While preparing a draft financial life plan for a new client recently, we were reviewing the client’s existing planning and came across a fairly standard issue that should be addressed in their plans: the efficient withdrawal of income during retirement. As financial planners, we can help retired clients manage cash flow by determining their most tax-efficient withdrawals, factoring in personal circumstances, and adjusting as needed through retirement.
To be fair, clear elements in the planning details were missing. This was caused by missing details, the clients answering questions to the best they understood them, and not having complete information. It appears that the underlying principles were the way questions were posed, the client’s understanding of them, and the detail of information requested and provided.
The issue at hand here was the tax-efficient withdrawal of income at, and during, retirement. There will be trigger points, potentially, or it could be a slow evolution. The level of cash flow will be based on the client’s needs and wishes tempered with the reality of how much they have available via income sources.
Retirees may be able to draw on a variety of income streams:
- government pensions,
- private pension plans,
- registered accounts,
- investment income from taxable accounts,
- rental income,
- proceeds from the sale of a home,
- inheritances, and
- even part-time employment income.
A well-drawn hierarchy of withdrawals will seek to smooth out tax rates over time, reducing the tax hit through retirement and, eventually, to the client’s estate.
For example, a single man, aged 65 with large RRSP/RRIF balances may decide to delay triggering Canada Pension Plan (CPP) and old-age security (OAS) in order to boost these amounts at age 70 and protect against longevity risk.
At the top of the client’s withdrawal hierarchy between the ages of 65 and 70 is making withdrawals from RRSPs and RRIFs beyond the required minimums. By drawing down on RRSPs and RRIFs between the ages of 65 and 70, the client will mitigate the tax hit, including potentially the OAS clawback, that he might otherwise have when he begins drawing CPP and OAS at 70.
Next in the hierarchy is tax-loss selling and liquidating non-appreciable investments in taxable accounts, followed by arranging a tax-efficient regime of withdrawals, such as investments that offer return of capital, to achieve tax deferral.
Finally, capital gain harvesting and withdrawing from a TFSA round out the client’s hierarchy. Taking out savings from a TFSA should be pretty low in the hierarchy because, even for seniors, it’s a pretty powerful account.
At 70, the client’s withdrawal hierarchy will change: he begins collecting CPP and OAS and withdraws no more than the minimum from a RRIF in order to manage income levels and OAS clawback.
Other client scenarios will generate different hierarchies. For example, for couples with uneven incomes, the higher-income spouse will look to boost pension income from certain sources so as to take advantage of income-splitting opportunities with a lower-income spouse.
At the end of the day, we want to work with our client to help them to create a retirement vision. It’s their retirement vision. We need to understand all the various retirement income sources and use those tax-efficient withdrawal strategies possible. As mentioned, as the client ages, their withdrawal hierarchy will change. Now in our client’s case, there was an opportunity to maximize account contributions, re-distribute monies to other accounts to maximize tax efficiencies and time to prioritize our recommended withdrawal strategies. Our recommended strategies made up for this area which was missed in their existing planning. Our client greatly appreciated our suggestions. This went a long way to their Keeping Life Current.