Three strategies to maximize income and minimize tax.
With the end of the year fast approaching, retirees will want to consider all the tax planning opportunities to maximize their retirement income.
Maximizing tax credits and minimizing claw-backs are the foundation of efficient tax planning, however there are a number of other crucial strategies you need to consider before December 31st. Let's take a look at a few of these retirement planning strategies.
Tax Loss Harvesting
If you have non-registered investments with unrealized capital losses, you may want to consider triggering these losses to offset capital gains from the current year, or net capital gains in any of the three previous years.
For retiree's, implementing tax loss harvesting will help to "reset" your non-registered accounts without needing to pay tax out of pocket. A few of the key benefits from implementing tax loss harvesting include:
Adjusting your cost base and decreasing the tax liability on future withdrawals.
Freeing up "tax paid" investments that can then be used to top up the TFSA in the new year.
Minimize tax paid during retirement and to your estate.
While this strategy is generally executed during a market downturn ( hmmm 2020 sound familiar?) there are still merits to reviewing your accounts on an annual basis to capture the benefits of tax loss harvesting.
While this all sounds great, be sure to watch out for the "Superficial Loss Rules." In simple terms, this rule dictates that you cannot repurchase the same investment within 30-days of triggering a capital loss.
This is easily avoidable by purchasing an investment with the similar exposure to an asset allocation or industry sector.
De-registration of Registered Assets
This strategy involves accessing additional funds from registered accounts (RRSP, RRIF etc.) in excess of what is needed for a regular retirement income.
Now you likely have some income from various sources including CPP, OAS, RRIFs, pensions etc. Tallying all of these incomes together and estimate your total taxable income.
Depending on your marginal tax bracket, it may make sense to "de-register" funds from your taxable accounts to bring your income up to the next tax bracket.
You are probably asking... why do I want to pay more tax now? Hear me out.
Have a look at this scenario using Saskatchewan marginal tax brackets.
Retiree 1: Has a $500,000 PRIF. On an annual basis, she withdrawals $30,000 from the account. She also receives $15,000/year between OAS and CPP. Her taxable income is $45,000.
She has no other assets so if she needs a lump sum in retirement, she will need to pull additional money out of her PRIF and in turn increasing her Marginal tax rate. Additionally, as she is single, her estate will pay nearly 50% ($250,000!!!) in tax at her passing.
Retiree 2: All the same facts as Retiree 1, however, with advice from her advisor she decided to “de-register” an additional $5,000 from her PRIF (Up to her next marginal tax rate) and rolled the after tax amount into her Tax-free savings account.
Yes she paid some tax, however, now she is building an additional pool of TAX PAID dollars within her TFSA. Another massive benefit, when she passes, her estate tax will be significantly reduced as the taxable accounts have been "de-registered" and flipped into a TFSA.
Sounds pretty good right? Here are the benefits laid our in crayon:
Minimize the tax in the long term and to your estate.
Maximize liquidity for the expected and unexpected expenses.
Added control of your registered assets before age 71! When your RRSP converts to a RRIF you loose control of your minimum withdrawals.
Optimize income and reduce the impact of the Old Age Security claw back.
Prescribed Rate Loan to Your Spouse
Another consideration is loaning funds at the prescribed rate to your spouse, directly or indirectly through a family trust, to invest in non-registered funds. These loans are an excellent financial planning tool and are one of the few income splitting strategies that remain for many Canadian families.
The first key hurdle this loan overcomes is the "attribution rules." In short, this is the Government of Canada's way of ensuring tax is paid on gifts made to a spouse or adult child.
Now it is a bit more complicated than this, so if you want some more detail please click the link above.
Ok with that out of the way, here is an example of how it works:
Paul and Joan are married. Paul is in the top tax bracket while Joan has no taxable income.
Paul has $500,000 to invest, but instead of investing the money himself, Paul loans Joan $500,000 at the current prescribed interest rate and properly documents this loan. Joan invests the funds.
Assuming the prescribed rate at the time of the loan is 2%, each year prior to January 30th Joan pays interest of $10,000 to Paul. In this example, Paul would be taxed on the annual interest income of $10,000, while Joan would be entitled to deduct the $10,000 of interest expense as the funds were used for investment purposes.
Joan would also be taxed on all income and realized gains generated by the investment portfolio. As Joan has no other sources of income, she would need to earn over $10,000 of interest income, $20,000 in capital gains or $50,000 in eligible dividends, net of the interest deduction, before incurring any Federal tax liability (whether there is a provincial tax liability depends on Joan's province of residency).
As Paul is in the highest tax bracket, the prescribed rate loan strategy results in a lower overall tax obligation for the family.
If the prescribed rate decreases to 1%, and Paul and Joan implement a prescribed rate loan subsequent to that decrease, interest of only $5,000 (instead of $10,000) would have to be charged and paid, and thus, $5,000 more could be taxed in Joan's hands at her lower marginal tax rates.
Any income splitting strategy, including a prescribed rate loan, is most beneficial when there is a significant difference between the marginal tax rates of family members and there are substantial funds available to lend and invest.
When considering a prescribed rate loan, many factors should be evaluated such as the expected investment performance as well as tax implications. Be sure to consult with a professional.
Here are a few other strategies to consider for you year end tax planning. I will try and cover a few more of these strategies in another blog post.
Pension income splitting with spouse
Maximizing your tax credits and deductions
Planning for disabled individuals
CPP & OAS issues
Taxes are one of the few things we actually can somewhat control when it comes to financial planning... unlike others (I'm looking at you investment portfolio)
Make a plan this fall and save yourself some tax.
Besides, do you really want to leave CRA a tip?
Written and published by Michael Isbister, IG Private Wealth Management as a general source of information only, believed to be accurate as of the date of publishing. Michael Isbister is a CERTIFIED FINANICAL PLANNER professional in Saskatchewan. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on up to date withholding rules and rates and on your specific circumstances. Trademarks, including IG Wealth Management and IG Private Wealth Management are owned by IGM Financial Inc. and licensed to its subsidiary corporations.