After a lifetime of saving, it can be hard to flip the switch and start dipping into the cash you’ve considered untouchable for decades. While you don’t want to go overboard and spend too much, you’re also not joining a Carthusian monastery — you want to enjoy this new phase of life. Here’s how to set yourself up for maximum (responsible!) financial enjoyment.
How do I decide how much to pay myself?
If you don’t want to outlive your savings, it’s best to start with a plan — preferably a conservative one, in case you make it to nonagenarian status. One common way to do this is to follow the 4% rule: give yourself an annual salary of 4% of your total retirement savings. In most cases, that should ensure that you don’t run out of money before you add the final candle to your cake. Add your CPP and OAS payments to that number, and there’s your new annual retirement salary to build a budget around.
Ready for some math (you can skip the next 3 paragraphs if not)? Here’s how the 4% rule works: if you have a $1 million portfolio, you withdraw 4%, or $40K, in your first year of retirement. That brings your account balance down to $960K, but since that money is invested in the markets, it still has time to grow. If you get a conservative return of 4%, your portfolio would be back up to $998,400 by the end of the year.
The following year, to account for inflation and keep your spending power equivalent to that initial $40K, you take out $40,800 (2% more than the previous year). The year after, you take out $41,616, and so on. Continue with this process and (theoretically, because it all depends on the markets) your account shouldn’t hit zero until 34 years later, when you turn… 99.
If you exhaust your time on earth before that, it just means you’ll leave a little money for your heirs. Should you want to leave more to them, even moderate decreases in spending will add up: every $1,000 you knock off of that initial $40K salary means roughly another $75K in the bank for them when you go. (At the ripe old age of 99, remember. Should your toes point permanently up before then, it’ll be even more.)
Which accounts should I take my money from first?
Although you can’t avoid taxes in retirement, you can influence how much you are taxed.
For example, many people wait too long to start taking money out of their RRSP. When you turn 72, the government makes you convert your RRSP into an RRIF, and that comes with annual withdrawal requirements that get bigger the older you get. Which often means big tax bills.
Instead, a lot of people would benefit from taking their RRSP payments earlier — just enough that, when it’s added to your OAS and CPP/QPC payments, your income falls right inside the lowest tax bracket. This way you have less in your RRSP when Ottawa gives you a not-so-gentle nudge to convert it to an RRIF, smoothing out your taxable income and lowering your overall taxes.
Any extra money you need can come from non-registered accounts, followed by TFSAs, which have already been taxed. Just realize that TFSAs can be great places to leave money for your heirs (more on that shortly). It can get complicated, depending on your retirement goals and how much you’d like to leave to heirs so we’d suggest catching up with an advisor or a financial planner to make sure you’re aware of all the implications.
What’s this about being forced to convert my RRSP into a RRIF?
Yeah, it’s the government’s way of making sure you start spending the money its tax breaks helped you build up. How much do they make you withdraw? To go back to the $1 million portfolio we used in the example above, you’d have to withdraw 5.40% of the total balance the year you turned 72. Make it to 90, and you’re forced to take out nearly 12%. Once you hit 95, that number jumps to 20%.
It’s worth noting, however, that RRIFs do give your portfolio extra years of tax-free growth, which the alternative — a non-registered account — does not. There can be positive and negative tax implications to either option, so again, check with an advisor.
What’s income splitting? Should I be doing that?
As the name implies, income splitting is when income is shared across two people with the goal of reducing their total tax burden. You most often see it in terms of RRSP contributions. If one partner has substantially more retirement savings than the other, they’ll be taxed more heavily in retirement. But spousal RRSPs allow the higher-earning partner to make contributions to (but no jokes about!) the lower-earner’s RRSP. We get into the details in this article. And here’s an easy flow chart to help you figure out if spousal RRSPs are right for you.
What about my heirs? Where should I put the money I want to go to them?
Unless your favourite scion is the CRA, you’ll want to be thoughtful about where you keep the money you hope to leave behind. Trusts can help (we explain how). But you can also get some protection through your TFSA and RRSP, assuming you set them up correctly.
If you haven’t set a beneficiary for your RRSP (or RRIF, once you’ve converted to one), do it now. Otherwise any remaining money is lumped in with your estate and taxed along with everything else. If your beneficiaries are your children, your RRSP proceeds will still be taxed as ordinary income when you die, but they won’t get stuck in probate. If your beneficiary is your spouse, they can transfer the assets in your RRSP directly into theirs without affecting their contribution room. And just as was the case for you, they have to pay tax on the proceeds only when they make withdrawals.
TFSAs are a little simpler, especially if you have a spouse or partner and named them as a successor holder. In that case, the assets in your TFSA simply become theirs and can keep growing tax-free. If you didn’t list a beneficiary, it’s less of an issue with TFSAs. Without a beneficiary, the assets in your TFSA will go to an heir, who will need to move them into their own TFSA (assuming they have contribution room) or pay taxable gains on anything accrued after your death.
