may want to consider taking CPP benefits and converting their RRSPs to RRIFs at age 65, so that they’ll pay less tax and perhaps salvage at least something of their OAS. Meanwhile they should continue contributing the maximum to their TFSA each year to provide fully tax-free growth and income down the road.
© 2019 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited. This article is for information only and is not intended as personal investment or financial advice.