Chess and retirement decumulation

The end game requires a dynamic strategy

Did you catch The Queen’s Gambit series on Netflix? It came out a few years ago, and is still playing if you want to take a look. It’s a fictional account of a 1960s prodigy who disrupts the world of chess. Apart from drawing millions of viewers, it’s led to a bonanza in chessboard sales.

There are some interesting parallels between chess and our income choices in retirement. As in chess, a lot of moving parts affect retirement, some we can control and some we must contend with. Both domains require strategy, forethought and flexibility. 

Decumulation with tax in mind

Some retirement decisions are one-time, like starting Old Age Security and Canada Pension Plan. Others may be infrequent, like winding-up a business, downsizing a home, whether to engage assisted living support or when to consider a move into long-term care.

In terms of private savings, a critical juncture is when to switch modes from building retirement savings to drawing from them. This is the move from accumulation to decumulation, with three common savings sources to draw from: an RRSP/RRIF (including locked-in versions), a TFSA and non-registered investments. Respectively, the draw from each of these sources is taxable, non-taxable and partially taxable.

Usually, the desire is to maintain a certain lifestyle while minimizing income tax. That’s not as simple a task as it may seem, given our progressive income tax system that charges higher tax rates on higher income levels. Paying tax may not be pleasant, but too much focus on reducing a current year’s tax bill could lead to a disproportionately heftier tax bill in future years, especially if brought into income at death. It depends on personal values how much of tax planning is about the here, the here together (as a couple), and the hereafter.

The key is to determine how best to draw on these savings sources to achieve the desired result.

Planning through the permutations

Effective decumulation is often framed as a search for the optimal order for depleting each savings source before moving on to the next. That’s the way financial planning software algorithms may solve for targets such as maximizing net wealth at life expectancy. In this case, the software might provide a rank order of the six possible permutations among the three savings sources.

But we shouldn’t expect the output to be a set-it-and-forget-it prescription. That would require knowing not only our present circumstances and intentions, but also all future developments.

Consider again the game of chess. The board is an 8 by 8 grid, with each of the two players having 16 playing pieces. So, before the game starts, half of the 64 squares are occupied. White chooses among 20 opening moves, as does Black to follow, leading to 400 possible board layouts when White considers move number two. By round three, there are 197,281 layout possibilities, and over 119 million two moves later.

Amazing as that is as an example of exponential expansion, it pales in comparison to our years in retirement. Life has far more variables, and more actions that may be taken with each. These include the option to draw from multiple sources from time to time to tactically exploit tax opportunities, rather than fully liquidating each source in succession.

Vision, revision and annual reviews

Chess and financial planning share the need to anticipate, act, observe and adapt. That’s what chess masters do, always looking a few moves ahead and then continually adapting as each turn comes around.

Similarly, as life unfolds in retirement, we are not necessarily bound to continue on a path that was suitable when set some years ago, but that may no longer fit current needs. Changes happen to us, and to the world around us:

    • Personal circumstances
    • Available wealth, in each savings source and as a whole
    • The world we live in, with particular attention on any new or modified tax rules

Often, things are fairly fixed over the short term, but become more flexible looking further out in time. With some foresight and forethought, adjustments can be made according to changing conditions – both as required and as desired – in the way we spend our time and how we spend our money.

The important point to emphasize here is that the process is dynamic, ideally anchored by annual reviews with a capable financial advisor. At each turn, advisor and client can plot the best course using the information presently at hand, with full understanding and intention that the plan will revisited as each year unfolds, and revised as necessary according to developments.

CPP premium increases through 2025

Final steps in a decade of CPP enhancements

We’re now through the Canada Pension Plan (CPP) enhancements announced in 2016, commenced a few years later, and completed in 2025. 

Phase One was a multi-stage increase in premium contribution rates spread across five years, followed by the introduction of a second layer of contributions in Phase Two that ran for another two years. 

Over the long term, with continuing annual indexation of both contribution components, these enhancements are designed to raise the CPP income replacement level from one-quarter to one-third of eligible earnings.

Phase One ended its five-year run in 2023

Phase One, which began in 2019, increased employer and employee contribution rates by 1% over five years, bringing the prevailing 4.95% rate in 2018 to 5.95% for 2023 and following years. For the self-employed, who bear both parts of the premium obligation, it was double the ascent from 9.9% to 11.9%.

The rate is applied to the year’s maximum pensionable earnings (YMPE). The YMPE for 2026 is $74,600. At that rate, the maximum contribution is $4,230 each for employer and employee. Self-employed individuals pay both parts, totalling to $8,460.

 

 

Personal budgeting in the wake of higher premiums

Over the five-year phase-in period, that cumulative 1% addition to the 4.95% rate worked out to an increase of just over 20%. While each annual addition over the five years may not have been all that noticeable to workers, in total it eroded as much as $631 on a person’s annual paycheque in 2023 from what it would have been without the changes. For those self-employed it’s as much as double that, or $1,262. 

Keep in mind that, though some people may call it a ‘payroll tax’, it truly is a premium payment that contributes to that person’s own CPP retirement pension down the road. As well, on a current basis employees get some relief when they claim a tax credit for CPP premiums paid when filing their annual income tax return, and for the self-employed the employer-side premium is deductible against business income.  

Still, this bit of imposed belt-tightening does affect paycheque to paycheque cash flow for employees at low to average income levels. And for those with income that pushes beyond the YMPE, the Phase Two changes have further implications for budgeting expectations. We turn to the details of that second phase next. 

Phase Two introduction of a second layer of contributions

Phase Two added a second earnings limit beyond the YMPE, that new figure now known as the year’s additional maximum pensionable earnings (YAMPE). The YAMPE began as 107% of the YMPE in 2024 alone, then moved to 114% of YMPE for 2025 and later years. Though the YMPE and YAMPE thresholds are separately indexed, they use the same standard indexation factor, so the YAMPE will remain at 114% of YMPE ongoing.

Employer and employee contributions up to the YMPE will continue at the 5.95% rate, while the premium rate between the YMPE and YAMPE is 4% for each of the parties. 

  • For employers, all contributions are deductible, whether on income below the YMPE, or on income between the YMPE and YAMPE. 
  • For employees, contributions up to the YMPE continue be entitled to a tax credit claim. For contributions between the YMPE and YAMPE, a deduction is allowed, which better aligns to the employee’s cost since it’s effectively at the individual’s marginal tax rate, rather than the low bracket rate accorded to the credit.

The YAMPE for 2024 is $85,000, being 114% of the YMPE, resulting in a maximum premium of $416 if income is at or over the YAMPE for the year. Alternatively, if the employee’s income is less than the YAMPE, the additional premium is based on income minus YMPE, so for example if the employee’s income is $5,000 over the YMPE then the YAMPE premium that year would be 4% of $5,000 = $200. 

Past, present, and future events prompting more changes?

The CPP is funded by employer and employee contributions. Excess cash flow is invested by the CPP Investment Board in financial markets to fund anticipated future cash shortfalls as the ratio of beneficiaries to contributors rises due in large part to the ageing of the Canadian population. 

In its fiscal sustainability report in 2020 – in the midst of the Covid-19 pandemic – the parliamentary budget officer (PBO) raised the spectre that additional funding may be required for the CPP. At the time, the PBO estimated that increased contributions or reduced benefits amounting to 0.1% of GDP may be required for the CPP to meet its 75y ear sustainability metric. In subsequent fiscal updates in 2021 and 2022, the PBO was no longer seeing a fiscal gap in the 75-year measure. 

Still, the pandemic brought to light how the global economy can be disrupted by unpredictable (or at least unpredicted) events. At time of article publication in 2026, we’re experiencing historic climate-related water and fire events (having both ecological and economic effects), multiple major military conflicts, and the pain and uncertainty of a trade tariff war with our closest trading partner. These will be important considerations when economists and policymakers eventually revisit the CPP (as it’s actually required to be reviewed triennially), so it may not be too long before we see further CPP adjustments beyond the current enhancement process. 

Deducting investment loan interest

Managing the tax aspect of borrowing to invest[1]

Investors may invest their own money, and may also borrow to put more money to work. Also known as ‘leveraged investing’, the presumed intention is to increase market exposure and multiply potential investment returns. Depending on market movement at a given time, that multiplication can work either for or against an investor, which is why such decisions should be discussed with a qualified investment advisor.

That advisor-investor discussion should focus first on how a planned strategy fits that individual’s financial circumstances, including objective risk tolerance and subjective comfort with risk. Attention can then turn to the tax issues, and in particular the rules for claiming interest expense as a tax deduction.

Requirements for deductibility

Interestingly, interest is not defined in the Income Tax Act (ITA), so case law has filled in that gap. Generally, it is compensation paid for the use of a principal sum, calculated on a day-to-day accrual basis. Less technically, it’s what a borrower pays for the use of a lender’s money.

When it comes to deductibility, the ITA deals with that in a roundabout way, first denying deductibility for interest in paragraph 18(1)(b), then setting out conditions to allow for exceptions to that denial in paragraph 20(1)(c).
The four key requirements follow.

1.     Paid or payable in the year

Most taxpayers will deduct the amount of interest that accrues in relation to a year, but if a taxpayer uses the cash method of accounting then it is the amount actually paid in a year that may be deducted.

2.     Legal obligation on borrower

A borrower records interest as an expense once all conditions for the legal obligation to make the payment have been met. If the payment is contingent on a future event then a deduction cannot be taken until that contingency has been fulfilled.

3.     For the purpose of earning income from a business or property

The borrower must have a reasonable expectation that the investment will earn income, even if the income may be less than the interest expense. This requirement will be met if the investment is capable of earning income (whether or not there is income in a given year), but not if the investment is only able to produce capital gains.

4.     Amount of interest must be reasonable

The reasonableness of the interest charge is determined with reference to prevailing market rates for debts with similar terms and credit risks. In an arm’s length transaction with a financial institution, the reasonableness will usually be obvious (though not guaranteed) by the commercial practices and documentation employed. In other cases a closer look at the circumstances may be required.

Application to marketable securities

Per the third requirement above, an investment may be made in either a business or property. Property may be either real property (more commonly known as real estate) or moveable property. Marketable securities fall into that last category of property.

Individual securities or mutual funds

Marketable securities include instruments like stocks and bonds, and may be either individually-owned or held as part of a pooled investment structure. Common pooled structures include mutual funds, exchanged-traded funds (ETFs), and segregated funds issued by insurance companies.

Qualifying account type: Non-registered

For interest to be deductible, the expected income must be taxable. Accordingly, the relevant type of investment account where the securities are purchased and held is a taxable account, also known as an open, cash or non-registered account.

Registered accounts

Interest is not deductible when a loan is used to earn income that is tax-exempt. Thus, no deduction is allowed when borrowing to invest in registered plans such as a registered retirement savings plan (RRSP), tax-free savings account (TFSA), registered education savings plan (RESP), or registered disability savings plan (RDSP).

This does not prevent a person from borrowing to fund such accounts, for example the practice of using RRSP loans, but rather it is a prohibition on deductibility of the associated interest when used in this manner.

Current use, and replacement property

It is the current use of the borrowed money that determines deductibility. On initial borrowing, the initial use and current use will be the same. Later transactions with the property can affect deductibility, depending on the value of the invested property, the outstanding loan balance, and how the proceeds are reallocated. *

When an original investment is disposed for an amount equal to the amount borrowed:

    • If the entire proceeds are moved to one or more qualifying investments, then all interest charges will continue to be deductible.
    • If the proceeds are divided among qualifying and non-qualifying property, deductibility will be limited to the proportion of the proceeds allocated to the qualifying investments.

If that original investment has grown in value relative to the amount borrowed, the investor has some flexibility in how the borrowing is linked to the replacement property.

    • The investor may still choose to allocate the borrowing proportionately among the new properties.
    • However, it may be advantageous to make a disproportionate allocation. Assume an original borrowed/ invested amount of $100,000 had grown to $150,000 when disposed, with the proceeds used to acquire qualifying investment “QI” for $130,000 and non-qualifying property “NQ” for $20,000. The investor may choose that the current use of the borrowed money is entirely for QI since its value exceeds the outstanding loan balance, allowing for continuing full deductibility.

Where the value of the replacement properties is less than the outstanding loan balance, a pro-rata allocation is required. Assume the original $100,000 borrowed/invested in the above example is disposed for $80,000, with $60,000 used to acquire QI and $20,000 used for NQ. The current use of the borrowed money would be $75,000 in a qualifying investment ($60,000/$80,000 x $100,000), limiting the deduction to 75% of the interest charges.

* In these examples, the gross proceeds are being used for the replacement properties, with any tax on capital gains (or recovered tax on capital losses) managed through an outside source/account. Alternatively, tax could be managed from within the investment, with the net proceeds reinvested. The numerical illustrations would be more complicated under the latter approach, but the investor’s net tax cost is the same either way, and the principles being discussed remain the same. 

Drawing down investments

As with any investment held over several years, realized income will be distributed and taxed to the investor annually. Assuming growth over the long term, the holding at any given future date will be a combination of the invested capital – in this case originating from borrowed money – and the undistributed growth of the investment, which for tax purposes is the unrealized capital gain.

There are two tax issues that arise on disposition of the investment:

    • A capital gain (or capital loss) will be triggered on a disposition. Though the tax calculation is no different whether the original money was borrowed or was the investor’s own source, it helps to first isolate and resolve the effect of the disposition, to then fully focus on what happens with interest deductibility thereafter.
    • It is the actions taken after the disposition that affect interest deductibility. This is the application of the ‘current use’ principles above, illustrated below according to the way in which the drawdown occurs.

Lump sum disposition

If an investor disposes of an investment in full, tax will be due on the realization of the entire capital gain in that one year. The remaining amount received will be a non-taxable return of capital (ROC). (See our article “Capital gains taxation – Deferred, preferred and more” for a more detailed discussion of the associated tax issues.)

If the investor reallocates the proceeds from disposition of an investment to other property, the deductibility of any continuing interest charges will be governed by the principles outlined earlier. On the other hand, if the investor decides to use a portion of the proceeds to retire the outstanding loan balance, there will be no further interest charges and therefore no deductibility issues to contend with.

Periodic or systematic withdrawals

An investor may instead decide to draw the money out periodically as desired, or on a regular routine through a systematic withdrawal plan (SWP). Either way, each withdrawal will be a combination of ROC and realized capital gains. (See our article “Systematic withdrawal plans” for a more detailed discussion of the associated tax issues.)

Often the plan for such accounts is to allow them to accumulate undisturbed for a period, then to use a monthly or annual SWP to supplement personal finances later in life. Whether used to acquire capital property for personal use or to spend on personal expenses, this is effectively a reallocation of the withdrawn amount toward non-income earning purposes. As such, a portion of the continuing interest payments will no longer be deductible.

In the simplest case where there have been no prior withdrawals and no further contributions beyond the original investment, the non-deductible portion will roughly equal the ROC component of the withdrawal divided by the outstanding loan. (A qualified tax professional should be consulted to verify the facts and perform the calculation.) However, the investor may preserve deductibility on future interest charges by paying down the loan by the corresponding amount, such that the remaining debt continues to be linked to an income earning purpose.

ROC on ‘t-series’ mutual fund distributions

Some mutual fund managers allow investors to receive a fixed annual distribution out of their mutual fund holdings using a t-series distribution. The “t” refers to tax, and specifically that such distributions may enable the deferral of tax on unrealized capital gains within the mutual fund.

The manager allows the investor to choose a single digit distribution percentage, usually in the 4% to 6% range. The rate is applied to the investment balance at the beginning of the year to arrive at equal monthly payments made over the course of the year. At the end of the year, the manager tallies up the fund’s performance and reports what portion of those payments were distributions of realized income, with the remainder being ROC.
For some mutual funds there may be no realized income, such that the entire year’s payments may be ROC.

Being a return of the investor’s own capital, the ROC portion is tax-free. Though appealing in the current year, the trade-off is that the investor’s adjusted cost base (ACB) is reduced by the amount of the ROC distribution. This means that a greater proportion of each future investor withdrawal will be taxable, as the realized capital gain part of a withdrawal is the difference between the fair market value of the withdrawal and its proportionate ACB.

As with a periodic withdrawal or SWP discussed above, the effect on interest deductibility depends on what the investor does with the distributed amount. To the extent that it is used for personal use property and spending, future interest deductibility will again be trimmed down. Importantly however, the degree of effect may be much larger on a t-series distribution due to the larger ROC proportion, potentially being the entire annual withdrawal. (Once more, ROC does not necessarily equal the at-risk amount of a loan. Consult a qualified tax professional.)

Managing and servicing the loan

Principal repayments

Pursuant to the first two requirements for deductibility above, the borrower must make interest payments and be legally obliged to do so. Invariably the borrower will also have a legal obligation to pay the principal back to the lender, either on a fixed schedule, at the end of the loan term, or in whatever manner the parties may agree.

Principal repayments do not entitle the borrower to a deduction, though they do reduce the amount of the outstanding loan on which future interest will be calculated.

Compound interest

By agreement or through a lender’s concession, a borrower may be allowed to forego an interest payment in a year, with the amount then added or ‘capitalized’ to the principal debt. As the borrower will not have paid interest in respect of that year, no deduction will be allowed at that time for the capitalized amount. A deduction will be allowed as interest is paid on the outstanding balance in future, as long as all other requirements are met.

Taxpayer onus, recordkeeping, and linking sources & uses of borrowed money

Once the decision is made to proceed with a leveraged investment strategy, an investor must understand that the onus is on that person as a taxpayer to prove entitlement to tax benefits, in this case the deductibility of interest on investment loans. Given the range of issues canvassed in this bulletin, it should be clear that an investor carries a substantial burden in meeting that onus.

Often, a single loan advance may be used to purchase qualifying investments in a single account. Alternatively, that advance may arrive in a temporary holding account which is then allocated to a combination of places, possibly all deductible (at least at first), or a combination of deductible and non-deductible purposes. A degree further in complexity might be the use of a line of credit for these various purposes, from which future draws are taken, interest charges paid, and principal amounts repaid.

Whatever form the borrowing may take, good organization and good recordkeeping will allow an investor to better monitor and evaluate the effectiveness of the borrowing strategy. That also sets the stage for both tax reporting and tax-based decision-making.

[1] For more information, readers may consult Canada Revenue Agency Income Tax Folio S3-F6-C1, Interest Deductibility.