Retirement planning can seem extremely complex, with scores of complicated terms and acronyms.
But like most things that are complicated when you first look at them, they can become pretty straightforward once you understand the concepts.
This column will explain some basic concepts of tax planning and deferral, then get into the extra choices business owners (and ex-business owners) have to make. Over the next several weeks, we will take a look at specific RRSP and TFSA considerations, but today will focus on overall strategies.
A good basic strategy is to defer the taxable sources of income as long as possible, and instead draw on tax-free or partly taxable sources in the early years of retirement
Certain retirement income is fully taxable, including OAS, CPP, pension income, RRSP, RRIF and LIF withdrawals and any ongoing employment or net self-employment and rental income.
Other types of income are tax-free. These include withdrawals from TFSA accounts and withdrawals of capital from savings accounts, bonds and any other non-RRSP or RRIF investments. However, if any of these investments have gained in value, then half of the gain is taxable in the year the investment is sold or redeemed.
Other types of income can be considered partly taxable or taxed at a lower rate. These include dividends on shares of publicly traded corporations or private corporations and appreciated investments on which there are capital gains.
Private corporations might be operating companies involved in businesses or investment holding companies, which may be the result of a business owner selling the business.
A good basic strategy is to defer the taxable sources of income as long as possible, and instead draw on tax-free or partly taxable sources in the early years of retirement.
This means using non-registered savings and TFSAs instead of withdrawing from RRSPs and RRIFs (until forced to do this at age 71) and spending the dividends, interest and other taxable investment income sources on non-registered investments. These amounts are taxable whether spent or not, so they should be used for living if the alternative is to draw on an RRSP, RRIF or LIF.
The exception to the rule of avoiding taxable sources of income may be when you have an entitlement, such as OAS, CPP or a company pension plan. Some of these payments will increase if deferred, so make sure you are clear on the formula. It might be worth your while to wait, especially if you plan to live a long time, but it does mean your total value from these plans could be decreased if you pass away early.
Complicating things is every dollar of "net" income above $72,000 results in 15 cents of OAS denied. Dividends add disproportionately to the calculation of net income, even though the actual tax on dividends is disproportionately low.
Owners of private corporations may have options for income splitting among family if they have set up their ownership structure properly. Generally, the best strategy is to pay dividends from these corporations in order to pay out the retained earnings over time. If the shareholder dies with large retained-earnings balances in the corporation, this may result in double taxation.
The shareholder is deemed to have sold the shares on death, resulting in a capital gain. However, the retained earnings are still within the corporation, and a taxable dividend must be paid to the surviving shareholders if that value is to be removed and used. So consider spending that money before RRSPs and RRIFs.
Regarding RRSPs, there is no requirement to withdraw and pay tax until age 71. By the end of the year in which you turn 71, you must convert your RRSP into an RRIF or annuity and take income in the following year. The minimum is 7.48 per cent of the previous Dec. 31 value, in your 72nd year.
There is a lot more than I can put in a single column, so I encourage you to get some good advice to plan your retirement and do some reading. I happen to have written a great book on this stuff.
David Christianson, BA, CFP, R.F.P., TEP, is a financial planner and adviser with Christianson Wealth Advisors, a vice-president with National Bank Financial Wealth Management, and author of the book Managing the Bull, A No-Nonsense Guide to Personal Finance.