Creative Retirement Tax Strategies
The number of effective tax-saving strategies is only limited by your creativity. There are more effective strategies, but I believe these are the 6 most effective that almost anyone can do.
Your goal is to receive the cash flow you need for your desired retirement lifestyle, while paying the least possible tax on it.
You can effectively decide your own taxable income. You can plan to be in low tax brackets, avoid the clawbacks, and possibly qualify for GIS.
You have many tools to use in creating strategies. Your tools include your mix of RRSPs and TFSAs, deciding how much to withdraw from your RRIF, TFSA and investments each year, investing tax-efficiently for deferred capital gains or dividends, using tax-efficient withdrawal strategies such as SWPs, using T-SWPS to defer capital gains, deferring CPP and/or OAS to age 70, starting CPP early at age 60, deciding on the best time to convert your RRSP to RRIF, accessing your home equity, contributing to your RRSP or cashing in some RRSP before you retire, and the 8-Year GIS Strategy.
If you had a salary all your life, you may have had limited tax deductions or tax saving strategies. When you retire, it is completely different. You have many options, especially if you plan for them before you retire.
This article originally appeared in the January 2018 issue of the Canadian MoneySaver .
Retirement Calculator: How We Got Here
Our free calculator predicts your retirement nest egg, and then estimates how it would stretch over your retirement in todays dollars, taking inflation into account. Our default assumptions include:
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A 3% inflation rate.
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Salary increases of 2% per year.
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A 5% rate of return in retirement .
Enter your age, income, current savings and monthly savings rate to see how you’re doing. If you wish, you can enter more details in the Optional settings, such as your expected rate of return before retirement and what you expect from Social Security . You can also fine-tune your retirement spending level, retirement age and more.
Defer Converting Your Rrsp To Do The 8
You can get up to $10,500/year of Guaranteed Income Supplement tax-free from age 65 to 72, if you have no taxable income other than OAS. You can still receive non-taxable income, such as from your TFSA or investments.
This is a cool strategy if you have enough in your TFSA or non-registered investments to give you income for these 8 years. You could plan for this by cashing in some RRSP before you turn 65 to maximize your TFSA or build up non-registered investments.
You could also get income by withdrawing from a secured credit line on your home during these 8 years.
To qualify, you could delay converting your RRSP to an RRIF until the end of the year you turn 71. You can also delay starting your CPP until age 70.
You could also make a large RRSP contribution before age 65 and defer the deduction until you need it during these 8 years to give you the maximum GIS.
At age 72, you have to start withdrawing from your RRIF, but you will still receive GIS for one more year since it is based on the prior years income. You will likely lose some or all of your GIS after that.
Deferring CPP to age 70 means you get 42% more CPP for the rest of your life. Delaying converting your RRSP gives it an extra 8 years to grow, during which time it could nearly double.
The 8-Year GIS Strategy can mean you have a much more comfortable retirement after age 71.
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Start To Protect Your Income By Using A Diversified Retirement Plan
While you’re saving for retirement, it’s important to diversify your assets among different types of investments to help reduce your exposure to market risks. The same principle holds true for taking income in retirement: Creating an income plan that includes money from different sources can help you cover the expected, and unexpected, risks that can come with retirement.
There are a number of ways to create diversified retirement income. Combining at least a few of the sources that are listed in the following chart can help you better protect your income from the risks that retirement may bring.
The assets listed in the chart above can be included in a healthy, diversified retirement portfolio. If you include several asset classes in your long-term portfolio, the upswing of one asset class may help offset the downward movement of another as conditions change.
Two Ways To Implement This Plan
Now that we know this information, lets take a closer look at two ways you can use this to your advantage.
The first method is easy. You simply continue to work until age 70 and then hang up the proverbial skates.
Working longer has many advantages. An older worker with plenty of real-world experience can be valuable and will likely be paid well for that. Continuing to work will help keep you busy, too. And those earnings can be saved for an upcoming retirement.
But there are disadvantages, too. Some folks can barely keep working until age 60 10 additional years in the workforce just isnt going to happen. And there are a million other things to do besides work. Life is short, and we only have so much time to enjoy it.
Theres another solution, but Ill admit its a little risky and unorthodox. What a retiree can do is stop working at age 60 or 65 and then refrain from taking CPP until age 70. They can then spend most of their retirement savings until their 70th birthday, and then a combination of CPP, OAS, and other sources of income take over.
And since most Canadian retirees have a paid-off house, the principal residence can then be sold if a bigger cash cushion is required.
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How To Maximize Your Retirement Income
You want to not only have enough money to live comfortably when you retire, you also want a little bit more. Maybe you want enough to travel, start that side business you always talked about or purchase your dream home since you’ll have time to enjoy it. Whatever your retirement dreams are, maximizing your retirement income can help.
Here are some ways to do just that.
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Start Saving as Soon as Possible
You’ve no doubt heard of the benefits of compound interest. The key is that the sooner you start saving, the sooner you start gaining the interest and the sooner that interest can start compounding. Two years makes a difference, but five or 10 years makes a big difference in the amount you end up with upon retirement. So even if you’re on a tight budget, start stashing at least a little bit of it away in a retirement account. Have it automatically deducted from your paycheck, so you’re not tempted to spend it. You’re investing in your own future.
Start Saving With a Lump Sum
This one isn’t always possible, but if you happen to have a nice lump sum of money come into your possession, consider using it as the base of your retirement fund. Graduations and weddings often result in gifts of cash, so use these as the seed of your retirement account for increased compound interest and a larger return when you retire.
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Understanding Your Investment Account Options
Now that youve made the right choice in deciding to save for retirement, make sure you are investing that money wisely.
The lineup of retirement accounts is a giant bowl of alphabet soup: 401s, 403s, 457s, I.R.A.s, Roth I.R.A.s, Solo 401s and all the rest. They came into existence over the decades for specific reasons, designed to help people who couldnt get all the benefits of the other accounts. But the result is a system that leaves many confused.
The first thing you need to know is that your account options will depend in large part on where and how you work.
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Making The Most Of Company Stock With An Nua Distribution
Do you own highly appreciated company stock in an employer-sponsored retirement plan? If youre worried about the potential tax burden in retirement, you may want to consider the benefits of setting up a net unrealized appreciation distribution.
Under the NUA rules, employees who have company stock in a 401 can roll over those shares to a brokerage account and pay tax only on the cost basis of the stock at the time of distribution. Then, later, when those shares are sold, rather than paying ordinary income tax rates, the account holder will pay the taxes at more favorable long-term capital gains rates.
We currently have a client who could benefit from doing an NUA distribution, tied in with a CRUT, and possibly convert some of his remaining 401 balance to a Roth. In other words, when youre looking at these tax-saving strategies, it isnt necessarily an either-or decision.
However, it can be complicated, which is why its wise to work with experienced financial professionals who can help you understand future income needs, the source of that money and potential taxes in retirement. Your financial adviser also can work alongside your tax professional to help ensure youre following all the IRS rules for whatever strategy you choose. Additionally, youll want to involve an estate attorney if youre creating a trust.
Kim Franke-Folstad contributed to this article.
When Does The Average Person Start Saving For Retirement
According to the Federal Reserve’s latest “Report on the Economic Well-Being of U.S. Households,” 62% of Americans between the ages of 18 and 29 have some amount of retirement savings, but only 28% felt like their savings were “on track.” This increases to 71% and 34%, respectively, for those between the ages of 30 and 44.
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Reasons You Should Claim Social Security Early
Your retirement planning likely includes getting income from the Social Security Administration, but when you start collecting Social Security benefits can have a big impact on your planning. The earliest you can collect is age 62, but you’ll get more money if you delay your benefits past your initial Social Security eligibility. If you wait until after your full retirement age to start collecting Social Security you can earn delayed retirement credits, which will increase your benefits even more.
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You might think that waiting for bigger benefits is better, but that’s not always the case. There is no definitive answer to when you should collect Social Security benefits, and taking them as soon as you hit the early retirement age of 62 might be the best financial move.
Get Your Full 401 Match
If you’re not getting your full 401 match from your employer, you’re missing out on a big part of your compensation. While a few percentage points of your salary may not sound like much, the numbers add up over time.
If you’re unsure of what your 401 match benefits are, contact your HR department and ask. They’ll be able to adjust your automatic contributions to the minimum amount necessary to get the match. If you can, contribute even more than that.
Which account should you use? A 401s is better way to save for retirement
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Don’t Take On More Risk
Some people make the mistake of taking on additional investment risk to make up for the lost time. The potential returns are higher: Rather than 7%, there’s a chance that your investments can grow by 10% or 12%.
But the risk, the potential for loss to your principal, is also much higher. Your risk should always be aligned with your age. People in their 20s can accept greater losses, since they have much more time in which to recover. People in their 40s can accept less risk, and people in their 50s still less.
Don’t accept extra risk in your portfolio. You might consider one of the following asset allocation formulas:
- Invest a percentage of 120 minus your age, in stock funds, with the rest going into bond funds. This represents a high but acceptable level of risk.
- Invest a percentage of 110, minus your age in stock funds, with the rest in bond funds. This comes with a more moderatelevel of risk.
- Invest a percentage equivalent to your age, in bond funds, with the rest going into stock funds. This is a more conservative level of risk.
How Do You Start Saving For Retirement
If you don’t have a 401, IRA, or any other retirement account, opening one of those should be your first step in saving for retirement. These accounts offer tax incentives that can enhance your savings. You can open a Roth IRA with a brokerage as easily as you can open a bank account. Simply provide basic personal information, link it to an existing bank account you have, and draw funds from that bank account to start saving. Once your retirement account is funded, you can put it into investments like stocks, bonds, or target-date mutual funds.
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How To Maximize Your Spending Power In Retirement
When youre in retirement planning mode, retirement can seem more like an abstract idea than a reality. But the retirement stage of life can be just as dynamic as the years that precede it.
Retirement has also changed over the years. For example, fewer people have traditional defined-benefit pension plans these days, meaning they need to develop their own strategies to ensure income lasts through the retirement years.
Abbotsford, B.C.-based IPC financial advisor, Dean Lewissays a retirement income plan that considers all aspects of your personal situation, expected income streams, and government benefits, as well as how to efficiently drawdown on your overall portfolio, is critical to help you maximize the spending power of your savings.
Dean explains how his approach helped his client, Sarah Jennings, secure herretirement incomeand meet her goal to retire early and address one of her main concerns higher healthcare costs.
Pay Attention To Taxes On Your 401
The 401 is a great vehicle for saving your money tax-free for retirement. But the trade-off is paying taxes when you make 401 withdrawals. In general, your 401 distributions are subject to regular income tax, effectively reducing how much you receive.
You still have to pay taxes in retirement, but some strategies can help reduce your tax burden.
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Keep Working In Retirement
Another way to boost your retirement income is to work during the first years of your retirement — at least a little. Working just 12 hours per week at $10 per hour will generate about $500 per month. Also, given that many retirees can find themselves restless and a bit lonely in retirement, a part-time job can help by offering more daily structure and regular opportunities for socializing.
Here are some possibilities: You could be a cashier at a local retailer or deliver newspapers. You might do some freelance writing or editing or graphic design work. You might tutor kids in subjects you know well, or perhaps give adults or kids music or language lessons. Make and sell furniture or sweaters or candles. Do some consulting — perhaps even for your former employer. Babysit, walk dogs, or take on some handyperson jobs. These days the internet offers even more options. You might make jewelry, soaps, or jigsaw puzzles and sell them online, or write e-books that you self-publish online.
Things To Keep In Mind When Getting Started
This is your current budget, which takes into account all of your present-day income and expenses. While you should have some idea as to what you’ll need to save per month based on your retirement goals, you also need to make sure that you have that money to save. It’s a good idea to put retirement savings as a line item in your budget, just like food and shelter costs, so that you can set aside those funds every month.
This is a tool you can set up between your checking account and your retirement account so you don’t forget to save. Set it up so that on the same day every month maybe it’s the day you get paid funds you’re earmarking for the future go from your bank account into your investments. By doing it this way, there’s no risk of you spending that money.
Having a separate emergency account usually with about three to six months of salary saved up will allow you to cover any unexpected costs without throwing your retirement plans out of whack.
One goal for everyone should be to reach 65 debt-free. That includes credit card debt and especially the high-interest reward card kind car and mortgage loans, any student and other big loans. The reason is simple: you don’t want to be going into your non-earning years owing money.
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How To Start Saving For Retirement
While starting early is always important even $25 a month in your 20s is helpful it’s OK to set money aside for more immediate needs first and then start tackling retirement in your late 30s and early 40s. However, you don’t want to wait much beyond that because you’ll need time to put money into a retirement account for that money to grow. The longer you wait the more you’ll have to sock away yearly making the challenge a lot more difficult.
Using Charitable Giving To Reduce Taxable Income
Concerned the sale of a highly appreciated asset could send your taxes skyrocketing? A specific type of charitable remainder trust, called a charitable remainder unitrust, or CRUT, might help blunt the impact.
A CRUT is an estate-planning tool that provides income to a named beneficiary . Then, after the beneficiary dies, the remainder of the trust goes to a charitable cause.
If our client were to take some of the real estate he owns and donate it to a CRUT instead of selling it as he planned, the tax benefit would be twofold: Hed receive an immediate charitable tax deduction and eliminate the capital gains from selling the property.
The trust also would produce income during our clients lifetime, and when he passes, the remaining trust balance would be donated to the charity of his choice. He would be selling the property, eliminating some of the taxes, maintaining an income stream and creating a legacy all with one strategy.
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