Hello everyone and welcome to the Retiring Canada Podcast. In today’s episode, we're going to discuss tax-wise decumulation in retirement.
Specifically, we are going to cover:
A simple example of how decumulation works
The nuances of personal finances
A counterargument to this planning strategy
The true number at the bottom of your statement
Lastly, a few action items for you to consider
I hope everyone had a wonderful Christmas break with their friends and family!
In today’s episode, I will discuss the decumulation phase that retirees face as they enter and go through their retirement years. The sound of decumulation might make you think about withdrawing funds from your retirement nest egg to a point where you end up running out of retirement funds.
Now, quite obviously, when you create a retirement start date and income plan, your goal isn’t to run out of money. Rather, you want to preserve your principal as best you can, ensure your income keeps pace with inflation, and arguably, most importantly, mitigate the taxes you pay during this stage.
I have spoken numerous times on this podcast about the years leading up to retirement and the potential tax valley opportunity that pre-retirees need to take full advantage of. The purpose of doing all this pre-planning is to prepare your finances for the next stage – tax-wise decumulation.
Now, taking a step back and discussing what this means at a high level: I am referring to a retirement income and tax plan that is forward-thinking – 5, 10, even 30 years out into the future – to help you optimize your income today while not losing sight of your golden years and ultimately your final estate.
At an account level, this involves a drawdown strategy on your registered accounts like your RRSP, RRIF, and LIRA accounts while factoring in your spouse’s income and the start dates of your government pensions, to name a few.
The end goal of this planning is to reduce the tax burden captured in these registered accounts and shift tax-paid funds to tax-free and tax-efficient accounts over time.
This kind of planning can’t be done in one year; rather, it’s an ongoing process that ebbs and flows with your personal finances. If done correctly, the amount of lifetime tax paid on your retirement nest egg can be minimized, and the devastating final estate tax on registered assets can be mitigated.
Now, as with any financial planning strategy, there is no one-size-fits-all solution. While this may make sense for some, others may not benefit in the same way.
Let’s go through a simple example to discuss this strategy, how changes in your circumstances can impact the annual tax planning, and one counterargument to implementing this planning strategy.
To lay some groundwork, this kind of tax-wise decumulation makes the most sense for individuals and couples who have over approximately $500,000 in things like RRSP and LIRAs. The more registered assets you and/or your spouse hold, the more value this level of
planning can provide.
Let’s assume you and your spouse have just entered retirement and each of you has $500,000 in registered assets, so $1 million dollars in RRSP. You have no debt and only require a modest amount of income from your RRSPs to sustain your lifestyle. You are both 65 and receiving CPP and OAS, and between these two pensions, your household receives about $3,500 pre-tax a month in government pensions. If we assume you need an additional $4,000/month pretax from your registered accounts, this brings your monthly pre-tax income up to $7,500 or $90,000 pre-tax a year to sustain your lifestyle.
Assuming things are split evenly, this is $45,000 of taxable income per spouse.
We now come to the main part of this strategy: The decision is should we A) only draw what is needed, allowing the registered accounts to defer and grow, or B) do we optimize our tax brackets and draw additional funds out of the registered accounts at a low marginal tax rate?
At our firm, we are strong believers in the latter – optimizing tax brackets – and here’s why.
First off, if we assume our hypothetical couple lives in Alberta, If we raised their taxable income from $45,000 each to $57,000 each in 2025, they would still be in the lowest marginal tax bracket assuming no other incomes or deductions.
Second, this couple could then use these additional after-tax dollars paid at a low marginal rate to top up TFSAs or non-registered accounts. These accounts represent tax-paid dollars that could help fund future lump sum purchases or income needs – giving this couple more flexibility in the future – rather than being reliant on fully taxable RRSP accounts for lump sum purchases.
Third, if we do nothing, sooner or later, the government will force withdrawals from registered accounts at age 71, when the full RRSP must be converted to a RRIF. There may be a scenario where the required minimum withdrawal from the accounts could actually push this couple into a higher tax bracket altogether.
The fourth reason we prefer this strategy, especially for couples, is the ability to balance income between the two. If one spouse dies prematurely, the full registered accounts would now be in the surviving spouse’s name. It’s at this point where OAS clawbacks for the now-widowed spouse can be a major issue.
As a refresher, the OAS clawback is an effective 15% tax on income earned over the clawback threshold, making our retiree one of the highest marginally taxed individuals in Canada.
Lastly, the reason why we like this strategy is to disinherit the Canada Revenue Agency from your estate as much as possible. In our example, if we do not properly manage taxes on a go-forward basis, this hypothetical couple could pay upwards of 50% tax on their RRSP or RRIF at last passing. You can do the math on what a 50% tax rate does to a $1 million-dollar RRSP portfolio.
Now, the counterargument to this strategy would be to defer additional withdrawals from the RRSP or RRIF account as much as possible and not manage taxes. While the compounding effect of money is very real, and the more money that stays invested rather than going to pay tax, the more these accounts will grow… but who benefits from this growth the most?
YOU or CRA? Are you okay with losing some or all of your OAS pension, an effective 15% additional tax? How about to your estate… how does it benefit you to pay CRA 50% tax on an even larger taxable number? Or does it make more sense to slide the scale down on your registered accounts tax-efficiently over time while sliding the scale up on your tax-free and tax-efficient accounts?
We all have to pay tax; there is no way to avoid it, but you do have a choice and some control over when and how much the government will receive.
I’ll leave you with this: Would you rather have $1,000,000 tax-paid and tax-efficient dollars or $1,500,000 in taxable money? Sometimes we forget that the number at the bottom of the statement doesn’t tell the complete story – and it’s a matter of tax.
Okay, so that will do it for today! Here are your action items for today’s episode:
If you hate tax as much as I do, I encourage you to scroll through my podcast catalog and check out a few relevant episodes, specifically Episode 34, which discusses the near 50% tax to the estate of the last surviving spouse.
Take out your last investment statements and do a hypothetical scenario. Add up the value of all of your household’s RRSPs, LIRAs, Defined Contributions pensions, and multiply this number by 0.5%... an assumed 50% marginal tax. That’s the tax bill if both you and your spouse were hit by the proverbial bus today.
If you then add in things like capital gains tax on non-registered accounts, vacation properties, rental properties, or land, you start to get a sense of who your largest estate beneficiary may be – the CRA.
Retirement planning strategies must be reviewed and considered on a case-by-case basis. I have come across scenarios where deferring registered accounts was, in fact, the optimal decision based on the household’s personal scenario. Personal finance is just that – personal.
If that number shocks you, it’s time to check out our website.
Okay, that will do it for today’s episode.
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All comments are of a general nature and should not be relied upon as individual advice. The views and opinions expressed in this commentary may not necessarily reflect those of Harbourfront Wealth Management. While every attempt is made to ensure accuracy, facts and figures are not guaranteed, the content is not intended to be a substitute for professional investing or tax advice. Please seek advice from your accountant regarding anything raised in the content of the podcast regarding your Individual tax situation. Always seek the advice of your financial advisor or other qualified financial service provider with any questions you may have regarding your investment planning.