Reducing taxes can go a long way in helping clients save for retirement. Here’s how to make it happen.
For low- to mid-income earners, consider the tax-free savings account (TFSA). In lower tax brackets, the registered retirement savings plan (RRSP) deduction isn’t worth as much — it gets less bang for the buck. And at withdrawal time for a TFSA, there’s no tax slip – so if clients are still lower-income earners during their retirement years, they’ll be more likely to receive increased government benefits.
Also, lower-income earners, especially younger clients, often like the liquidity of the TFSA. What happens if they need to withdraw money for a vacation, car, home or for an emergency? When they take money out of a TFSA, they’re not taxed (unlike a withdrawal from an RRSP).
RRSPs are a sound option, especially for higher-income earners. Ultimately, the pros and cons of a TFSA versus an RRSP contribution may depend on whether a client’s tax bracket in retirement is lower or higher than it was when the client made the initial contribution. Another consideration involves Canadians working past age 65 and even into their 70s, who could be in a higher tax bracket when withdrawing money from an RRSP (not an ideal situation).
- ASSET ALLOCATION
As a client approaches retirement, it may be beneficial to put assets taxed at a higher level into tax-sheltered accounts. This might mean allocating bonds primarily to RRSPs and TFSAs, because interest is fully taxable. Clients with remaining RRSP or TFSA contribution room after purchasing all their bonds could then consider buying stocks. Just remember to take care when allocating foreign stocks that pay dividends inside a registered account. The ability to claim the withholding tax on foreign payments is lost when held inside an RRSP or TFSA. For this reason, it’s sometimes beneficial to hold foreign stocks that pay dividends in non-registered accounts, allowing clients to maintain the ability to claim a foreign tax credit on their Canadian tax returns.
As a general rule, it’s a good idea to hold Canadian dividend-paying stocks and investments that generate capital gains in a non-registered account, since these have preferential tax treatment.
- INCOME SPLITTING
For higher-income earners, income splitting — redirecting income within a family unit — can be one of the most powerful tools for families to reduce their tax burden and keep after-tax dollars in their hands (versus more of their income going to the Canada Revenue Agency).
Income splitting opportunities permitted under current legislation include, but aren’t limited to:
- Opening a TFSA for all family members over the age of 18
- Loaning funds at the prescribed rate of interest to a spouse1
- Making a gift to an adult family member
- Having the higher income earner pay family expenses
- Using the benefits of a registered education savings plan (RESP) or registered disability savings plan (RDSP)
- Investing child tax benefit money in the child’s name
- Pension splitting with a spouse
- Loaning money to a spouse to produce business income
Encourage clients to consult with a tax expert before committing to any of these or other options.
- RETURN OF CAPITAL PROTECTION
In the non-registered investment environment, clients may want to consider using annuities and segregated fund contracts with guaranteed income (for their return of capital features and protection for longevity risk). Along with being tax efficient, they can offer insurance protection.
- TAX-LOSS SELLING
From a tax perspective, if a client holds an investment that’s lost value at the end of the year in a non-sheltered account, it might be a good idea to sell it. The loss can reduce capital gains on other investments. It can also be carried back up to three years, or carried forward indefinitely. Encourage clients to talk with a tax expert to learn more.
If a client’s business can qualify as a small business corporation in Canada, incorporating it can give clients the ability to access the small business corporate tax rate. Other advantages of incorporating include:
- Limited liability
- Tax deferral and control of personal income payments
- Income splitting opportunities
- Access to the small business deduction
- Access to the lifetime capital gains exemption
- OAS CLAWBACK
In retirement, a popular tax-minimization goal often becomes avoiding clawbacks of Old Age Security (OAS). Because TFSA withdrawals aren’t considered taxable income, they don’t affect clients’ eligibility for OAS. For example, for 2018, if clients receiving the OAS have income over $75,910, the government will claw back some of their OAS benefit, and the benefit completely disappears at the $122,843 annual income level.
Clients can use non-registered investments — T-series, annuities, segregated fund products — with return of capital features to help with OAS clawbacks. If clients have significant pension income or a lot of money in RRSPs that need to be converted into a registered retirement income fund (RRIF) or annuity, there may not be much they can do to minimize the OAS clawback.
Consistently monitoring clients’ taxable income each year helps ensure government benefits aren’t clawed back.
LESS TAX CAN MEAN MORE RETIREMENT MONEY
Clients today need more income-producing assets in retirement than previous generations, especially because they’re living longer.2 RRSPs are often the first choice because they provide upfront deductions and deferred taxation, but other good options are available.
With regard to tax planning, encourage clients to do it regularly (consider at least an annual review). Most government benefits in Canada are income-tested, so if clients can plan tax efficiently for retirement, they’ll be more likely to maximize their overall retirement income and send less money to the government.
Use these resources to help in your client conversations:
- Which investments can reduce your tax bill? – Simple explanations about how clients’ choice of investments can affect how much tax they pay
- Where to stash your cash: RRSP or TFSA? – An overview of the tax advantages associated with each option
- RRSP calculator – A tool to show clients how changes to their RRSP contributions can affect their retirement savings
- Retirement savings calculator – A tool to show clients how making adjustments to their retirement income sources can help achieve their retirement savings goals
- Saving for retirement when interest rates are low – Insight into low interest rate environments, including 5 recommendations for clients to consider
To learn more about tax and retirement planning strategies, contact your Sun Life Wealth Sales Team.
1 Spouse also refers to common-law partner.
2 The average Canadian reaching 65 years old in 2013 can expect to live until 87, which is about five years longer than the life expectancy of the average Canadian reaching 65 in 1970. This means that many retirees face the challenge of stretching their retirement savings over a longer lifespan than their parents and grandparents did (Financial Consumer Agency of Canada, June 2016).