Retirement income sources go way beyond investments

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The financial industry sometimes overlooks the significant differences in investment knowledge from one person to the next. Some people are savvy, self-directed investors, while others do not understand the difference between an RRSP and a TFSA.

Recent research by Angus Reid for Tangerine found that only 74 per cent of those surveyed knew that TFSA stands for tax-free savings account. Despite being around much longer than the TFSA, the RSP acronym was only known by 39 per cent. Retirement savings plans are often referred to as RRSPs or registered retirement savings plans as well.

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One of the problems with money is that people who are smart and successful in other areas of their lives may be hesitant to let their lack of financial literacy show. It is one of the reasons these same people can be vulnerable to some members of the financial industry who may exploit their lack of knowledge.

A recent poll from FP Canada and CIBC found 54 per cent of Canadians define a financial plan as something that details long- and short-term investment products. This leaves out many other elements, such as retirement planning, not to mention tax strategy, insurance needs and estate planning. An investor’s understanding of how their investments will turn into a paycheque in retirement can be overlooked at the expense of an industry focus on investment sales.

For all the non-experts planning for retirement, here is a quick summary of the retirement income sources you may have at your disposal.

Government pensions

Canada Pension Plan (CPP) is a contributory pension meaning you contribute to it and the more you contribute, the higher your pension. Contributions are made based on your employment and self-employment income. A contributor generally needs 39 years of maximum contributions to get the maximum CPP at age 65 — currently $1,365 per month. However, the average recipient gets much less, only $758 per month as of October 2023. The CPP is indexed annually to inflation in January each year.

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Old Age Security (OAS) is a non-contributory pension meaning you do not contribute to it. The government pays it to long-time or lifelong Canadians residents. Someone who has lived in Canada for 40 years or more between age 18 and 65 will be entitled to the maximum OAS which is $714 currently. The pension is adjusted for inflation each quarter. At age 75, there is a 10 per cent increase in your OAS pension.

If your income is higher than $90,997 for 2024, your OAS will be subject to a pension recovery tax or clawback. If your income is below $51,840 and your spouse or common law partner does not receive an OAS pension, you may be entitled to an additional amount called the Guaranteed Income Supplement (GIS). If your spouse receives OAS or if you are single, widowed, or divorced, the income threshold is lower. The maximum GIS is $1,065 per month for a single, low-income OAS recipient.

CPP can start as early as age 60 or as late as age 70. OAS can start as early as age 65 or as late as age 70. You need to be receiving OAS to qualify for GIS. The earlier you start your pensions, the lower the monthly payments.

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A retiree receiving the maximum combined CPP and OAS pension at age 65 would be receiving $24,940 today but most people receive less.

RRSP withdrawals

You can withdraw from your registered retirement savings plan at any time. You do not need to wait until you retire or until you are a certain age. But withdrawals are fully taxable income. The reason is you put the money in on a pre-tax basis, because of the tax deduction on your contributions, so there is tax to pay on the way back out.

Generally, a retiree waits until they are no longer working to start RRSP withdrawals. You have to take withdrawals no later than age 72. Most people will convert their RRSP into a registered retirement income fund (RRIF) once they start taking withdrawals or no later than Dec. 31 of the year that they turn 71. RRIFs have minimum withdrawals that start at 5.28 per cent of the account value at age 72 and rise to 6.58 per cent by the year you turn 80.

The sustainable withdrawal that a retiree could take from their RRIF and not run out of money could be higher or lower than the minimum withdrawal. It depends on their investment risk tolerance, future market performance, investment fees and life expectancy. Taking the minimum withdrawal often results in some money remaining in a RRIF account as an inheritance.

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Locked-in retirement accounts (LIRAs) are like RRSPs in that they are tax deferred, and you need to start taking minimum withdrawals by no later than age 72. They differ because they come from a pension plan transfer instead of your voluntary personal contributions. As a result, they have stricter withdrawal restrictions including maximum annual withdrawals.

Workplace pensions

Employer pensions are most commonly defined benefit (DB) pensions or defined contribution (DC) pensions. DB pensions pay a monthly amount based on a formula and the estimated future income is generally reported on your annual statement so that you have a rough sense of what to expect in the future. Some DB pensions are indexed to inflation once they begin, but most are not.

DC pensions are like RRSPs in that you buy mutual funds that will rise and fall over time and eventually have minimum withdrawals that are required to begin no later than age 72.

Pension income is fully taxable.

Other assets

Tax free savings account (TFSA) withdrawals are always tax free and can be taken at any time. TFSAs are effective retirement saving solutions for people with low or moderate incomes saving for retirement, often better than RRSPs.

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Someone with non-TFSA, non-RRSP savings — so-called non-registered investments — may have little tax to pay on withdrawals. Withdrawals from a savings account do not result in any tax. Withdrawals from accounts holding stocks, bonds, mutual funds, or exchange traded funds (ETFs) may result in capital gains if an investment is sold for a profit but the tax generally ranges from as little as 10 per cent of the capital gain to about 25 per cent. Otherwise, the annual income from interest, dividends and realized capital gains is taxable to the investor even if they do not withdraw the money. So, the income is taxable, not the withdrawal, which often includes tax-free principal.

If you own other assets like rental properties or a business, retirement income planning becomes more difficult.

A rental property may provide an indexed income stream in retirement, but the rental property equity can also be used to fund retirement by borrowing against it or selling it.

Most businesses stop producing income when the owner retires, but others can be sold. A business owner may have corporate savings retained and invested in a corporation. Retirement planning for business owners can be more complex.

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Home equity

Retirees with a home they own can access that equity in different ways. They can sell the property and downsize or rent instead. They can also borrow using a line of credit or mortgage. They may find themselves somewhat limited by conventional borrowing options that have income qualification requirements. There are a handful of lenders offering reverse mortgages allowing a senior to borrow up to 55 per cent of their home equity, albeit at higher interest rates, but have no monthly payments or income verification required.

Tax management

A retiree with taxable income of $50,000 may pay 10 to 20 per cent tax. At $75,000 of income, it may be 20 to 25 per cent, and at $100,000, maybe 20 to 30 per cent. The tax payable varies significantly by province or territory but even more so based on the type of income, as well as tax deductions and tax credits.

Keep in mind withdrawals from your TFSA are tax-free and only some of your non-registered withdrawals are taxable. Couples can split eligible pension income including RRIF withdrawals and DB pension income to equalize their incomes and minimize their combined tax.

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Summary

Retirement income planning should be an important consideration for anyone saving, investing, buying a home, or making any other big financial decisions regardless of age or stage. If you are not sure how much you need to save or what you are saving for, it is like being on a road trip without a destination.

If you are retired and unsure about how much you can afford to spend each month, you run the risk of spending too little during your healthy years or spending too much and running out of money later in life. If you have a financial adviser ask them. Even if they do not provide retirement planning personally, someone in their organization may be able to assist. If you are a self-directed investor, that means you need to plan your self-directed retirement.

Jason Heath is a fee-only, advice-only certified financial planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever. He can be reached at jheath@objectivecfp.com.

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