We all know the over-worn adage about the inevitability of death and taxes, but just because we recite it doesn’t mean we have to stand by idly and just let it happen.
In fact, for those who take the time to understand and manage their income sources as they age, tax burdens may be reduced or delayed.
For those who take further advantage of options when planning their estate, surviving spouses and other beneficiaries may be delivered a gift of ongoing tax relief – all at the expense of the tax collector along the way.
Income in retirement
Registered money
For most of us, our principal income source will be a draw from a registered plan of some sort. The most common types of such registered income plans are:
- Life annuities from a registered pension plan (RPP);
- Annuity payments from a registered retirement savings plan (RRSP) or deferred profit sharing plan (DPSP); or
- Payment from a registered retirement income fund (RRIF).
While terms and investment performance will dictate how much income will actually be received, in all cases the income is fully taxable.
Non-registered savings
The tax treatment of non-registered savings will depend on investment choices and how the Canada Revenue Agency (CRA) characterizes the income derived from each. Non-registered savings income includes:
- Fully taxable interest income;
- Capital gains, 50% of which is taxable as income;
- Dividend income with net tax cost generally falling in somewhere between interest and capital gains (varies by income level and marginal tax rate); and
- Non-taxable return of capital or drawdown of capital.
The ability to choose the type of investment return and manage its timing can be a valuable tool for balancing a person’s tax bill over time.
Canada/Quebec Pension Plan
The Canada/Quebec Pension Plan provides monthly retirement benefits to pensioners, based on credits accumulated during their working years. The maximum monthly pension for 2008 is just under $885, and is fully taxable.
A pensioner may draw their full pension entitlement at 65, elect to receive an earlier, reduced base pension or delay payments to obtain a higher monthly amount later in life. Clients may elect to receive as little as 70%, beginning at age 60, or as much as 130% if they defer until after age 70. The amounts can be strategically coordinated with the timing and tax treatment of other income sources.
Old Age Security
OAS entitlement is based on years of residence in Canada after age 18. It becomes payable upon reaching age 65, but is subject to a 15% clawback for those earning income above a minimum threshold. In 2008 this threshold is set at $64,718. A person entitled to a full OAS annual pension of approximately $6,000 will have it fully clawed back if they earn more than $105,043.
Interestingly, tax on an OAS pension may be paid monthly, where the CRA withholds taxes payable from each pension payment (electable), quarterly, which may be required by law in some circumstances, or annually – many people calculate their tax owing when filing their annual tax return.
There are also a number of non-taxable benefit programs related to OAS, the full details of which are beyond the scope of this article. Some of these include:
- Guaranteed Income Supplement (GIS) for low-income OAS recipients;
- Allowance for low-income seniors (age 60 to 64) whose spouse or common-law partner is eligible for, or currently receiving OAS and GIS; and
- Allowance for the survivor, a payment to low-income widowed spouses (age 60 to 64) who are not yet eligible for OAS.
Tax credits
Age amount
A person may claim the age amount beginning in the year they turn 65. The federal credit is determined by applying the lowest bracket federal rate to a prescribed amount. For 2008, that calculation is 15% x $5,276 for an annual credit worth $791. Similar calculations are used to determine provincial credits, which range in value from $216 to $364.
There is a 15% clawback of the federal credit for income over $31,524 in 2008. The credit is fully clawed back at $66,697. Similar clawbacks apply for provincial credits but the threshold and clawback rates vary.
Both the prescribed amount and the clawback income thresholds are indexed annually.
Pension income amount
This pension credit is determined by applying the lowest bracket federal rate of 15% to the actual eligible pension income received, to a maximum of $2,000, resulting in a maximum possible credit of $300. In contrast to the age amount, the prescribed $2,000 amount is not indexed. Once again, similar calculations are used when calculating provincial credits, some of them indexed, with credit values ranging between $53 and $300.
For someone 65 or older, common qualifying income types include:
- Life annuity from a RPP;
- Annuity payment from a RRSP or DPSP;
- Payment from a RRIF;
- Income component of certain annuities.
For those under age 65 the definition is more restrictive, generally being limited to:
- Life annuity from a RPP; or
- Income from RRSP, DPSP or RRIF sources described above if the income comes from the death of a spouse or common law partner.
Disability amount and medical expenses
While these credits are not age specific, it is more likely they can be claimed as the client ages and feels the effect of their accumulated years.
Amounts transferred from your spouse or common-law partner
If a taxpayer has reduced taxable income to zero but still has unused tax credits, those may be transferable to a spouse. Again, this is not necessarily an age specific issue, but may be more likely to arise for retired couples if, for example, retirement income is earned by one spouse while the other spouse has disability or medical issues.
Pension income splitting
Announced in the 2007 Federal Budget, pension income splitting is now a reality. At tax reporting time, a qualified pensioner and his or her spouse can report up to 50% of eligible pension income received on a spousal return.
There are four principle benefits:
- Bracket management. Shifting income from a high tax bracket pensioner to a lower tax bracket spouse can reduce net taxes paid.
- Old age security. Shifting reduces income for pensioners who are in the clawback range.
- Age amount. Like OAS, the shift reduces income for pensioners over 65, who are in the clawback range.
- Pension amount. Where the spouse does not otherwise have eligible pension income, this tax credit may be accessed.
Bear in mind that reducing the pensioner’s income will obviously increase the transferee spouse’s income, potentially triggering clawbacks or “bracket creep” which could offset the benefits of transferring amounts in the first place.
TFSAs
The 2008 Federal Budget put in place a new savings vehicle called a tax-free savings account, or TFSA. Beginning in 2009, each person 18 and older will be entitled to use $5,000 of TFSA contribution room, cumulative each year, with that figure indexed upward over time.
The simplest way to understand the tax characteristics of the TFSA is to compare it to the commonly known RRSP/RRIF arrangement:
- RRSP/RRIF: Pre-tax money goes into the plan, no tax is paid on income earned in the registered account, all assets are fully taxable when withdrawn.
- TFSA: After-tax money is invested, no tax is paid within the account, withdrawals, including gains, are100% non-taxable coming out.
The TFSA could have great value for those past their income earning years, who are no longer accumulating RRSP room, especially for those past age 71 when RRIF minimum payouts force the depletion of other tax sheltered funds.
Testamentary trusts
Testamentary trusts can be created for your spouse or any other beneficiary using your will. The key tax benefit of this type of trust is that a separate taxable entity is entitled to graduated tax bracket treatment. This allows and facilitates income splitting opportunities between the trust and its beneficiaries, especially wealthy beneficiaries. In effect you are lending a part of your legal personality to an ongoing trust that may last for years or even decades into the future.
That’s one way that you may be gone but not forgotten – at least in a tax sense.