Money management for retirees comes with plenty of mixed advice, especially when it comes to strategically spending your money to manage tax payments. If you have multiple pools of money to draw from, you might be tempted to choose those that help you avoid paying as much tax as possible. While many financial advisors have recommended paying low taxes in the early years of retirement, taking a mixed approach can create more significant savings in the longer term. In this article, we’ll explain why.
Why a Mixed Approach Is Best
The traditional wisdom for retirement income is to leave tax-deferred accounts untouched for as long as possible, allowing them to reach their maximum growth. This leads many retirees in their 60s to focus on using other savings accounts first, allowing them to pay little or no tax in those early years. While paying less tax is an excellent strategy in the short term, it can leave you reeling from tax bills in your 70s and 80s.
Here is where the main issue arises: At age 71, Canadians must begin to withdraw from their RRSPs, which is considered income and taxable. By this age, most Canadians will also be collecting their pensions, which is also taxable. Suddenly, they’re faced with higher than expected income tax bills due to the sudden increase in annual income. This is why many financial advisors recommend that their clients use a mixed approach for managing retirement income. The goal should not be to reduce taxes on a year-to-year basis but should focus on the larger picture of reducing overall lifetime taxes.
Types of Accounts
Deferred Tax Accounts
A tax-deferred account means that you avoid paying tax on that money right away when you contribute to these accounts. Instead, you defer the payment. Later on, when you withdraw from that account, you will be subject to income tax on your withdrawals. In Canada, the most common tax-deferred account is a Registered Retirement Savings Plan (RRSP). Canadians can contribute money to their RRSP until they turn 71. Once they’ve reached the age limit, they must withdraw their cash or roll it over into an annuity or a Registered Retirement Income Fund (RRIF).
Canadians can contribute a limited amount to RRSPs on an annual basis. Going over the annual limit is allowed but comes with financial penalties. The owner of an RRSP can withdraw from the account at any time, but the withdrawn funds will be subject to income tax payments.
Tax-Free Savings Account
The Tax-Free Savings Account is a more flexible account that Canadians can use to save money. The accounts are tax-free, meaning that the amount contributed is not subject to tax, nor are the withdrawals. TFSAs have maximum yearly contribution limits, but they do a rollover, meaning if you don’t hit the maximum limit in one year, the remaining amount gets added to the following year. Account-holders can also withdraw money from their TFSA at any time.
Old Age Security
Old Age Security or OAS is a government pension financed by Canadian tax dollars. The OAS is a monthly retirement benefit for any Canadian who is 65 years of age or older. Canadians can choose to defer their benefit to receive higher monthly payments later. The monthly payment is determined by the age of the recipient and their income level. The OAS benefit is considered income and is subject to income tax.
Withdrawals on Rotation
The balanced approach for managing income from retirement accounts involves rotating where you withdraw your money. If you have both a TFSA and an RRSP to rely on, we may advise that you use both to balance the amount of tax you’ll pay (depending on your situation). Once you begin collecting your pension, you’ll still be able to balance withdrawals from your accounts and save money in the long term.
Retirement Financial Planning in Edmonton
At Regan Schiller & Associates Private Wealth Management, we provide our clients with investment strategies, tax organization, and retirement planning for their financial goals and aspirations. You can request an appointment with our advisors, and we’ll be happy to discuss the strategies best suited for your unique needs.
This is a general source of information only. It is not intended to provide personalized tax, legal, or investment advice, and is not intended as a solicitation to purchase securities. Regan Schiller is solely responsible for its content. For more information on this topic or any other financial matter, please contact a Consultant from Regan Schiller & Associates Private Wealth Management.