The key for those with pensions is to take a long-term view of taxation, rather than focusing strictly on minimizing taxes year by year.Nuthawut Somsuk/iStockPhoto / Getty Images
This article is part of a new Globe Advisor series, Pensions Unpacked, exploring how workplace pensions fit into retirement strategies, and the technical details and decisions that come with the plans.
Retirement income strategies, just like retirement savings strategies, must be designed around a client’s employer-sponsored pension plan. That’s because both defined-benefit (DB) and defined-contribution (DC) plans have a profound impact on cash flow, tax and investment planning.
Jason Evans, financial planner at Evans Retirement Planning in Winnipeg, sees a DB pension plan as a solid foundation on which to start income planning. He usually assigns it to cover as many core expenses as possible, with other savings allocated toward discretionary spending.
In contrast, Mr. Evans says the Canada Pension Plan (CPP) and Old Age Security (OAS) are the foundations for someone with a DC plan. He often recommends deferring the CPP and OAS benefits to increase the amounts and maximize the guaranteed-for-life component of the retirement income plan. He also considers annuities to boost guaranteed income.
Creating a reliable income stream is important, no matter the type or size of pension, Mr. Evans adds, because without one, people in retirement may feel they shouldn’t be spending the money they accumulated during their working lives.
“Retirees tend to spend more when they’ve got more pension income versus just a pool of investment savings,” he says.
Be strategic to minimize taxes
Retired people with pensions can adjust several levers to lower taxes while drawing an income in retirement.
Laura Southall, senior wealth advisor with the Southall Group at Assante Financial Management Ltd. in Kingston, Ont., finds it easier to save taxes in retirement than while people are working. That’s because, outside DB plans, there’s flexibility to structure what money comes from where, and when – including choosing how much to withdraw from DC and registered plans, and when to start CPP and OAS.
“You can strategize to save more taxes and be very thoughtful about it,” she says.
Pension income splitting of eligible pension income can be a tremendous tax-saver for a couple, Ms. Southall points out. There’s also a pension income tax credit available for those who claim eligible pension income on their tax returns.
The key, from Mr. Evans’ perspective, is to take a long-term view of taxation rather than focusing strictly on minimizing taxes year by year and potentially paying significantly more taxes later in life.
As a simple example, when one spouse (with a pension) retires later than the other spouse (with no pension), the temptation may be to live off the working spouse’s income while the retired spouse conserves savings in a registered plan.
However, that means the retired spouse isn’t taking advantage of a period of low taxable income to withdraw from the registered plan. There may very well be a time later – after the working spouse’s pension starts and deferred CPP and OAS kick in – when they’ll be in a higher tax bracket and regret the missed opportunity.
“We project what [a client’s] expected tax brackets are going to be throughout retirement,” Mr. Evans emphasizes.
Choosing when to start receiving CPP and OAS benefits to complement pension income must be done case by case, says Darius Muica, senior wealth advisor and portfolio manager with Lakeview Wealth Management at Wellington-Altus Private Wealth Inc. in Burlington, Ont.
One factor to consider is that OAS tracks inflation slightly better than CPP because payments adjust quarterly rather than annually. Another more consequential factor for couples is that when one spouse dies, a percentage of CPP continues, whereas OAS stops immediately.
“If you would like to defer one and apply for the other one, I would always recommend deferring the CPP and taking the OAS, [because with] the CPP, there’s no clawback and there’s going to be a CPP benefit” even if that spouse passes away, he says.
Guaranteed DB income and investment strategy
Mr. Muica treats DB plans that adjust for inflation as part of the fixed-income allocation of a client’s portfolio, which means there’s more room to explore growth-oriented investments elsewhere.
If a DB plan is not inflation-adjusted, it’s important to find ways to replace the value lost to inflation – perhaps with extra fixed-income holdings in a client’s investment portfolio.
On the other hand, Mr. Muica sees a DC plan as more like a RRIF, as investment decisions and the associated risk are the pensioner’s responsibility. Similar to a RRIF, there’s also more flexibility with a DC plan than with a DB plan.
Another planning strategy, he adds, involves holding the most tax-efficient investments (those that generate capital gains and Canadian dividends) in non-registered accounts, while interest-bearing investments taxed at higher rates are concentrated in DC and registered plans. That’s especially important for people with pension plans as they’ll often be in a high marginal tax bracket in retirement.
From an estate planning perspective, it can also help to hold investments that grow less quickly, such as those that bear interest, in an RRSP or RRIF, and to focus growth potential in TFSAs and non-registered accounts, which are not taxed as heavily on death.
“A lot of people [say], ‘I’m very happy! My RRSP has been maintaining the same value!’ What you want to be happy about is the RRSP dropping, the TFSA increasing and the non-registered [accounts] increasing. That’s something to be joyful about,” Mr. Muica says.