Tuesday, June 30, 2009

Tax Planning Strategies for Retirees

It sucks getting old. Not that I would know. However, my children seem to delight in reminding me (and my wife) of how OLD we are. It reminds me of a couple bumper stickers you see on cars belonging to "older perople".

I'm spending my children's inheritance.

Live long enough to spoil your grandchildren.

Gratefully, the federal government has taken leave of its senses over the past few years. Tax rates have been reduced for the population as a whole, but no segment of society has benefitted as dramatically as those who have reached the Golden Years. You may not be fully aware of the impact but here goes.

In addition to the Canada Pension Plan (CPP) and Old Age Security (OAS) programs, the government has taken steps to ensure that senior incomes are taxed at lower and lower rates. Here is a brief rundown on some of those steps:

  • Age credit at 65 - for 2009, everyone gets the basic personal exemption of $10,320 but once you reach age 65, you can earn an additional $6,408 before you pay any taxes.
  • Pension income tax credit. The first $2,000 of pension income is tax free after age 65. For those with qualifying pension income, the fiirst $2,000 is tax free before age 65. Even if you don't need the money, this is beneficial. You could recontribute the money back into your RRSP or move it into a TFSA (tax free savings account).
  • You are able to allocate up to one-half of your income that qualifies for the existing pension income tax credit to your resident spouse/common-law partner. This will usually result in greater after tax income from your retirement plans.
  • Age tax credit. If the recipient does not need all of the age 65 tax credit in order to reduce his or her tax payable to zero, the unused portion can be transferred to a supporting spouse.
  • Disability tax credit. The disability tax credit can be transferred to any supporting relative. The strange fact is that many seniors may qualify for the Disability credit but don't know it. Something as simple as pronounced hearing loss may save you thousands of dollars.
  • Buy a GIC from a life insurance company. If you do not have any qualifying pension income, are age 65 or over, and do not want to draw down your registered assets at this time, simply purchase a GIC through a life insurance company because the interest is considered eligible pension income.
  • In additon, there are several other ways to reduce taxable income once you retire. For RRIF's:

    • If your spouse is younger than you are, you can base your RRIS withdrawals on your spouse’s age, thus reducing your minimum annual withdrawal.
    • If the RRIF has been set up prior to December 31, consider postponing the first withdrawal to the subsequent calendar year, thereby deferring income to the following year.

    • In the case of a spousal RRSP being converted to a RRIF, ensure withdrawals do not exceed the minimum required for the first three years. This should serve to avoid attribution back to the contributing spouse.

    Another thing you can do revives a product that is not mentioned that much anymore. With the current low interest environment, people who rely on interest income are finding it difficult to manage. Why not an insured annuity strategy. An Insured Single Life Annuity is the unique concept of purchasing a single premium prescribed life annuity with little or no guarantee period to generate income for a person's lifetime. This kind of annuity on its own does not provide any estate benefit but it produces the largest amount of monthly income of all the forms of life annuities. For estate purposes, the annuitant uses some of the income from the annuity to purchase a permanent life insurance policy, normally for the amount of the annuity. The insured single life prescribed annuity ensures the annuitant a high after-tax income during his/her lifetime and the insurance protects the annuitant's capital while providing an estate benefit for his/her spouse or children. Compared with traditional income-generating investments, insured annuities offer distinct advantages even when compared with the most conservative of investment vehicles. The payments from the annuity are not fully taxable (assuming the annuity was purchased with cash), and the "effective rate of return" for these plans is often 7% to 8%.

    Another way to save on taxes (assuming you have excess cash) is by lending money to family members. Providing you charge interest on the loan at the rate prescribed by the CRA — or at the current commercial rate (whichever is lower) — you can avoid attribution back to you for income earned on the money lent. This interest must be paid to you by January 30 of the year following the year the loan was made and will be taxed as your income. The family member will be taxed on the investment income but can deduct the interest paid on the loan. This is an especially attractive option right now due to the low interest rate environment. The loan rate is set once and remains there forever. As of April 30 2009, the prescribed rate was an astronomically low 1%.

    A more complicated and risky venture is to "melt down" your RRSP's and/or RRIF's. This is a very aggressive strategy and it is not suitable for all investors. Before considering such a strategy, discuss it with the qualified financial professional that normally assists you with your financial planning.

    Here's the strategy: Borrow a bunch of money, say $100,000, and invest it in stocks or mutual funds in a non-registered savings plan, to yield you a stream of capital gains into the future. That will cost you about $4,000-$6,000 a year in interest, at today's low rates. Now, to pay that interest, remove the same amount of money from your RRSP or RRIF. The withdrawal is subject to tax, of course, but meanwhile the $5,000 in interest on your investment loan is 100% deductible from you taxable income. This means you face a $5,000 taxable withdrawal but enjoy a $5,000 taxable income deduction -- for no net tax. The consequence is that you establish a $100,000 investment portfolio outside of your RRSP to give you low-taxed capital gains, while financing this from your RRSP or RRIF. This is a worthy strategy for those with too much inside a registered plan, or for seniors who hate giving up half their RRIF payments to Mr. Flaherty.

    As always, Stay Well and Pay It Forward.

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