Helping your clients to save enough for retirement is only the first step; once your clients retire, they need to get their savings working in the most efficient way possible. Although there are many strategies available to do this, one size does not fit all. So, you need to look at each client’s unique circumstances.
A major consideration is the order in which a client’s assets should be liquidated. Conventional wisdom says that non-registered assets should be depleted first so that registered assets continue to grow tax-free; however, this tenet is being challenged.
“Every situation has to be assessed individually,” says Daryl Diamond, president of Diamond Retirement Planning Ltd. in Winnipeg.
The problem is that if clients wait until they are 71 years old to establish a registered retirement income fund (RRIF), the required minimum withdrawals could result in clawbacks to your clients’ old-age security benefits and/or push your clients into a higher tax bracket. Couples are particularly vulnerable because when one of them dies, the registered assets usually are transferred to the survivor, thus significantly increasing his or her taxable income when mandatory payouts occur.
Diamond and other financial planners, including Barbara Garbens, president of B.L. Garbens Associates Inc. in Toronto, say that you need to develop a plan for clients for drawing from their savings in retirement about five years in advance. The emphasis needs to be on how to generate the cash flow that your clients will need – which can mean both a change in asset allocation and a shift in assets among accounts, including withdrawing some RRSP assets.
“Cash flow” refers to the amount a client is spending, not his or her total income. So, the plan should start with determining the total income – in the form of pension income, government benefits and RRIF withdrawals – that the client is certain to receive. This provides a baseline for the client’s minimum taxable income.
Key in establishing the baseline is the client’s age when his or her RRIFs are set up. Projections need to be run to see what the mandatory RRIF withdrawals will be if the RRIF is set up at these different ages. If waiting until age 71 could trigger OAS clawbacks, it may be better to begin withdrawals earlier – or start withdrawing RRSP assets before the client stops working. It also could mean that the client should stop making RRSP contributions before he or she retires.
Many clients who are approaching retirement may be well advised to take an amount out of their RRSPs each year that will result in pushing them near but not into a higher tax bracket, Diamond says.
The next step is to look at how much the client wants to spend, then figure out the most tax-efficient way to generate the required cash flow over the client’s lifespan.
To do that, you need to scrutinize the types of investments held within the client’s savings plan. For example, dividend-paying stocks are excellent investments in the accumulation period because of the dividend tax credit. But, says Garbens, dividends are grossed up by 38% in calculating the dividend tax credit – and the grossed-up amount is what is used in calculating taxable income. Thus, too much dividend income could push your client into clawback territory or into a higher tax bracket.
If your client is married or in a long-term relationship, another important tool to consider in a retirement income plan is income splitting. Any type of pension income – except for government benefits – can be split between married or common-law spouses at age 65 or older. (If your client receives income from a workplace pension plan, this can be split at any age.)
Income splitting opens the door for various strategies. For example, a non-working spouse could withdraw assets from a spousal RRSP before his or her partner retires and pay little in taxes. Then, in retirement, the total RRIF withdrawals can be split between the spouses. Depleting the spousal RRSP shouldn’t be a problem as long as there are no concerns about a marital breakdown.
However, there’s an important caveat, says Alan MacDonald, director of wealth management with Richardson GMP Ltd. in Ottawa: withdrawals from a spousal RRSP are taxable in the hands of the spouse making the contributions until three years after the final contribution.
Another strategy is to sell some of the non-registered assets to the spouse with the lower taxable income using a prescribed loan, says Carol Bezaire, vice president for tax and estate planning with Mackenzie Financial Corp. in Toronto. That will mean that the income from those assets is taxed in the hands of the lower-income spouse.
Capital gains taxes are due at the time of a sale of assets. But if a prescribed loan is used, these taxes can be paid over five years. Prescribed loans are low-interest loans made between non-arm’s-length parties, including family members.
As much money as possible should be put into tax-free savings accounts. Income not needed for cash flow or transfers from non-registered accounts are two possible sources.
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