March 12, 2019

Dealing with Complex Retirement Considerations

As eluded to in our latest Portfolio Update, Boy! is the Canadian retirement system complex. We recently have been doing some research on retirement planning and will now report our findings here. We won’t cover every possibility as we concentrated on our own situation. It should still give you hints on major points to consider. We’ll remain thorough but try not to lose you in all the details. We suggest you pick up all that applies to your retirement situation and refine other pertinent details on your own from there. At least, our exploration should give you a decent head start.

Our main objectives in all those proceedings in to retire comfortably and to try to provide as much money for our kids and grand kids while we’re alive and not only after we die. From the beginning, we thought that minimizing taxes along the way would be one of the best ways to achieve this. As we discovered, it may not be that simple.

Before we start, we would like to mention that, because a lot of time will elapse before our true retirement days, many factors can affect the ultimate outcome or outcomes. And many of these factors can be difficult if not impossible to predict. Just think about the effect of a major economic crisis, a deadly war, a ravaging natural disaster or life-threatening illness…Also consider less tragic- for-humanity possibilities like tax regulation changes or altered retirement benefit stipulations. Any of these on its own could have a huge influence on your retirement conditions. So, their combined impact could be astonishingly mind boggling.

Our intention is not to scare you as we are not at all advocate of doomsday scenarios, but we must admit long-term retirement circumstances are almost impossible to anticipate. In that context, we will just say that it’s always good to have options and when it comes to retirement, it may not be a good idea to over-plan (I feel like I’m talking to myself). Let’s try to enjoy it as much as possible when we get there. Hopefully, most of us will have the opportunity to do so.

Taxes Are Only the Tip of the Iceberg

We thought that taxes were our biggest concern. But subsequently discovered there was a lot more to it as a lot of different considerations apply to retirement planning. The whole process is much more complex than we initially anticipated. All these various possibilities are kind of tough to grasp and circumvent. To tell you the truth, the complexity of the choices surprised us. All this even if we are quite comfortable with financial planning subjects and are never afraid of extensive number crunching. Heck! We usually relish it!

In regard to retirement, just these simple questions can get things quite complicated:

How much will you need?
How much will you get?
How much will the taxman take away?

Before everything else, we were particularly wary about the infamous OAS clawback, the 15% benefit reduction that kicks in when your net income goes over a certain level ($77580 in 2019). Hence, we were concerned about controlling our income level in retirement. In that context, having too much RRSP could cause a problem. Especially after age 71, where you only plausible option requires you to convert any RRSP into a Registered Retirement Income Fund (RRIF). The pitfall of RRIFs is that they come with a yearly minimum withdrawal percentage that gradually increases with age. That eventuality pushes the RRSP vs TFSA debate right up front.

Not long after that, we stumbled on a couple more things to consider. Here’s a few. The possibility to anticipate Canadian Pension Plan (CPP) benefits as early as age 60. The other way around, deferring CPP or Old Age Security (OAS) benefits till as late as 70. In the same sense, the in-vogue tax breaks or benefits granted to those working after 65. Obviously, anticipated benefits will be lower and deferring them or working later in life will get you more but, obtaining more precise figures can be quite a challenge. Already puzzling and we’ve not even tried to consider overall impacts yet.

Furthermore, additional interrogations arise like objectively evaluating and accounting for our general health condition. Should we stash away some money for a costly retirement home? Will our surviving family members quarrel about getting bigger shares? On so on…You get the picture. For everyone but especially when you accumulate more money, anything related to estate planning can be a drag. On top of it all, we must admit that so far, we failed to find to right financial professional to assist us with those various sensible issues. The ones that we consulted either lacked skills and knowledge or only seemed interested in selling us expensive products. So, we are content on doing what we can on our own before we discover that rare and precious effective unbiased trustworthy help. We know, we are asking for a lot.

To summarize the complexity of retirement dealings, just consider the simple fact that from an income standpoint, things change a lot. Most of us pass from one main stream of income, a weekly (bi-weekly in our case) paycheck to 4 or more different sources of income like pension benefits, CPP, OAS and investment proceedings.

Meanwhile, one important concept we learned from all our financial planning experiences is to prepare and protect ourselves from worst-case scenarios. Along those lines in the retirement realm, financial considerations for the surviving spouse merit plenty of our attention. So, we’ll elaborate on it quite a bit as we go along.

Our Enviable Retirement Situation

We know our retirement situation is not typical. We feel kind of spoiled as our retired life should be quite easy, financially at least. If we exclude public pensions and only consider our generous work defined-benefit pension plans, our net retirement income will be around 98% of our actual net income. Because saving money won’t really be necessary anymore, this means we could spend more in retirement, which is quite rare.

Two main elements can explain our great situation. First, before taxes, our larger-than-most combined work pensions will roughly give us 71% of our gross job income if we retire a little before 60. Second, our average pension income will only get reduced by about 21% because of taxes. Comparatively, on top of taxes, our salary gets amputated by other deductions like CPP and pension contributions, EI premiums, etc. This results in a net job income of only 56% of our gross income.   

So, our retirement together should be a breeze. Remember that we will additionally qualify to receive some CPP and OAS benefits. If fiscal rules don’t change too much, retirement income splitting and our spousal RRSP should allow us to work around the dreaded OAS clawback.

It will be quite a different story after one of us leaves for a better place. If I’m the lone survivor, I’ll have to manage with 59% of our net income. Lady N would be inconsolable but would have more with 73%.

What’s most surprising is that the surviving spouse will have issues dodging the OAS clawback. In fact, it will be next to impossible to avoid it. It’s kind of odd that we should manage to evade the clawback as a couple when we don’t necessarily need the money but that it will kick in and reduce benefits to the lone survivor that will need it more. Canadian social programs and fiscal system are wonderful and quite elaborate. Unfortunately, their complexity involuntarily creates discrepancies like this one for the surviving spouse in our specific situation.

We realize that getting our OAS benefits clawed back won’t be the end of the world. We are privileged and still won’t have any money problems in retirement. After all, OAS is a safety-net program and there’s no question that many Canadians need it and will need it more than us.

Our enviable situation means we possibly will have to deal with more taxes. That’s why our first incline was trying to limit them. In that sense, generating too much revenue in retirement and having too much RRSP money, both in retirement and at death, still are the main factors that could amplify our tax apprehensions.
Dealing with Too Much

Having too much money aside and too much retirement income sure gives us options. Despite fiscal complications, it’s a great problem to have.

As you’ll see from the following report of our findings, we were on the right track back in January as we posted about Not Blindly Contributing to your RRSP.

At first glance, from a fiscal standpoint, TFSAs looked much better than RRSPs, especially in our situation. Contrary to RRSPs, TFSA withdrawals don’t generate taxable income. So, we thought about transferring most if not all our RRSPs into our TFSAs. No RRSP and more TFSAs would mean less taxable revenue in retirement, no more OAS clawback issues and no more juicy tax bill at death. If only it was that simple and easy!

As we vividly plunged into the RRSP vs TFSA debate or how to proceed with the transfer, a couple complications immediately surfaced.  To start, we are lacking sufficient TFSA contribution room to transfer most of our RRSPs. Furthermore, US dividends don’t get to same tax treatment in TFSAs as they are subject to a 15% withholding tax. We also can’t neglect tax bills we would incur if we withdraw funds from our RRSPs for those transfers. Let’s have a closer look at those issues.

As a couple, our TFSA contribution room is amazingly still a little over 100 000$. We contributed regularly to our TFSAs but also withdrawn quite a lot. For instance, for all our wonderful trips. Those frequent TFSA withdrawals generated contribution room the following year. These days, TFSA regulation also allow us the contribute an extra 12000$ (6000$ each) every year. While our contribution room won’t allow us to transfer all our RRSPs into our TFSAs, we should be able to transfer a big chunk of it over the upcoming years. Finding a tax-friendly place for new money we should manage to save will also be a challenge. Lady C is growing up fast and we will make sure to indirectly use her TFSA contribution room as she turns 18. At some point, unregistered accounts will probably come into the mix.  

Before all this, we didn’t fully realize the preferable tax treatment of US stocks in our RRSPs. We knew about it but kind of invested our US stocks on auto-pilot in RRSPs. But after more considerations, paying a 15% withholding tax on US dividends in our TFSAs wouldn’t be the end of the world. Considering 4% annual dividends on average, it only would represent 0.60% in extra tax (4%x15%). It would mean a little more paper work which we hate but could manage. We’ll try to avoid it as we concentrate our US dividend holdings in our remaining RRSPs.

Transferring our RRSPs into TFSAs all at once would result in a huge tax bill and wouldn’t be that wise. That way, we would entirely miss the point of all this elaborate tax planning. As we mentioned before, our main fiscal strategy has been to keep my taxable income just under the lower tax bracket (that level is $46605 in 2018) where taxes are under 30%. For the purpose of upcoming TFSA transfers, we will be willing to go over that level and pay up to 38% in tax which is much better than almost 50% we got deducted as we contributed or over 50% at death. Being Quebec residents, we will have to account for a particular tax, the contribution to the Health Services Fund which translate into a 1% tax on withdrawals over a certain level (about $15000 in 2019).

We must be careful because, contrary to TFSAs, withdrawn RRSP funds don’t generate new contribution room and you lose them forever. In that context, RRSP withdrawals have to be measured. At this stage in the proceedings, RRSPs look better than their non-registered counterparts but it’s not clear if the latter would provide more flexibility to control our taxable income in retirement. For instance, capital gains appear especially versatile as you can somewhat choose when to realize them. On the other hand, regular non-registered dividends seem even worse because technically, they are grossed-up by 1.38 for income tax purposes before you get any dividend tax credit.

So, all this signifies we will make most new contributions to our TFSAs and gradually transfer an important portion from our RRSPs, about an additional $15000 each year. We will try to max out our TFSAs within about ten years and before retirement.

A quick mention again about unfortunate surviving spouses. Make sure to max out TFSAs before death, for instance in case of severe sickness, as TFSAs can be rolled over to the surviving spouse without affecting contribution room. If necessary, the potential surviving spouse could even make TFSA withdrawals as they will generate new contribution room the following year. It will not be the case for the dying spouse. Let’s put a stop to all this morbid talking as Lady N sure hates it a lot.

Next, we briefly explored annuity and life insurance avenues but almost immediately excluded them. Annuities can be a nice option to provide safe guaranteed income if for instance, you don’t have access to robust work pensions like we do. Some life insurance products could provide potential tax-free benefits. But premiums still must be paid with after-tax dollars, administration fees and commissions are often high and finally, offered investment vehicles are most of the time limited to a few options, not always producing interesting enough returns.     

With most RRSP considerations studied, we got back to our too-much rhetoric. We concentrated on our income stream and how too much revenue in retirement could impact us, especially tax wise.

Anticipation/Deferral Options

Apart from RRSP withdrawals, CPP/OAS benefits are probably what’s going to affect our taxable income in retirement the most. So, let’s now talk about anticipation and deferral options these retirement programs offer.

For now, the normal age of retirement is 65 in Canada. Yet the new normal seems to be people retiring either way earlier like the FIRE (Financial Independence Retire Early) enthusiasts or way later as many never retire and continue working almost till they die.  The regulators picked up these new trends, so they gave everyone a lot more options. For instance, you can ask to receive CPP benefits anywhere between 60 and 70.

Because of labour shortage, recent policies tend to encourage people to remain on the workforce as late as possible. So, in that sense, anticipating CPP before 60 would give you 0.6% less per month (7.2% per year) and deferring it would give you 0.7% more per month (8.4% per year). The consensus among specialists seems to be around 6% for the value of every anticipated/deferred year so the regulators sure are taking/giving us a little more.  

Just considering those figures, the optimal solution would be to defer both CPP and OAS. But many other factors have to be considered like your health, your life expectancy and also your tolerance to risk. For instance, health issues could tilt the balance in favour of anticipation. Similarly, more aggressive investors could potentially make anticipated sums grow faster.

You also must take into account other sources of retirement income and fiscal ramifications. For example, more CPP/OAS benefits could provide safer inflation-adjusted revenues but would diminish margin to avoid OAS clawback. With all these conflicting impacts, one-size-fits-all solutions sure won’t cut it to make these crucial retirement choices.

In our case, lower anticipated CPP benefits would be good for our taxable income concerns later on. But, at the same time, these early CPP benefits would likely boost our RRSP or investment balance which would have an opposing effect. Even using non-registered investment accounts would increase our income level from time to time. As we said above, non-registered dividends would in fact make it even tougher to avoid OAS clawback because they are grossed-up by 1.38 for income tax purposes before any dividend tax credits kick in.  

We still have time to make our final decision and analyzed all the repercussions further but for now, it looks like we will both take CPP and OAS at 65. We already risk enough with our substantial investment portfolio to additionally gamble with anticipated CPP amounts. Deferred benefits would pose definite OAS clawback issues even if it would allow us to draw down more RRSPs earlier on. Our health condition will merit some attention as we get closer to those retirement decisions. For instance, I have a blood condition that is under control but an aggravation of it would simplify the anticipation decision, at least for me.

As eluded to before, all scenarios pose OAS clawback issues for the surviving spouse. The answers to that problem are less taxable income, less RRSPs and more TFSAs. A balanced approach in that regard is still inevitable as we have to deal with limited TFSA contribution room, US dividends tax withholding tax in TFSAs and tax deferral advantages inside RRSPs compared to non-registered.

Our Conclusions so Far

You will note that information in this post in often partial as it refers only to our particular situation. Make sure to double-check details that could apply to you and keep in mind that some information may simply have been omitted because of lack of pertinence to our case.

We initially thought analysing our future retirement would be quite simple, but we were in for a couple surprises that make things more complicated and some interrogations still persist.

To sum it up, we found out more TFSAs could be great in our situation as they have no impact on retirement taxable income. But the TFSA solution has its limits. Maxing out our TFSAs sooner will still be one of our main adjustment.

OAS clawback concerns is probably what’s complicated our analysis the most. It involves controlling both our annual taxable income over our entire retirement venture to avoid that financially unpleasant prospect.

As we said before, having these worries, insignificant when you reflect about it, is a good problem to have. We would suggest keeping things simple as all these elaborate considerations are probably not necessary for most.

Are our retirement plans perfect? Heck no!
But they are our own and are probably much better than most.

Are all these sophisticated analyses an optimal use of our time? Not at all!
But we love number crunching, personal finance research and scrutinizing possibilities, especially with our own figures in the mix.

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