Like the generation entering it today, retirement in Canada has changed. Less than 40 per cent of Canadian workers have a registered pension plan; there is no longer one standard age of retirement; and, increasingly, retirement itself lasts longer. Individual responsibility for retirement is greater than ever before, and the mechanics and options for how to retire are more complicated.
For many people nearing, entering or in retirement, registered retirement savings plans (RRSPs) and tax-free savings accounts (TFSAs) are as much a part of their lives as are seniors’ discounts and driving glasses. Deciding whether, how much and when to contribute to an RRSP or TFSA is no easy task, nor is deciding when and how much to withdraw. The considerations are different for everyone.
To make contribution decisions pre-retirement, experts recommend understanding how much income you’ll need in retirement. “As a rule of thumb, you’ll need somewhere between 60 to 70 per cent of your current take-home income in retirement,” explains Graham Heron, regional tax leader at MNP LLP. This assumes certain expenses – like mortgage payments, childcare and work-related items – won’t exist in retirement. “On the other hand, you’ll have a whole bunch of extra time on your hands and if your hobbies are on the more expensive side, maybe 60 to 70 per cent won’t be enough.”
Understanding your current burn rate – how much money you actually spend – is vital to knowing what you’ll need in the future. “It doesn’t have to be onerous but it’s really fundamental to retirement planning – knowing what your cash needs are on a monthly basis,” says Judi Meyer, CFP and senior financial planning consultant at Scotia Wealth Management.
Don’t overlook irregular expenses. “One should definitely consider major, infrequent expenses (major house repairs, dental costs, etc.) as well as routine monthly expenses,” advises Doug Chandler, a Canadian retirement research actuary with the Society of Actuaries. Heron agrees, particularly in relation to later in retirement. “Medical costs and care, assisted living – those costs can be fairly substantial and can become a very significant concern in your late 70s or 80s.”
Inflation is a factor many underestimate. “People often mistakenly look at CPI and the Bank of Canada indication of 1.8 per cent and believe that’s their inflation rate,” says Meyer. “But in Calgary our inflation rate is closer to three per cent.” At this rate, she says, the purchasing power of the dollar is cut in half every 24 years. “Inflation really erodes buying power over time.”
Increasing lifespans also affect how much is needed in retirement – in 2014 the average life expectancy of a 65-year-old Canadian man was 87.1 years and 89.4 years for a Canadian woman. “Many of us underestimate our lifespan,” says Meyer. “For a 65-year-old couple today, there is a one in four chance that one spouse will live to age 94.”
When determining whether to put money marked for retirement into an RRSP or TFSA, Heron recommends comparing the tax rate now to that in retirement, since an RRSP is taxable income when withdrawn. If the marginal tax rate is expected to be lower in retirement, put the money in an RRSP. “You’ll get the tax deduction and an absolute savings because the deduction will be at a rate that’s equal to or greater than the corresponding rate when you pull the money out.”
On the other hand, all experts agree on the power of TFSAs. “TFSAs are an excellent savings tool and can be used long and medium term,” Meyer says. “For many people they’ll be the first line of order for savings.” Heron highlights their usefulness for retirement planning. “TFSA accounts are the biggest change to retirement income planning in decades. The eligible contribution for TFSAs continues to grow and as of 2017 the eligible contribution into this savings option will be $52,000 and will continue to grow at $5,500 per year subject to future government changes.”
So what should a retiree draw on first? As with contributions, it depends on a person’s circumstances but in general, Heron advocates an approach that first looks to government programs – Canada Pension Plan (CPP) and old age security (OAS) – to determine how much of retirement income needs are met by these programs, and go from there.
One important consideration, especially for upper-middle-income individuals, is the income threshold for the OAS clawback, which in 2016 was $73,756. “As soon as your taxable income in retirement exceeds the clawback threshold, for every dollar you earn over that threshold you have to forfeit $0.15 or 15 per cent of your OAS receipt,” Heron explains. While not typically a huge component of retirement income, OAS is not unsubstantial. “If you can preserve it as a base level item in your retirement income, the better off you’ll be at preserving the rest of your capital for that 25-year retirement span,” he says.
When you withdraw your RRSP – early or late – can be critical. For those with a large pool in their RRSP, deferral of withdrawals until the mandatory age of 71 could help to keep income levels below the clawback threshold. On the other hand, early withdrawals of small amounts (for example, $2,000 per year from age 65 through 71) is another strategy. “That $2,000 will be considered pension income and eligible for the pension income credit,” says Heron. “It will effectively come out at a very marginal tax, or no tax, but it’s also dropping that pool of required income that will come out after you turn 71.”
In addition to the OAS clawback, Chandler notes other income-tested benefits and tax credits that start at age 65, all of which suggest the RRSP should be used first. In addition to the Alberta Seniors Benefit there is phase-out of the federal and Alberta age amount tax credits, the GST rebate and the new Alberta carbon rebate. “It might even make sense to continue to add to a TFSA with extra RRSP withdrawals after retirement,” he says.
Money withdrawn from a TFSA doesn’t show up on the tax return and thereby has no effect on income-tested benefits. “It could be your rainy-day fund,” says Heron. “If you’re drawing money from your RRSP and are below the OAS clawback and then something comes up – your furnace needs to be replaced or you need to buy a new vehicle – pulling the money from your TFSA is a better place to pull it from. I generally would be reluctant to draw on the TFSA until I was worried about the OAS clawback.”
Chandler agrees, noting delaying CPP benefits can also help. “For some seniors who have paid off their mortgage, the CPP and OAS benefits payable at age 70 might cover their routine expenses, leaving TFSAs for vacations, unexpected expenses and (maybe) an estate.” Meyer adds, “For those with a long lifespan, seriously consider delaying CPP benefits. Compared to age 65, you get a 42 per cent bump to age 70, whereas it’s a 36 per cent reduction to age 60.”
On the other hand, Chandler says, if the strategy is to maximize income-tested government benefits after age 65, then drawing CPP early at age 60 can reduce taxable income. “Once again, individual circumstances like life expectancy and ability to manage money each make a difference.”
Not an uncomplicated exercise by any means, for Calgarians thinking about or in retirement there are many things to consider. Both RRSPs and TFSAs are powerful tools and when used correctly can make for a comfortable retirement. Understanding where one is at, and where one would like to go, is the key.