How To Plan Your Retirement Income In Seven Easy Steps
Fee-for-service financial planner and founder of PlanEasy.ca
Planning retirement income is one of the most challenging aspects of a retirement plan. There are often multiple income sources of income to plan for, as many as 5+ for individuals, and as many as 10+ for couples. These income sources also “phase in” at different times throughout retirement.
Here are some of the most common sources of retirement income…
- Government pensions like…
- CPP (Canada Pension Plan)
- OAS (Old Age Security)
- Defined benefit pensions
- Registered accounts like RRSP/RRIF
- Locked-in registered accounts like LIRA/LIF (and Defined Contribution Pension Plans)
- Government benefits like GIS
- TFSA accounts
- Government pensions like…
Understanding how much income to expect from each of these income sources can be a challenge. They may start at different times in retirement, they may also increase with inflation or not.
On top of understanding how much income these different sources may provide it’s also important to understand how they’re taxed. Some of these income sources are taxed differently. Some are also eligible for income splitting at different points in retirement. This income splitting is a distinct tax advantage for couples and shouldn’t be ignored.
In this post we’re going to look at the seven most common sources of retirement income and some of the planning considerations to keep in mind when planning your retirement income.
Warning: Because of the complexity when planning retirement income it’s impossible to fully highlight all the nuances for each of these sources of retirement income in one post. If you feel uncomfortable planning your retirement income then please speak with a professional (ideally an advice-only financial planner) about building a custom retirement plan. Understanding the phasing of retirement income sources, the tax implications, and the possible government clawbacks on benefits like GIS is well worth the money.
Step 1: OAS Income
OAS income is probably the easiest government pension to plan for because it’s simply based off years of residency in Canada. Anyone with over 40-years of residency or citizenship between ages 18 and 65 will qualify for the maximum amount.
It is possible to delay OAS, potentially all the way until age 70, but this only makes sense in some cases. When OAS is delayed there is an “actuarial adjustment” that increases the future OAS benefit, making OAS started at age 70 exactly 36% higher than when started at age 65.
Because of the small adjustment (relative to delaying CPP, which would provide +42%) this makes delaying OAS a bit less attractive. It can make sense to delay OAS in certain circumstances but many of us can simply plan to take OAS at age 65.
Step 2: CPP Income
CPP is unfortunately a bit more difficult when it comes to planning your retirement income. CPP benefits are based on your contributions between age 18 and when you begin CPP (between age 60 and age 70). It matters how many years you’ve contributed and how much you contributed each year.
If you start CPP at age 60 you need at least 35-years with maximum contributions to get the max CPP. If you start CPP at age 65 you need at least 39-years of maximum contributions.
Most people will not receive the maximum CPP.
This gets more complicated because there are certain “drop out” provisions that allow a retiree to drop low earning years. The general drop out provision allows 17% of low income periods to be dropped. Plus the child rearing provision allows low income years to be dropped when caring for small children.
You can get an estimate of your future CPP benefits from your myCRA account but be warned that the CRA assumes you’ll keep working until age 65 and you’ll keep earning your average annual income. They also do not include any special drop out provisions like the child rearing drop out. For anyone retiring early, or who has experienced an increase or decrease in income, or who’s had low income years while caring for children, this estimate can be very misleading.
In most cases it’s a good idea to get a professional to estimate CPP if you’re more than a few years away from retirement.
Delaying CPP is another option to consider when planning your retirement income. The “actuarial adjustment” is +8.4% for each year CPP is delayed after age 65 to a max of 5-years or +42%. Most people choose not to delay CPP for any number of reasons… but the fact is that delaying CPP can be very attractive in certain circumstances. Delaying CPP can significantly improve the long-term success rate of a financial plan in many situations so definitely consider delaying CPP.
In our case, because both my wife and I do not have defined benefit pensions, our plan is to delay CPP as long as possible to get the highest inflation adjusted government pension we can.
Step 3: Defined Benefit Pension Income
A defined benefit pension is an amazing source of retirement income, especially when a pension is indexed to inflation. Defined benefit pensions have a number of benefits that should be considered when planning your retirement income.
The first benefit is when a pension is indexed to inflation. This is extremely important because over time a non-indexed pension will lose value. This may not seem important but when retiring at age 55, 60, 65 there is a long retirement period to plan for. This makes inflation a very important factor. When a defined benefit pension is not indexed to inflation we need to plan additional savings/investments to help close this gap.
Another benefit is when a DB pension provides a bridge benefit. A defined benefit pension typically provides a “lifetime” pension amount that will continue from the first day of retirement until death. Then some pensions also provide a “bridge” benefit from retirement until age 65. When planning retirement income it’s important to plan for when the bridge benefit disappears.
The last unique planning opportunity for those with a defined benefit pension is income splitting. Couples have a unique advantage when receiving a DB pension in retirement. This income can be “split” at a younger age than other types of retirement income. This can help save thousands in tax each year.
Step 4: LIRA/LIF Income (Including Defined Contribution Pensions Too)
Locked-in accounts like the LIRA/LIF are a bit more complex and when it comes to retirement income planning have some special rules that you should be aware of.
Defined contribution pensions also fall into this category because they’ll often be converted to a LIRA/LIF after leaving an employer.
Planning retirement income from a locked in account is slightly more difficult because assets within the account can only be withdrawn once converted to a LIF (with some exceptions, like the unlocking rules). The LIF (life income fund) has both a minimum annual withdrawal and a maximum annual withdrawal.
How much you choose to withdraw each year will ultimately be based on other aspects of your plan (like tax planning). At the very least you can plan to withdraw the minimum each year. But sometimes it can make sense to draw down a locked in account faster than the minimum annual withdrawal to make those funds more accessible and maximize TFSA contribution room each year. However, sometimes this can trigger higher marginal tax rates so plan LIRA/LIF income carefully.
Step 5: RRSP/RRIF Income
RRSP/RRIF income is quite flexible. It’s possible to draw from the RRSP at any point in time. This makes it helpful for early retirees who may need to wait 10, 15, 20+ years before starting government pensions like CPP and OAS.
Withdrawals from an RRSP/RRIF are taxed at your marginal tax rate. In many cases the withdrawals from an RRSP/RRIF can be planned strategically to lower overall income tax in early retirement.
Thanks to the flexibility of the RRSP any amount can be withdrawn each year, from $0 to the entire account. No matter how much you withdraw make sure to plan your income tax accordingly.
At some point retirees will convert their RRSP to a RRIF. The RRIF has a minimum annual withdrawal. The last age to convert an RRSP to a RRIF is the calendar year you turn 71. This will begin mandatory minimum annual withdrawals the following year when you’re 72.
Even though age 71 is the last possibly year to convert an RRSP to a RRIF there are many advantages to converting early.
- Unlike RRSP withdrawals, minimum RIF withdrawals are not subject to withholding tax
- Unlike RRSP withdrawals, RRIF withdrawals are not subject to partial deregistration fees at many financial institutions (but not all, some still charge $25 to $100!)
- RRIF income is eligible for income splitting after age 65, a possible advantage for couples.
At the very least you’ll need to make the minimum annual RRIF withdrawal each year. This is the base level of retirement income you could expect from a RRIF but in many cases the minimum isn’t the right amount.
Step 6: Government Benefit Income (GIS/GST Credit etc)
Over 1 out of 3 retirees will receive some form of government benefit in retirement. This could be GIS, GST/HST credits, provincial benefits like the Trillium Benefit in Ontario etc. etc.
Some government benefits like GIS can be quite generous but come with a very high “clawback” rate. This clawback rate means that government benefits like GIS are reduced by 50% to 75% of each extra dollar of income. This income includes CPP, pensions, LIF withdrawals, RRSP/RRIF withdrawals, employment income etc etc. One exception is OAS income. OAS income does not impact GIS benefits.
A $5,000/year CPP benefit will reduce GIS by at least $2,500. This makes it very important to plan retirement income in a way that minimizes these clawbacks. A little bit of planning in the 5-10 years before retirement can save tens of thousands in lost benefits.
How many people does this impact? Millions. Approximately 1/3rd of seniors receive some GIS benefit. That means one in three retirees is being impacted by these high clawback rates.
Step 7: TFSA Income
The last source of retirement income to plan for is the TFSA. When planning retirement income the TFSA is often the last account we want to draw from. The TFSA has many advantages and one is that it can continue to grow into retirement. In many cases this makes it very advantageous to maximize the TFSA each year as new contribution room becomes available. This could be done by drawing more from registered accounts to maximize the TFSA (this does not make sense in all cases, especially when on the edge of a higher marginal tax bracket).
The result is often that the TFSA continues to grow in retirement. This can provide assets later on in retirement after RRSPs/RRIFs/LIFs have been exhausted. This can also provide assets to support higher spending for in-home care, extra medical expenses, or long-term care.
Other Sources of Retirement Income
Of course there are other sources of retirement income. Each income source below has its own tax rules and drawdown rules. Plus, for survivor benefits like the CPP survivor benefit, there could be a reduction in this survivor benefit when CPP is started.
For example, a retiree may also need to plan for income from…
- Non-registered investment income
- Canadian Dividends
- Foreign Dividends
- Capital Gains
- Interest Income
- Annuity income
- Etc etc
- CPP survivor benefits
- Defined benefit pension survivor benefits
- Deferred profit sharing plans
- Employment income
- Self-employment income
- Non-registered investment income
How To Plan Retirement Income
Planning retirement income is one of the most challenging aspects of a retirement plan. There are often multiple income sources to plan for, as many as 10+ for couples. These income sources also “phase in” at different times throughout retirement.
For example, if retiring at age 55 there may be heavy withdrawals from registered accounts like the RRSP/RRIF/LIF in early retirement. These withdrawals may be reduced as government pensions like OAS and CPP begin. OAS may start at age 65 and CPP at age 70.
This phasing in of government pensions could require larger withdrawals from RRSP/RRIF/LIF while a retiree waits for these government benefits to begin. It’s important to understand how quickly these accounts are being drawn down during that period. We don’t want to reach age 65 having nearly depleted investment assets.
It’s also important to plan taxes on retirement income. Different sources of retirement income will be taxed differently. Depending on the circumstances it’s possible to minimize the impact of taxes and minimize the impact of government benefit clawbacks.
When figuring out how to plan retirement income it can be beneficial to hire a professional to help put together the initial plan. At PlanEasy we create pre-retirement plans at a very reasonable cost. This reduced cost reflects the fact that a retiree often has a much simpler financial situation with little debt, no dependents, and a good sense of savings/investments.
Don’t plan retirement income alone, get a bit of help to ensure you make the most of your hard-earned savings & investments!
Financial planner, personal finance geek and founder of PlanEasy.