During their work life, most people receive a single paycheque from a single source: their employer. When you retire from employment, it becomes your responsibility to replace your earned income. For many people, their income in retirement comes from multiple sources. The better you can organize the many sources of income you draw in retirement, the more stable and dependable it will be.
I’ll address government benefits, pension money, RRSPs and TFSAs, other investments and savings and a couple possible backup plans. Each person’s sources of income might be slightly different, so don’t worry if you don’t have all of these. With the strategies and tools below, you can organize your sources of income in retirement to reduce risk and experience less worry.
The first consideration is tax because it reduces the amount of income that you receive. Second is flexibility because life is unpredictable. It’s important to have a plan, but when things don’t go according to plan, having flexibility allows you to adjust. Finally, we’ll coordinate all the sources of income to work together.
Most Canadians qualify for CPP and OAS. Some people will also receive the Allowance or GIS. These benefits are taxable and are inflexible. Once you start receiving them, you can’t stop or make changes. I have written elsewhere about when to start government benefits, but the basic idea is that it makes sense to start these when you retire or when you qualify. The reason is that you can start and stop income from other sources and control how your investments are allocated. Also, government benefits end at death (unless they support your spouse), whereas other sources of income in retirement can be passed on to your beneficiaries.
Some employers still offer a pension for their employees. If you have a pension benefit, i.e. a guaranteed income for life, it is taxable and inflexible. I suggest treating it the same as government benefits and starting it as soon as you retire. The employer may allow an employee to transfer the pension (commuted value) into their own investment account and manage it themselves. It would be deposited into a LIRA and you are responsible for the investment decisions (for better or worse) and the amount of income to draw from it, within certain minimums and maximums. This could make sense if you leave your employer before your retirement. If you don’t trust that your employer will remain able to meet their financial commitments, a copycat annuity might make sense. If the employer offers a bridging benefit from retirement to age 65, that’s valuable.
More often, employers offer a retirement savings program that leaves the investment responsibility with the employees: a group RRSP, DPSP or possibly an RCA. If you have one of these accounts through your employer, it’s a valuable savings tool. In retirement, however, it will likely be transferred into your RRSP.
Most Canadians with an income over $50,000 per year contribute to an RRSP. It provides a tax deduction as well as tax-sheltered growth for retirement. In retirement, it is converted to a RRIF and the income from withdrawals is 100% taxable and some taxes are withheld. There is a minimum withdrawal amount each year, but no maximum. This is the next source of income in retirement, given that it is taxable, but flexible.
Most Canadians should have some savings in a TFSA. It doesn’t provide a tax deduction, but it does shelter investment growth from taxes, and withdrawals are tax-free. It is a great way to save for people with a lower income and people who have already maximized their RRSP. Because it is both tax-free and flexible, it is normally the last source to draw retirement income from. In fact, it could be useful to save RRIF payments if the minimum exceeds the amount of income you need.
Other Investments and Savings
These are usually in a bank savings account, GICs or a non-registered investment account. These sources of income in retirement are more taxable than a TFSA (no sheltering), but equally flexible. The level of taxation depends on the type of income earned: interest (fully taxable), divdends (tax credit) or capital gains (50% inclusion rate). Tools such as a T-SWP can make the income as tax-efficient as possible. For those who have non-registered investments, they can be useful in minimizing your taxable income and reducing or avoiding the OAS clawback.
Putting it all Together
I think of the different sources of income as layers. As the foundation, you have guaranteed income. For most Canadians, that means CPP and OAS. It could also include an employer pension. The next layers will be inflexible and taxable, then flexible and taxable, then flexible and non-taxable. That means drawing from a LIRA/LIF next, then an RRSP/RRIF, then a non-registered account and lastly a TFSA. How much from each account depends on tax brackets. From the viewpoint of your entire lifetime, it’s most efficient to withdraw from taxable accounts up to the next tax bracket. If you need more income, you can draw from a partially taxable (non-registered) or non-taxable (TFSA) account.
The other strategy is based on guarantees. Most advisors don’t offer any guarantees besides GICs. But there are three other approaches that you may consider. An annuity is a buy-your-own pension. If you’re not willing to expose your retirement fully to market risk, you can augment the guaranteed income from government benefits with a lifetime annuity. This gives you a guaranteed floor of minimum lifetime income. The costs are the low current interest rates and the fact that it ends at death (unless it’s joint), so it’s not available as an inheritance.
A GMWB (guaranteed minimum withdrawal benefit) is half-way between market investments and an annuity. You choose your investments for market growth, but if the market drops you will never receive less than your guaranteed income (unless you dip into the capital). There is an additional cost for this guarantee, but it protects against running out.
Finally, the ALDA (advanced life deferred annuity) was recently approved in Canada. At retirement, you could allocate 10% – 20% of your capital to a deferred annuity (or bond fund) that would not be tapped for income. Instead it would continue to grow until needed. If markets crash or you overspend, this tool can turn into guaranteed lifetime income. It’s like a backstop because it guarantees that you won’t outlive your savings. Not every person needs every guarantee, but it’s helpful to explore all the options to ensure that you have the highest probability of success.
What if you forgo guarantees and things start to go wrong? There are a few backup plans that could get you through. I don’t advise counting on these, but they are possibilities for a financial plan that’s off track. Working in retirement may not be your dream, but it allows you to socialize and meet people, produce some income and draw less from your investments. Most homeowners have a large amount of equity in their home. That’s helpful, because it avoids the cost of rent, but it can be accessed either by downsizing or taking a reverse mortgage. Downsizing might be a good solution, especially if it alleviates the needs for yard care and maintenance. A reverse mortgage is rarely a good idea because of the obligation and inflexibility of debt. For some people, an inheritance may also bolster retirement funds, but that’s outside of your control.
I would prefer to have enough capital and guarantees that I won’t need to rely on backup plans. In retirement, you will receive income from a number of sources. The strategies, tools and products that you use to organize your income will determine how much risk you experience and how likely it is that you will never run out.
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