Income in your retirement – where is yours coming from?
One of the challenges faced by people who earn a higher income is finding tax efficient ways to save for retirement. In order to maintain the same standard of living after retirement as they enjoyed prior to retirement, experts most often suggest that 70% of pre-retirement income is needed. Government plans and registered plans provide sources of retirement income but income tax rules cap the amount that can be contributed to (or in the case of defined benefit arrangements, received from) employer-sponsored pension plans (RPPs) and individual Registered Retirement Savings Plans (RRSPs). In fact, once “earned income” exceeds a specific amount, potential RRSP contributions for the next taxation year will be capped.
There are a number of retirement savings vehicles that are regulated by tax and pension rules. There are tax-assisted programs to which individuals and/or their employers might contribute to help accumulate a retirement nest egg. These would include:
Registered Pension Plans (RPPs), Deferred Profit Sharing Plans (DPSPs), and Registered Retirement Savings Plans (RRSPs) The Income Tax Act (“ITA”) places limits on the “tax assistance” for registered plans. “Tax assistance” means the tax advantages that an employer and/or employee will receive because contributions are tax deductible and the income/growth is not taxed until withdrawal from the plan.
There are also government-administered programs that provide retirement income based on employment and/or residence in Canada. These programs include:
Old Age Security (OAS) and, on a needs basis, Guaranteed Income Supplement (GIS)Programs established by the provinces (e.g., Ontario’s Guaranteed Annual Income System (GAINS)) Canada Pension Plan (CPP) and Quebec Pension Plan (QPP)
Once contributions to (or benefits received from) tax-assisted plans are maximized, those who want to ensure additional sources of funds are available in retirement must find alternate vehicles. Non tax-assisted programs that an individual or their employer might establish which would be a source of retirement income include:
– Various stock plans
– Various profit sharing plans
– Personal savings vehicles/investment portfolios
– Free Savings Account (TFSA)
With the exception of the TFSA , these non-registered savings options often produce income that is taxable annually. A tax deferral is available for investment in stocks that are held for the long term rather than being traded from time to time. As long as no gain is realized, no income tax is due. However, since most people use mutual funds (or segregated funds) as their vehicle for investing in stocks, and since the underlying assets are generally actively traded, gains are realized each year, triggering taxation. Regardless of which approach is used, there will come a time when the underlying stocks must be liquidated, either to produce an income or on the death of the owner or spouse, thus realizing the gains and triggering taxation.
Tax Free Savings Accounts (TFSA)
The Tax-Free Savings Account (TFSA) is a flexible, registered, general-purpose savings vehicle that allows Canadians to earn tax-free investment income to more easily meet lifetime savings needs. The TFSA complements existing registered savings plans like the Registered Retirement Savings Plans (RRSP) and the Registered Education Savings Plans (RESP).
Insured Retirement Program
Using a Leveraged Insured Retirement Program (IRP) to fund retirement This strategy involves purchasing a participating whole life (PAR) or universal life (UL) insurance policy generally a minimum of 15 – 20 years prior to retirement. Policies that qualify as “exempt” under the ITA (all PAR and most UL policies issued in Canada qualify), allow funds to accumulate inside the policy on a tax-sheltered basis by virtue of sections 148 and 12.2 of the ITA. In a UL policy the other component of the policy is the life insurance component. It is separate from the investment, but both form part of the same life insurance policy. What makes universal life insurance attractive is premium flexibility. A client can deposit more or less into the plan, as long as there is enough to cover the premiums for the life insurance component. While PAR policies also have a level of premium flexibility we cannot separate the life insurance from the investment component. In UL contracts the excess contributions (up to a maximum limit calculated with reference to ITA rules) form part of the investment account in the policy that can grow on a tax-sheltered basis. Upon the death of the insured, the total death benefit is paid out tax-free to the beneficiary(ies). This applies whether the contract is PAR or UL. Tax may be payable if the policy is disposed of and the investment funds withdrawn, in whole or in part, before the death of the life insured.
How do access the funds at retirement?
Withdrawal from the policy
Withdrawals can be taken directly from the life insurance policy’s cash surrender value. When a partial withdrawal is taken, the adjusted cost basis (ACB) may have an impact on the net amount withdrawn as the difference between the amount withdrawn and the ACB is taxable. The amount of the ACB is proportional to the total amount withdrawn.
Funds can also be accessed as a policy loan. In essence, these are not typical loans, but rather advance payments of the policyholder’s entitlement under the policy. The advances do not have to be repaid to the insurer. A policy loan constitutes a disposition for tax purposes and will attract taxation when the total loan amount exceeds the adjusted cost basis of the policy. The insurance company will charge interest on any outstanding balance of policy loan. Any outstanding loan balance will be deducted from the policy proceeds at death with the net amount then being paid to the beneficiary(ies).
To find out which strategy would work best for you and ensure your retirement income last, please contact me to for a free consultation and retirement plan.
By Andrew W Bradley a licensed Life & Health Insurance Broker Registered Retirement Consutlant – RRC® helping Ottawa families since 2011. Combining this with his previous working experience with the Canada Revenue Agency enables him to help a wide range of individuals, families and businesses. As an Independent Broker he devotes time to educating the consumer and implementing comprehensive financial plans for both individuals and businesses in areas including insurance and investments.
The information is of a general nature only and does not take into account your individual objectives, financial situation or needs. It should not be used, relied upon, or treated as a substitute for specific professional advice. I recommend that you obtain your own independent professional advice (preferably me) before making any decision in relation to your particular requirements or circumstances.