Tax-efficient retirement strategy options for Canadians

Shall we increase our RRIF payments while I am still working and since we are in a low/no tax bracket? Whatever we do not need, we would just reinvest into our TFSAs; we still have room. We would like to wind down our taxable investments in the most tax-efficient manner. Your thoughts?

—Carol 

Withdrawal strategies and taxes for Canadian retirees

This is a layered question involving income, retirement, self-employment and savings. Carol, without additional information I’m not able to give you a proper answer. So, instead, let me give you a few things to think about as you work through this yourself or with a financial planner.

First, “to wind down our taxable investments in the most tax-efficient manner” can mean three things: 

• minimizing the final tax on your estate,
• creating a tax-efficient retirement income,
• and/or maximizing the wealth transfer to your children. 

It is possible that one approach will accomplish all three objectives, but it’s very unlikely. It’s more likely that each objective requires a different wind-down strategy, with different consequences, which I’ll illustrate with a few simple examples.

How to minimize tax on an estate

Minimizing or eliminating tax on your estate suggests a spending or gifting strategy. Taking it to the extreme, your only remaining investments at death should be in tax-free savings accounts (TFSAs) with a named beneficiary and possibly a life insurance policy. Everything else should be spent or gifted.

This strategy may mean paying more tax than necessary while living, and it may also mean losing out on some tax credits and government benefits.

Creating a tax-efficient retirement income strategy is easy

Don’t start registered retirement income fund (RRIF) withdrawals until age 72. Only draw the minimum amount based on the younger spouse’s age. Split your pension income, and put surplus RRIF income into a TFSA if there’s room.

However, the problems with this (extreme) strategy are that you’re in danger of dying with too much money and you risk letting tax dictate your lifestyle. So, you’re not doing the things you want to do. Plus, when you die, your estate pays the largest tax bill of your lifetime.

Gifting children an estate when you’re alive

Maximizing the wealth transfer to your children before you die sometimes means paying more taxes personally as you’re drawing from taxable accounts and gifting to children. There’s a risk of gifting too much, running out of money and reducing your lifestyle to quell those fears.

Registered investment taxes in retirement

Those were three extreme, broad examples of how to wind down taxable investments, but there’s a missing piece.

Carol, you have to start by identifying the lifestyle you want, the income required to live that lifestyle and how much money is enough. With that you can construct a tax-efficient income and, doing as you suggest, make extra RRIF withdrawals to contribute to TFSAs.

Once your TFSAs are topped up, the question is what to do next, if you continue to draw extra from your RRIF. Gifting to children or investing in non-registered accounts? If you have more than enough money, then gifting to children or charities may be the best option, but does making extra RRIF withdrawals to contribute to non-registered investments make sense? 

Think about the full investment life cycle when you draw money from a RRIF to make a non-registered investment. 

The money comes out of the RRIF and is taxed, leaving less money to be reinvested in a non-registered account. Every year, you earn interest and/or dividends and pay capital gains tax, reducing your investment growth. Your taxable income may be higher, thereby reducing access to tax credits and benefits. And, upon your death, there are likely capital gains tax and probate fees to be paid. 

Leaving money in your RRIF means a larger amount to grow and compound, the distributions aren’t taxed, and with a named beneficiary there is no probate. 

Withdrawing from a RRIF for tax savings

The only way to really know whether you should draw extra from a RRIF to make non-registered investments or you should leave the money in your RRIF is to compare the after-tax value received by by your beneficiaries. The results will be influenced by marginal tax rates over time, investment types and your lifespan.

Carol, creating a tax-efficient withdrawal strategy involves in-depth calculations you may not be able to do yourself. The good news is that if you take the time to identify the lifestyle you want and its costs, that will point you in the right direction and probably provide you with at least 75% of your solution. 

Allan Norman provides fee-only certified financial planning services through Atlantis Financial Inc. and provides securities-related business through Aligned Capital Partners Inc. (ACPI). ACPI is regulated by the Investment Industry Regulatory Organization of Canada (IIROC.ca). Allan can be reached at atlantisfinancial.ca or [email protected].

Read more from Ask A Planner:

• How much to take out of your RRSP in your 60s
• Financial gifts: What you need to know before giving money or investments
• Financial planning in your 70s
• The tax implications of gifting adult children money and more

About Allan Norman, MSc, CFP, CIM

With over 30 years as a financial planner, Allan is an associate portfolio manager at Aligned Capital Partners Inc., where he helps Canadians maintain their lifestyles, without fear of running out of money.

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