common question from a retiree is, “How do we best withdraw
income from our investments?” This is a very important issue
that needs careful consideration as the wrong strategy will
result in the retiree paying too much in taxes and exhausting
their life savings or having to reduce their lifestyle spending.
strategy that is often recommended to retirees is the tax
deferral method. This method results in deferring taxes as
long as possible. This deferral allows the retiree to maximize
the growth of their investments and maintain their nest egg
The Tax Deferral Method
retirees have various sources of income, such as pension plans,
their own RRSP's/RRIF's, spousal plans and non-registered
accounts. By selecting the proper sequence to draw upon these
accounts, a retiree can maximize their current after-tax income,
and help to maintain their wealth as long as possible. The
tax deferral method will not only provide the retirees with
the largest nest egg for themselves, but also the largest
process is to select the accounts that will produce the income
required for the retiree at the lowest possible tax rate.
The Optimal Draw Down
recommended sequence to withdraw retirement income follows.
Income—The first source for retirement
income would be any pension incomes such as employer pensions
and government pensions including Canada Pension Plan (CPP)
and Old Age Security (OAS).
Assets—if the pension
incomes do not provide an adequate income source, the first
assets to be redeemed are the non-registered assets that a
retiree may own. The reason being is that the income taken
is not all taxable, since part of the income is made up of
the retiree’s own capital. The redemption order is based on
► Marginal Tax rate of Spouses
- The optimal drawdown is based on each spouse’s current and
future tax brackets. Normally, the assets withdrawn first
are those of the spouse that has the lowest marginal tax rate,
followed by the higher marginal tax rate spouse’s assets.
► Order of the Investments/Assets
–The sequence for non-registered assets is to first withdraw
the highest ratio of cost base to market value. This is to
reduce any capital gains taxes on the selling of assets to
produce the income. To break any ties the rate of return is
used, with the lower yielding assets being redeemed before
higher yielding assets. This process is to defer capital gains
for as long as possible.
the income available is still not enough, the next source
of income is the registered assets. For retired couples, the
normal order for withdrawing an income is:
► The spouse with the lower marginal tax rate, followed by
► The spouse with the higher marginal tax rate.
there is a tie based on tax rates, the assets are redeemed
in order of their total return from lowest to highest.
entire process is used to forecast income and assets over
the retiree’s lifetime and needs to be updated annually based
on the most current spending requirements and tax situation.
Tax Allocation of Investments
important feature of this strategy is to place investments
in the accounts so that they attract the least amount of taxes
today. For example, this would mean that any fixed income
type of investments, such as bonds or GICs should be placed
in RRSP or RRIF accounts and the investments that generate
the most tax effective gains such as equities or equity mutual
funds should be placed in non-registered accounts.
type of tax savings can also be accomplished in non-RRSP accounts,
by having the spouse with the lower marginal tax rate own
the interest income investments, and the higher income spouse
owning the equities/equity mutual funds that generate tax
preferred income such as capital gains.
impact of other assets such as downsizing a house in the future,
selling a cottage property or the expected costs of a long-term
health care facility can be incorporated into the planning
process. It is important that the process be customized to
each retiree’s unique situation.
most important part of retirement income planning is that
it is a continuing process and not a one time event. Each
year the income plan has to be updated to reflect any changes
that may occur. The changes may include personal aspects such
as changes in spending habits, health changes, special plans
(i.e. trips) and investment aspects such as asset allocation
re-balancing or a review of tax changes. A systematic review
at the beginning of each year based on current goals and objectives
will help the retiree feel more comfortable with their retirement
income regardless of what happens in the stock market.
The information contained in this commentary is designed
to provide you with general information only, and is not intended
to be comprehensive advice applicable to the circumstances
of any individual. We strongly urge you to seek professional
assistance before acting upon information included herein.