Are you curious about the different sources of retirement income in Canada and how they are taxed? In this blog, we will discuss the three main pillars of retirement income: government benefits, employer pension plans, and private savings and investments.
Government Benefits
- Canada Pension Plan (CPP): Provides a monthly retirement pension based on your contributions over your working years. You can start receiving funds as early as age 60 or delay until age 70. The longer you wait, the more you receive.
- Old Age Security (OAS): Available to most Canadians at age 65. The amount received is based on how long you’ve lived in Canada after age 18. Delaying the start increases the benefit amount. There’s also a Guaranteed Income Supplement (GIS) for low-income OAS recipients.
Employer Pension Plans
- Defined Benefit Plan: Provides a guaranteed amount based on your salary and years of service. This amount is guaranteed for life.
- Defined Contribution Plan: Involves contributions from both employer and employee, with retirement income depending on investment returns. The risk here is on the employee, as the returns depend on market performance.
Personal Savings and Investments
- Registered Retirement Savings Plan (RRSP): Contributions are tax-deductible, and the investment grows tax-free until withdrawal. Withdrawals are taxed as ordinary income.
- Tax-Free Savings Account (TFSA): Contributions are not tax-deductible, but the investment grows tax-free, and withdrawals are also tax-free.
- Non-Registered Investments: Include mutual funds, stocks, bonds, ETFs, real estate, and more. These do not receive special tax treatment but can provide preferential tax treatment for capital gains and dividends.
Taxation of Retirement Income
- CPP and OAS: Treated as ordinary income. OAS is subject to a clawback if your net income exceeds a certain threshold.
- GIS: Not taxable but affected by other income sources.
- Employer Pension Plans: Both defined benefit and defined contribution plans are treated as ordinary income.
- RRSPs: Fully taxable as ordinary income upon withdrawal. Converts to a Registered Retirement Income Fund (RRIF) by age 71.
- TFSAs: Withdrawals are non-taxable, providing a strategic advantage for tax efficiency.
- Non-Registered Investments: Capital gains and dividends receive better tax treatment compared to interest income, which is taxed as ordinary income.
Strategic Planning for Retirement
Planning your retirement income is crucial due to the various sources and their tax implications. It is recommended to start planning at least 10 years before retirement to create a flexible and tax-efficient strategy. If you’re already in retirement, it’s never too late to develop a financial plan to optimize your income withdrawals.
For more detailed information, check out my videos on RRSPs, CPP, and OAS. Stay tuned for weekly updates based on real client conversations.
Take care, and happy planning!
Full Transcript
Are you curious to hear about sources of retirement income in Canada and how they are taxed? If that’s the case, you’re in the right place. Today we’re going to talk about the different sources of retirement income and how they are taxed. And the way I see it, I really see it as three pillars. One, you have the government benefits. Two, you have the employment pension plans. And lastly, it’s your private savings and investments. Okay, so let’s start off with the government benefits. The first one is the Canada Pension Plan, which provides a monthly retirement pension.
If you have contributed, because it’s based on how much you’ve contributed over your working years, you could take funds from this as early as 60, or you could delay it as long as 70. The longer you delay it, the more you receive, and the earlier you take it, the less you receive. I have an entire video on CPP. You can check my channel to see me discussing how it works. There’s also the Old Age Security, and that’s also among the payments.
It is available to most Canadians at age 65 and older. Now I know some people confuse CPP and OAS, and some people think that you can take OAS at age 60. That’s actually not the case. It starts at age 65. And the longer you delay it, the more you receive. Also, the amount received is based on how long you’ve lived in Canada after age 18. If you’ve been here for at least 40 years, then you qualify for the maximum amount.
The minimum number of years you need to have lived here to receive some type of payment is 10 years. It’s really proportional. So, for example, if you have only been here 20 years after age 18, when you first start collecting OAS, you’d only receive half the amount of the full qualification that you would have received if you had lived here for 40 years. So that’s OAS.
The difference between CPP and OAS is that CPP is really based on your contributions, and OAS is based on your residence and being a permanent resident. You don’t have to necessarily contribute to OAS. Then we have the GIS. GIS is money that’s provided to folks who qualify for OAS, so they’re really OAS recipients, but they have a low income. Based on your income threshold, the government will provide you with GIS income.
I will talk about how that’s taxed, but it really depends on your annual income and also your marital status.
Now let’s talk about the employer-sponsored pension plans. You have the defined benefit plan and the defined contribution plan. As the name suggests, a defined benefit plan provides a guaranteed amount. The way it works is that an employer will look at your salary and your years of service. Based on that, they will tell you how much you qualify for, and usually, there is a portal you can log into, or you could call whoever is responsible for administering these plans, and they can tell you how much you qualify for now and the trajectory you’re on. A beautiful thing here is the amount you receive is guaranteed for life, right?
Then you have the defined contribution plan where the employer contributes, and you as an employee can also contribute. The retirement income depends on investment returns. That means you’re contributing monthly, but it is being invested in some type of fund or portfolio.
Your return will depend on what the market does. So, you have investment returns from these accumulated funds over time. More recently, I’ve been seeing a lot more defined contribution plans versus defined benefit plans. The reason for that is because with a defined benefit plan, the employer has all the risk because they have to provide that return for life. With a defined contribution plan, the risk is more on the employee.
It is on the employee because it depends on what the market does. Now let’s talk about your personal savings and investments. The first one is the registered retirement savings plan (RRSP). I also have a video on that, so check it out. The investment here is tax-deferred in this retirement savings plan. However, your contributions are tax-deductible. When you contribute, you receive a tax deduction. That money grows tax-free until withdrawal.
Then we have the tax-free savings account (TFSA).
When you contribute to the TFSA, you don’t get a tax deduction. But the beautiful thing is that it grows tax-free, and the withdrawals are also tax-free. Lastly, we have non-registered investments. When I say non-registered, people go, “What is a non-registered investment?” As the name suggests, it’s just something that hasn’t gotten any type of preferential treatment in terms of tax purposes or government purposes.
So the RRSPs allow you to use tax deductions, and it grows tax-deferred.
In a TFSA, you don’t get the tax deduction, but it grows tax-free, and withdrawals are tax-free. With non-registered investments, you don’t necessarily get those benefits. We’re going to talk about how they’re taxed and how they’re treated, but you don’t get those protections, right? This could include mutual funds, stocks, bonds, ETFs, real estate, and other investments that could be placed in a non-registered fund. Now let’s talk about the taxes. How are these different investments and accounts treated? CPP is treated as ordinary income. So, just as you earned while you were working, you file your taxes and pay taxes on your ordinary income. CPP is treated the same way. OAS is also treated as ordinary income and is subject to a clawback if your net income meets a certain threshold. You get the income, but if you reach a certain threshold, the net income will.
If the net income is a certain level, you get hit with what’s called a clawback, and that money gets returned, right? GIS is not taxable, but it’s affected by other income sources, which could reduce the amount received, right? So, you may get it, and it’s not taxed, but it’s all based on a certain threshold. We’re going to talk about how important it is to have different accounts towards the end of this video, because as you can see,
so far, ordinary income seems to be the most prevalent.
It doesn’t stop there, because when you look at employer-sponsored pension plans, both defined benefit and defined contribution plans are treated as ordinary income. Your RRSPs are fully taxable as ordinary income when you withdraw from them. An RRSP converts to a RRIF by the end of the year when you reach age 71, and there’s a minimum amount that’s required to be taken out. Even then, it’s treated as ordinary income. TFSA is the saving grace. It is non-taxable. When you withdraw from a TFSA, it’s non-taxable. This is really important because a lot of times people think of the tax-free savings account and all they do is save in this account as opposed to invest in this account with the opportunity to use it in retirement, not realizing how important it is.
This is important because, as you realize, certain funds, for example, like the OAS, have a clawback aspect to them, where if you reach a certain income threshold, you get hit with a clawback, and that money has to be paid back, right? So once that happens, and you see you’re reaching that threshold, what could you do from a strategic standpoint to protect yourself? You could start pulling funds from a TFSA because when you pull from a TFSA, it’s not taxable, right? So why is it so important to have a TFSA? Non-registered investments are also something to consider because there’s certain preferential treatment, particularly with capital gains and dividends, which receive better tax treatment than interest income, which is treated as ordinary income.
So if you’re strategic in how you have these accounts before you get to retirement and you give yourself an opportunity to be tax-efficient with TFSAs and non-registered investments, what it will allow for is a more tax-efficient retirement income, right? That’s why it is so important. Now I know you may be asking, when should I take retirement income? I have all these different sources. And quite frankly, that is the challenge with retirement.
When you are working, for most people, they get one source of income, maybe two if you have rental property or some other sources, but for most people, they’re working a nine to five or something along those lines, and they get one source of income.
Now, when you get to retirement, you have CPP, OAS, RRSPs, TFSAs, non-registered accounts, and all these moving parts. You’re thinking, “Okay, what do I take? When do I take it? How is it taxed?” This is why it’s so important to have a financial plan in place because there is no cookie-cutter answer for this. There is no one set framework. It changes, and quite frankly, depending on the years when you’re pulling from these different retirement sources, it may also change. So what’s important is to have a framework and to be strategic before you even get to retirement.
I always recommend starting at least 10 years before you get to retirement to allocate these funds with an idea of what retirement may look like. Now, will it be exact? Maybe not. But at a minimum, it will allow you to create some flexibility, particularly with looking at accounts like TFSAs and non-registered accounts. If you have an RRSP that’s growing at a high rate, you might start to pull from that and allocate it into different funds in years when you’re in a lower income bracket. Just be strategic.
It may also mean delaying CPP or OAS, because taking all of these benefits with other sources of income may put you in a higher income bracket. Right? There are all these different moving parts, and each individual has their own situation. You can’t necessarily create a cookie-cutter framework to do it. That’s why it’s so important to start planning at least 10 years in advance for your retirement income. But if you’re already in retirement and you are where you are, it’s also great to start having a financial plan now and decide how you should start withdrawing from these funds, which is so important. Hopefully, this was helpful. Hopefully, this provides you with some information. A lot of the funds I talked about, like RRSPs, CPP, and OAS, I’ve done videos about, so you can check those out afterward. Again, once a week, based on conversations I have with clients, I come here and speak for eight to ten minutes and share with the world. Take care. Bye.
