Retirement Income: Sorting the Pieces of the Puzzle
The Financialist • Issue 105 • April 2010
BY ANNE HAMMOND BA CIM CFP
“Retirement” is a word that evokes many different emotions – anticipation of relaxation time, concern over how to define one’s self-worth apart from a job or vocation, excitement about having the freedom to try new things, and anxiety about whether one can actually afford to retire from paid employment to pursue other activities.
To many people, the concept of retirement represents a simpler lifestyle, with fewer obligations and more freedom. How ironic, then, that your income in retirement is generally more complicated than during your working life. As an employee, your income comes primarily from your regular paycheque, deposited directly to your bank account with the appropriate amounts withheld for income taxes, pension or group RRSP contributions and any benefit fees or dues associated with your employment. You might also have some investment income, but generally this tends to represent a small portion of your income.
By contrast, in retirement, your income may come from several different sources, arriving in your bank account at various times throughout the month or year. It may or may not have income taxes withheld, and it may be deemed fully taxable, partially taxable, or not taxable at all.
Let’s consider various common sources of retirement income and how they work. The most basic and widely-received sources of retirement income are government benefits, the Old Age Security (OAS) and Canada Pension Plan (CPP).
Whether you are eligible to receive OAS is determined by your residency. If you were a Canadian resident for at least 40 years after you turned age 18, then at age 65, you are eligible to receive the full OAS pension. If your residency was less than that, you may still be able to receive a partial OAS pension.
At the time of writing, the maximum OAS payment that can be received is $516.96 per month. Payments are adjusted quarterly for inflation and are fully taxable. In addition, OAS is partially “clawed back” if your individual net income exceeds $66,733 per year, and it reaches $0 once your individual net income is $108,090 or more.
The CPP is a contributory plan, meaning that you are only eligible to receive benefits if you have contributed to CPP during your working life. You may begin collecting a reduced CPP as early as age 60 or the full CPP at age 65. Delaying your start date beyond age 65 increases the benefits you receive (see page 8 for details on upcoming changes to the CPP).
At the time of writing, the maximum CPP that can be received at age 65 is $934.17 per month. CPP payments are adjusted annually for inflation and are fully taxable.
Please note that you must apply for both OAS and CPP; they do not begin automatically. There are two other, less common, government benefits available to low-income seniors, the Guaranteed Income Supplement and the Allowance.
The next most common source of retirement income is an employer-sponsored pension plan. The benefits received may be determined either by a formula, usually based on your salary and years of service (a defined benefit plan), or by the contributions made and the earnings thereon (a defined contribution plan). Payments received are fully taxable.
As employer pensions are becoming less common, RRSPs – either individual or group plans set up through employers – are becoming increasingly important as a source of retirement income. Any funds withdrawn from an RRSP are fully taxable in the year in which they are withdrawn.
You can delay withdrawals from an RRSP until the year in which you turn 72. In the year in which you turn 71 (if you haven’t done so already), you must do one of the following: fully withdraw the RRSP funds, transfer them into an annuity (which functions much like a defined benefit pension plan), or convert them into a Registered Retirement Income Fund (RRIF). Once you convert the funds into a RRIF, you must withdraw at least a certain percent each year, but you are permitted to withdraw more if you wish.
Non-registered investments, which may include real estate, may also generate a portion of your income in retirement. Unlike the sources of income already reviewed, only the earnings on your investments (interest, dividends, rent and/or realized capital gains) are taxable. You may withdraw your principal with no income tax implications.
The newest available source of retirement income is the Tax Free Savings Account (TFSA). Withdrawals are not taxable, nor are the earnings on your investments. Thus, these accounts will likely become increasingly important for retirement income planning as time passes.
A final potential source of retirement income is the value of your home and/or other personal-use properties. These may have capital gains associated with them, but a principal residence exemption is available from the Canada Revenue Agency, which may help to reduce or eliminate any realized capital gains when these properties are sold or transferred.
To review your personal (potential) sources of retirement income and how they fit together, please contact your Rogers Group Financial advisor.