Retirement Income:

Start With RRSP, Non-Reg or TFSA?

Owen Winkelmolen

Fee-for-service financial planner and founder of PlanEasy.ca

When it comes to generating an income in retirement things can get very confusing, very fast. During your working years you probably have one, maybe two, sources of income, typically a paycheck that arrives every 2-weeks, in retirement however you will likely have 5-10 different income sources coming every month.

A typical retiree will have both CPP and OAS payments in retirement (unless you’re extremely high-income and your OAS is entirely clawed back), plus a typical retiree will also have some investments in an RRSP, TFSA and non-registered account to draw from. Add to that pension payments from a defined benefit pension or maybe a defined contribution pension that was converted into a LIRA/LIF, and we’re up to 6 income sources already. Then we have to add additional payments from government benefits like the federal GST/HST credit, Guaranteed Income Supplement (GIS), and provincial benefit programs like the Trillium benefit in Ontario. Some of these arrive monthly, some quarterly, some just once per year.

And if that wasn’t confusing enough, each income source has its own tax and benefit claw back rules too.

For example, RRSP, CPP, OAS and pension income are all taxed at 100% of your marginal tax rate, but capital gains are taxed at 50% your marginal tax rate, and at some income levels dividend income has a negative tax rate!

Then you have TFSA withdrawals which have no tax at all, and most government benefits are tax-free as well!

All those different income sources naturally create a lot of different strategies to on how to drawdown your retirement assets in the most efficient manner…

Some people believe that drawing down their RRSPs first is the best strategy. Others believe drawing down non-registered assets first makes more sense. There might even be a few people out there who think that drawing down their TFSA first is best.

But the best way to create retirement income and drawdown your retirement assets is actually to mix them all together. Like an expert baker, the key is to mix retirement income sources in just the right proportions to get the best result. The tricky thing is that the exact proportions will depend on your specific situation, how much you have in each account, and how much retirement income you’re trying to create each year.

How much is planning your retirement income worth? How about $100,000 or more in reduced income tax! Even low- and mid-income seniors can benefit from strategic retirement income planning to help them avoid GIS claw backs, which can easily be worth $1,000’s per year.

At the end of this post we’ll show you 7 different withdrawal scenarios’. The difference between the best and the worst is over $328,490 in today’s dollars.

First, a bit of background on why we want to mix retirement income…

 

 

Paying Zero Tax In Retirement

Is it possible to pay zero tax in retirement, or at least part of retirement? Absolutely it is.

The key is to mix retirement income in just the right proportions.

Let’s consider an example where we have a couple who has $1,000,000 and wants to retire early at age 50. They each have $200,000 in RRSPs (this could be LIRA too), $200,000 in non-registered assets, and $100,000 in TFSA. When we add up each account they have $500,000 each for a total of $1,000,000. They have no pension but can expect to receive reduced CPP at age 60 and full OAS at age 65.

Our fictional couple is already good at tax planning so they hold Canadian equities in their non-registered account, US equities in their RRSP, and international equities and bonds/fixed-income is spread across their RRSP and TFSA.

Our couple already knows that eligible Canadian dividends have a negative tax rate at low and moderate income ranges. Because our couple lives in Ontario, any dividend income under $47,000 per person has a marginal tax rate of -6.86% (thank you dividend tax credit). That means every $1,000 in eligible Canadian dividends will lower their tax owing by $69. That’s right, the more dividend income they receive, the lower their tax payable.

With enough eligible Canadian dividends, our couple will pay zero tax each year. But we don’t want too many dividends because these are non-refundable tax credits, so unless we have other income to offset, these tax-credits will disappear each year.

 

 

Best Strategy Is To Mix Retirement Income Sources

As you’ll see in the examples below, drawing down just one type of asset isn’t the best strategy because we might be leaving non-refundable tax credits on the table each year. The best strategy is to mix retirement income sources to use up these non-refundable tax credits every year. To ensure that we maximize the dividend tax-credits we want to plan a mix of different income sources in retirement.

In most cases we can mix income sources proportionately to ensure we pay the minimum amount of tax. This could be pension payments, RRSP/RRIF withdrawals, LIRA/LIF withdrawals, GIC interest, bond interest etc.

In our example, our couple also has a large amount of registered assets in RRSPs. When these assets are withdrawn, they’ll trigger income tax at their marginal rate. Every year our couple can withdraw a certain amount from their RRSP to maximize their non-refundable tax credits and still pay zero tax.

If our couple plans their RRSP withdrawals strategically they will pay zero income tax from age 50 all the way until age 70. Twenty years of zero tax even though they’re spending $50,000/year in today’s dollars.

Even when CPP starts at age 60, and OAS starts at age 65, the tax credits are enough that our couple still pays zero income tax. Only when non-registered assets are fully depleted at age 70 do they start to pay a small amount of income tax each year.

Of course, every situation is different. Dividends aren’t the same each year, the proportion of assets in each account won’t be the same, CPP and OAS will be higher/lower etc. etc. They key thing to keep in mind is that drawing down one type of asset before another is rarely the best strategy. Often the best strategy is to mix income sources in retirement to minimize taxes and maximize government benefits.

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Seven Different Retirement Income Strategies To Generate $50,000/Yr:

Disclaimer: The scenario’s below are examples only and should not be used for planning purposes. Even small changes in timing, asset values, mix of assets, rate of return, government benefits etc can have a large impact on income tax and government benefit strategy. If you’re unsure about the best way to generate retirement income given your unique situation then we recommend you speak with an advice-only financial planner.

 

 

Best Scenario: Hybrid Withdrawals from Non-Reg, RRSP and TFSA to Maximize Non-Refundable Tax Credits

  • Total After-Tax Income From Age 50 to 100: $2,550,000
  • Total Income Tax Paid: $56,858
  • Estate Value After Tax: $1,794,571

*Totals above are in today’s dollars, values in graph are in future dollars.

Sub-Optimal: Non-Reg, then RRSP, then TFSA

  • Total After-Tax Income From Age 50 to 100: $2,550,000
  • Total Income Tax Paid: $100,039
  • Estate Value After Tax: $1,591,310

*Totals above are in today’s dollars, values in graph are in future dollars.

Sub-Optimal: Non-Reg, then TFSA, then RRSP

  • Total After-Tax Income From Age 50 to 100: $2,550,000
  • Total Income Tax Paid: $193,437
  • Estate Value After Tax: $1,466,565

*Totals above are in today’s dollars, values in graph are in future dollars.

Sub-Optimal: RRSP, then Non-Reg, then TFSA

  • Total After-Tax Income From Age 50 to 100: $2,550,000
  • Total Income Tax Paid: $56,530
  • Estate Value After Tax: $1,583,061

*Totals above are in today’s dollars, values in graph are in future dollars.

Sub-Optimal: RRSP, then TFSA, then Non-Reg

  • Total After-Tax Income From Age 50 to 100: $2,550,000
  • Total Income Tax Paid: $76,040
  • Estate Value After Tax: $1,516,971

*Totals above are in today’s dollars, values in graph are in future dollars.

Sub-Optimal: TFSA, then Non-Reg, then RRSP

  • Total After-Tax Income From Age 50 to 100: $2,550,000
  • Total Income Tax Paid: $193,460
  • Estate Value After Tax: $1,466,480

*Totals above are in today’s dollars, values in graph are in future dollars.

Sub-Optimal: TFSA, then RRSP, then Non-Reg

  • Total After-Tax Income From Age 50 to 100: $2,550,000
  • Total Income Tax Paid: $100,274
  • Estate Value After Tax: $1,466,081

*Totals above are in today’s dollars, values in graph are in future dollars.

Owen Winkelmolen

Financial planner, personal finance geek and founder of PlanEasy.

New blog posts weekly!

Tax planning, benefit optimization, budgeting, family planning, retirement planning and more...

New blog posts weekly!

Tax planning, benefit optimization, budgeting, family planning, retirement planning and more...

4 Comments

    • Owen

      Thanks for your comment Garth! You’re of course referring to the fact that dividends are already taxed at the corporate level and the integrated tax rate between corporations plus individuals is not negative. While this is true, from a personal financial planning perspective its important to recognize that different types of income are taxed differently, and at some income levels this tax rate can actually be negative for an individual. By taking this into account we can actually make things easier for clients and plan to pay less tax (often the largest expense for a retiree).

      Reply
      • Garth

        I just think that too many people prefer dividend income over interest income or cap gain income because they think there is a tax advantage. Corporate tax is paid on behalf of the shareholder and should be considered equivalent to individual income tax. It is as if you paid the tax yourself.

        Reply
        • Owen

          I agree Garth! Great point. Investors definitely shouldn’t chase dividends just for the sake of the dividend tax credit.

          Reply

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