Whether you’re just easing out of the workforce or you’ve been in retirement for a few years now, it's critical to understand the potential outcomes of your financial decisions. This is especially true as we head into 2021, following a tumultuous and unpredictable year. If you’re working with an advisor or looking at your finances yourself, one central goal during retirement is managing your wealth when it comes to taxes.
There are ways to avoid owing more taxes in many cases, but this usually requires proactive action beyond tax season. Below we’ll explain four tips you can utilize throughout the year to help minimize your tax obligations in retirement.
Tip #1: Take Your Required Minimum Withdrawals
Required minimum withdrawals refer to the smallest amount that must be withdrawn from your retirement accounts - such as your RRIF, RPP or PRPP. These required withdrawals begin when you, the retirement plan account owner, by the end of the year you turn 71.
If you choose to withdraw from your RRIF sooner than 71, there is a formula you can use to determine your minimum withdrawal amount:
1/(90 - your age)
For example, if you were 70 years old, the formula would be:
1/(90 - 70), or 1/20 - which equals five percent.
In this case, you would be required to withdraw five percent of your RRIF account. If you have $200,000 in your RRIF account, this would equate to $10,000 (or around $833 a month).
Tip #2: Avoid the Old Age Security Pension Recovery Tax
As a retiree, a portion of your income will likely come from your Old Age Security (OAS) pension. However, seniors who earn above a certain threshold are required to pay back a certain percentage of their OAS pension in the form of a recovery tax.
As a retiree, there are two instances in which you would be required to pay this recovery tax:1
- If your annual net world income is $77,580 or above (for the 2021 tax season)
- If you reside in a country with a non-resident tax on Canadian pensions that is or exceeds 25 percent
The recovery tax will be approximately 15 percent of the income amount that exceeds the $77,580 threshold.
There are several ways to avoid this recovery tax (commonly referred to as the OAS clawback). For example, you could split pension earnings or any annuity payments with your spouse to keep both incomes under the threshold. Work with your financial professional to determine whether or not you may be able to avoid the OAS recovery tax.
Tip #3: Figure Out if You Need to Pay Tax Instalments (If Not, You May Decide to do it Anyway)
If you don’t have taxes withheld automatically, you may need to pay estimated tax instalments. This can be common for retirees who earn income of which tax is not withheld - this often affects people like rental property owners and self-employed individuals.
The requirements for paying tax instalments depend largely on where you live and how much you’ll be owing in taxes.
Each territory or province determines their threshold for net tax owing. If you exceed the threshold, you will be required to make tax instalments.2 Failing to pay on time will result in interest and, in some cases, a penalty charge.
In some cases, you might decide to pay tax instalments, even if not required, to avoid the inconvenience of paying a large sum all at once.
Tip #4: If You’re Moving to a New Province or Territory, Get to Know Its Tax Laws
If you’re relocating during retirement, consider the impact of the move on your financial situation, as tax laws can vary across the country. For example, provincial and territorial income tax brackets can vary greatly.
While you may be moving to live closer to your adult children or for a change of pace, it’s important to review what this change could mean for your tax situation.
In many cases, an individual or couple is working with a fixed amount of wealth to last throughout retirement, so taking the proper financial steps is essential. By working with an advisor and keeping these four tips in mind during the year, you can make sure you’re not paying more than you need to. When it comes time to finalize gifting to your children or grandchildren, you can further reduce taxes by incorporating other strategies, like charitable giving, into the equation.
Please consult financial, legal, or tax professionals for information specific to your situation. The information and material presented are general, may have changed since the published date shown, and should not be considered financial advice. LetsPlan.ca is published in Canada exclusively for residents of Canadian jurisdictions where our products and services may be legally offered. The services offered within this site are available exclusively through our Canadian advisors. While we often provide original content, Twenty Over Ten initially provided the subject matter for this post. It has since been edited, reviewed and approved by our Privacy and Compliance Officer. Advisors may only conduct business with residents of the province(s) in which they are licensed and registered.