The Affluence Partners financial planning team works closely with our clients to develop forward looking tax strategies that can significantly reduce the amount of taxes you pay throughout your retirement. Lower taxes mean less of your money is needed to pay your taxes and thus provides an opportunity to both take on less risk while at the same time helping your dollars last much longer.
Canadian national debt is projected to rise to $683,000,000,000 by the end of 2020 and will continue climbing for years to come. The growing government debt will likely force personal tax rates higher in the future. Most Canadians save for retirement inside a Registered Retirement Savings Plan (RRSP), Registered Pension Plan (RPP) or Locked-In Retirement Account (LIRA) and every dollar that comes out of these plans is fully taxable as ordinary income. (The same rates as T4 employment income.) Many of the good savers find themselves paying more income tax in retirement than they did during their working years. Income taxes play a central role in determining how long your retirement fund will last.
Most of us think that Income Tax Preparation and Filing is Tax Planning. It is not. Tax preparation is what your accountant does to record history on your income tax return. Tax Planning is what you do today to create forward looking strategies to legally minimize the amount of tax you pay by taking advantage of opportunities presented in our tax code before the end of the calendar year to reduce the amount of tax you pay for the current year.
For instance, compare the retirements of twin brothers Josh and Adam. They both need $8,000 per month after tax income indexed at inflation to maintain their lifestyle in retirement. They both have saved the same amount of retirement dollars.
Josh did what most Canadians do and instead of embracing tax planning, he embraced tax preparation. Now in retirement, Josh's portfolio can sustainably provide him with a 100% taxable income of $10,733.92 per month, which will net him the $8,000 monthly cash flow he needs in the province of Alberta at an average tax rate of 31.39% to maintain his lifestyle. It is important to note that Josh's taxable income for the year will be $128,807 so, most of the age credit amount and Old Age Security (OAS) will be clawed back.
Adam on the other hand embraced tax planning while saving for retirement. By design, he only accumulated money in his Group RRSP equal to the company match so he could take full advantage of his employer RRSP matching program. Adam did this because he knew that these dollars would be 100% taxable when paid out to fund retirement. Beyond those dollars he accumulated money in both a non-registered account and has used all contribution room for his TFSA yearly since TFSA's came into being in 2009. As a result of his commitment to long-term tax planning, Adam's portfolio can sustainably provide him with two kinds of income. Adam's total cashflow per month will consist of both taxable and tax-free income streams. A taxable income amount of $5,852.33 per month and a tax-free income of $3,340 per month will net the $8,000 monthly cash flow he needs in the province of Alberta at an average tax rate of 20.37% to maintain his lifestyle. It is important to note that Adam's taxable income for the year will be $70,226 and his total draw on his retirement savings will be $110,307.96. Adam will suffer the same fate as Josh with the age amount credit claw back, however he has avoided the Old Age Security claw back completely with his good planning.
This means that Adam can match Josh's $8,000 net of taxes spendable monthly income goal with $18,499.04 less withdrawn from his retirement nest egg each year.
Whose money is likely to last longer during retirement? Obviously, it's Adam because the price tag on his lifestyle is much less because of tax planning. But that's not the whole story.
There is an even greater difference between the two.
Josh's plan is running at full speed to provide him the $8,000 net of tax income each month. He has no real wiggle room in his plan for additional unexpected expenses, so he'll have to include emergency savings in his monthly budget to be safe.
Adam on the other hand has some wiggle room. Due to his foresight and embracing of tax planning in the pre-retirement accumulation phase, his portfolio gives him the option of an additional and sustainable $8,200 of after-tax income per year for life which equates to an additional $683.33 after tax monthly top-up to save or spend whichever Adam chooses. Adam can comfortably spend his whole $8,000 net income knowing that he has reserves available, if necessary, to handle unexpected expenses.