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Susan Wood. I’m the director of wealth strategies with CIBC Private Wealth.
So clients are often confused about the various pools of funds that they have. In general, the following approaches to fund cash flow can be considered and I’ve broken it into three different steps, three different pots that you would look to from in order.
So step one, which would be to look at your after tax cash flow that you will have from these various sources of income, which could include employment income. Even if you are still working, you may have some employment income, which is kind of an ever growing trend that we see. Other income may include government income, such as CPP or OAS, maybe some pension income that we talked about. If you’re over 71, you may have some mandatory receipts or payments from your RRIFs or your RRSPs, and you will have potentially some investment income, including rental income. And interest in dividend income, which is often more variable than fixed on your non-registered funds.
So once you’ve kind of looked at the total of that in any given year, your lifestyle expenses may be expected to be greater than the total of that sum. And if that’s the case, then you want to go kind of to your next pot on your next step in order to withdraw funds from your other assets that are still more tax efficient than the third pot, but perhaps less than step one. So generally it’s best to first redeem from assets that attract the least amount of tax such as capital dividends from your private corporation. They can be withdrawn tax free, or if you have a shareholder loan that’s due to you in your private corporation, it also can be withdrawn tax free. Additional sources you could look to your tax free savings account for tax free withdrawals. The other place to go to for tax efficient funds are your non-registered assets beginning with those investments that may have the lowest approved gains, often little or no taxes payable.
Finally, taxable dividends from your private corporation if you have one, because these are generally taxed at a preferred rate. And then finally, if you still have need for further funds, I would go to the third pot of funds and look to the following assets, which, if you deplete them, are probably the least tax efficient. And these include your lump sum drawings from your RRSP or your RRIF, because these are fully taxable. So these would be drawings that are in excess of your mandatory minimum. And then also payments from your locked in registered plans, again, above and beyond the mandatory income. These amounts, too, are fully taxable.
A couple of additional details regarding your registered in corporate funds, as it relates to RRSPs and RRIFs. For many of our wealthier clients, drawing down on their RRSPs can be deferred until age 72, because they have other funds available to them that they can draw on to sustain their lifestyle needs. If you can do so, I would encourage you to defer drawing on these assets for as long as you can, so that they benefit from the compound tax deferred growth in the registered plan. The only exception to this may be at age 65. If you have no other pension income that is eligible for the $2,000 pension tax credit, you could consider converting a portion of your RRSPs to RRIF to generate only enough pension income to allow you to claim the full $2,000 pension tax credit annually.
So keep in mind, this represents an annual tax savings of about $300, but over the seven year period between age 65 and age 72, that represents a total of $2100 in total tax savings or for a couple potentially $4,200. Another comment I’d make about TFSAs in particular. So other clients with substantial non-registered and corporate financial assets who may not need the assets in their TFSAs will do well to leave these assets to grow on a tax free compound basis for as long as they can. As tempting as it may be to use this account for tax free funds, leaving these assets growing on a tax deferred basis compounded over your lifetime will likely maximize the after tax value of your estate. And perhaps more importantly, the after tax amount that can flow to your beneficiary.
Final comments that I’d make as it relates to corporate investments. If you do have investments in a personal corporation that cannot be taken out tax free, either because there’s no positive capital dividend account balance and no shareholder loan that can be repeated from the corporation, it is generally advisable to draw down on any personal non-registered assets first and retain any funds not required for lifestyle needs in your corporation to take advantage of the tax deferral – particularly if these corporate funds were generated from an operating business and subject to low tax rates at the time that it was earned, this will allow you to have more control over your personal taxable income, and may also allow you to reduce your estate’s probate taxes if you are employing a dual will strategy, if for instance, you are an Ontario resident or perhaps a BC resident.