This post will delve into ten strategies that retirees or those nearing retirement can employ to reduce their tax burden. Note that the following list isn’t exhaustive and doesn’t follow a specific order of importance:
1. Spousal RRSP Contributions: In Canada, due to the progressive tax structure, two retirees each earning $50,000 annually pay significantly less in taxes than one earning $100,000 alone. A recommended approach to equalize retirement incomes and enjoy tax benefits is through contributions to spousal RRSPs. A spousal RRSP allows one partner to contribute while the other is the legal owner. There’s also the possibility to keep contributing during retirement if one plans on doing part-time or consulting work. Always be mindful of the attribution rules when making withdrawals from these accounts.
2. Strategic Withdrawal Order: To maximize tax deferrals in retirement, it’s useful to follow a withdrawal hierarchy from various sources. This sequence can help improve after-tax retirement income:
- Guaranteed income sources (e.g., employment income, CPP/QPP, OAS, employer pensions)
- Investment income from investment holding companies
- Non-registered account of higher-income spouse
- Non-registered account of lower-income spouse
- LIF of lower-income spouse
- RRSP/RRIF of lower-income spouse
- LIF of higher-income spouse
- RRSP/RRIF of higher-income spouse
However, this order isn’t fixed and might need adjustments based on individual circumstances.
3. Optimizing Investment Income: For better after-tax retirement income, investments generating Canadian dividends, capital gains, or return of capital are more tax-efficient. Note that equity-based investments come with their risks. It’s often advisable to hold fixed income in an RRSP/RRIF and equities in a non-registered account.
4. CPP/QPP Sharing: Couples can share up to 50% of their individual CPP/QPP retirement benefits to reduce their collective tax liability. This is especially beneficial when one partner has a higher income and a greater CPP/QPP benefit.
5. Prescribed Rate Loans: An effective income-splitting tactic involves the higher-income partner lending money to the lower-income partner at a prescribed interest rate, thus enabling the borrower to invest without facing income attribution rules.
6. Utilizing Extra Assets: By assessing one’s financial plan, retirees can identify and channel their surplus assets more effectively. Two popular options include purchasing a tax-exempt life insurance policy and gifting surplus assets to family members.
7. Prescribed Life Annuities: For conservative investors unsatisfied with their fixed income from traditional assets, a prescribed life annuity can be an appealing choice, ensuring a consistent tax-effective retirement income.
8. Leveraging RRSP/RRIF Withdrawals: This involves withdrawing from an RRSP/RRIF and simultaneously obtaining an investment loan for non-registered investments. The interest on this loan is tax-deductible, helping to counterbalance the tax from RRSP/RRIF withdrawals. This strategy carries risks and is best suited for those with a longer investment horizon and higher risk tolerance.
9. Minimum RRIF Withdrawal: If you have sufficient pension and non-registered assets to cover most of your retirement expenses, you might only need to withdraw the compulsory minimum from your RRIF, LIF, or PRIF annually. A few tactics to maximize tax deferral within an RRIF include basing the minimum withdrawal on the younger spouse, converting the RRSP to an RRIF by the end of the year one turns 69 but delaying the first withdrawal until the next year, and withdrawing the annual minimum as a lump sum at the year’s end.
10. Tax Bracket Management: Being aware of your tax bracket and making withdrawals and investments that keep you in a favorable bracket can result in significant tax savings.
Remember, these strategies are general guidelines. It’s always a good idea to consult with a tax professional or financial advisor to ensure the best approach for your personal circumstances.
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