Is what a client of mine asked this week during a review meeting of her retirement plan. I don’t blame her for thinking that she was to defer paying taxes as long as possible because it’s often recommended that retirees draw income from low- or nontaxable income sources first, such as Tax-Free Savings Accounts (TFSAs), and minimize withdrawals from income sources taxed at their marginal rate, such as Registered Retirement Savings Plans (RRSPs) and Registered Retirement Income Funds (RRIFs).
While this is often good advice, there is no definitive withdrawal sequence that applies to everyone. As a retiree, some of the best financial planning advice you’ll need is around the order and timing of asset withdrawal; you’ll need to consider your personal situation, your tax rates at various times throughout your retirement and your upcoming financial needs. Here are some common reasons why:
You may have a retirement income gap.
Many people retire prior to their employment pension or government pension kicking in. So, in these “gap years” your income may be lower than it will be in the future. In this instance, it may be worthwhile to draw retirement income from your RRSP, rather than your TFSA or via the sale of securities.
By making a RRSP withdrawal during a gap year (rather than from low or non-taxable sources) you may be unnecessarily triggering taxes – but on purpose. You would do this if your tax rate today is lower than it will be in the future (after you begin receiving your pension), therefore generating more after-tax dollars – in other words, keeping more money in your pocket instead of the CRA’s. Further down the road, after you convert your RRSP to a RRIF, because you made RRSP withdrawals earlier, all else equal, your RRIF assets will be lower and therefore your mandatory RRIF withdrawals will also be lower, which can further lower your tax bill.
You may have inconsistent retirement income
Not everyone’s retirement income will be as smooth as a guaranteed pension. Taking on occasional work, or starting another career in retirement can result in relatively volatile year-over-year income. While planning ahead is not always easy, if a contract is coming up “next year” or a lump sum payment for a job will soon be paid out, consider smoothing
your year-over-year income by coordinating uneven employment income with investment withdrawals. Smoothing your income can help avoid one-off years with high income
generation and higher taxes. While it may mean pulling income forward and paying more tax today, in the long run it can lower your overall taxes.
Your income needs may vary from year-to-year
Drawing income from your investments is often driven by your needs (or wants, let’s be honest), rather than solely providing steady income to cover the bills. You may be planning to buy a cottage, take a long vacation or complete a big home renovation. You might also be looking to help out your children, or make a significant charitable donation. In these instances, withdrawing the funds over multiple years, rather than in one lump sum, could help lower your taxes. Similar to coordinating retirement employment income with investment withdrawals, smoothing your year-over-year income to fund longer-term objectives can also help save taxes.
Now you are in-the-know with Word on the Street.
Enjoy the weekend,
Investment & Wealth Advisor