Your Potential Streams of Income in Retirement

Saving for Retirement is Easy; Spending in Retirement – Not So Much

You have been saving for retirement all your life. If you are a resident of Canada, you have been building up credits toward receiving Old Age Security (OAS). If you have been employed, you have been contributing to the Canada Pension Plan. Depending on your employer, you may also be participating in an employer-sponsored retirement savings scheme. Finally, you may have made efforts to save for retirement on your own, using RRSPs, TFSAs, or by using other methods.

 

Now, however, you have reached the age when you want to retire. Conventionally, that has been age 65, and although many Canadians retire earlier or later, since 65 is the earliest age at which you can begin to receive OAS and also happens to be the age at which a variety of tax credits begin to apply, it makes sense to consider 65 as a starting point, regardless of whether you retire earlier or later.

 

The problem arises, however, in coordinating those various sources of income that are now potentially available for you to draw from. For today’s blog post, we will undertake a comprehensive overview of those options and consider their pros and cons.

 

Government Pensions

Canada Pension Plan (CPP)

 

This is probably the most well-known retirement plan in Canada, but it has occasionally encountered controversy. Most often thought of as a social insurance program for retirement income, it also provides financial benefits for those who are disabled or the surviving spouse or child of a deceased person. It is funded by mandatory contributions from employees, employers, and the self-employed and is designed to replace a portion of an eligible individual’s earnings upon retirement. For many years, that portion was targeted at 25%, but it is gradually shifting toward 33.33% of earnings over the next several years. The amount received depends on a recipient’s earnings history and the age at which benefits are started, but if you begin at age 65 and your earnings history is sufficient to have maximized your payment, as of 2024, you will receive $1,364.60 per month. The average 65-year-old retiree, however, receives $816.52 per month.

 

Old Age Security (OAS)

While CPP may be better known, OAS is probably the most widely utilized of government-sponsored pension plans. Unlike CPP, OAS is funded from general tax revenues and is subject to a possible clawback of payments if a person’s income exceeds a certain income level. In 2024, if your net income exceeds $90,997, 15% of every dollar will be clawed back via the “Old Age Security Pension Recovery Tax.” Assuming you are age 65, you have 40 years of qualifying residency in Canada, and your income is such that clawbacks are unlikely, for the July to September 2024 quarter, you will receive $718.33 per month. If you are age 75 or older, your payment will increase by 10%.

 

Guaranteed Income Supplement (GIS)

GIS is a component of OAS and provides additional support to low-income seniors aged 65 or older who receive OAS. GIS is designed to assist those with little to no income, helping them to ensure that they can meet their basic needs. In other words, GIS benefits are income-tested from the first dollar, unlike OAS, which is only income-tested above when a relatively high threshold has been reached. A single person of age 65 or older who receives OAS can receive up to $1,072.93 per month as of the July to September 2024 quarter. Different circumstances, including the presence of a spouse/common-law partner who may or may not receive OAS or the Allowance will receive differing amounts and face different income thresholds.

 

Income that is excluded from consideration is OAS, money withdrawn from a TFSA, and up to $5,000 in earned income. Earned income between $5,000 and $10,000 is partially excluded. That means that money from CPP, a pension, an RRSP/RRIF, or a non-registered account will count against you.

 

Pros of Government Pensions

• Government pensions provide guaranteed income for life that is adjusted for inflation.
• No investment risk or management is required.
• A government safety net that provides some financial security for the lowest income earners (OAS, GIS).
• Partial OAS is available even with less than 40 years of residency in Canada.

 

Cons of Government Pensions

• The amounts one receives are fixed, albeit adjusted annually (CPP) or quarterly (OAS, GIS).
• CPP, OAS, and GIS may not fully cover living expenses.
• Not all individuals will qualify for the maximum amounts.

 

Employer-Sponsored Plans

Not all employers provide pension plans. Unfortunately, this situation often seems to apply to those who work low-wage or casual jobs, that is, those who are least likely to be able to save on their own. For those who do participate in a plan, various arrangements are possible.

 

Defined Benefit (DB) Pension Plan

This is probably what most Canadians think of as a “pension,” that is, a steady stream of income that will carry on for the remainder of your life. You and your employer, or sometimes your employer alone, contribute to a DB pension plan as part of your overall compensation. At retirement, the amount of the pension benefit is calculated using a formula. The formula may include a final average salary or a best five-year average, for example, multiplied by the years of pensionable service, with a final multiplier that is included in the specific pension benefit details.

 

The pension is usually paid as a monthly annuity for the rest of the retiree’s life. If there is a spouse or common-law partner, legislation may require that a survivor receive at least 60% of the retiree’s pension for the remainder of the survivor’s life.

 

Some, but not all, DB pensions provide for an annual cost-of-living adjustment or COLA to mitigate the impact of inflation.

 

Defined Contribution (DC) Pension Plans

Many employers who used to offer DB plans have changed to offering DC plans. In this situation, the employee is not promised a “defined benefit,” a specific dollar amount per month for the rest of the employee’s life, but rather a “defined contribution,” an amount that the employer will contribute toward the pension plan with each paycheque, typically matching an amount deducted from the employee’s pay (for example, 5% from the employee and 5% from the employer), with nothing more guaranteed. These plans are typically managed by an insurance company which provides a variety of investment options from which the employee selects what is deemed the best choice. If the employee does not wish to customize the investments from within the available choices, they are often able to accept a default portfolio that is often a target-date fund, which will gradually grow more conservative as the retirement date approaches.

 

The balance of the plan at retirement, whatever it may be, is then used to fund the retiree’s income during retirement. A common choice is to transfer the pension to a Life Income Fund (LIF). This allows the assets to continue to grow while in the LIF by continuing to invest in a portfolio of securities while periodically withdrawing at least a minimum percentage and not exceeding a specified maximum percentage each year, although “unlocking” may be permitted.

 

An alternative is to effectively convert your DC pension into a DB pension by using the proceeds to purchase an annuity from a life insurance company. Doing so will give the retiree a steady monthly payment for the rest of his or her life, including the option to provide for a surviving spouse. The retiree can also choose to blend both choices, keeping part of the money in a LIF while buying an annuity with the remainder.

 

Group Registered Retirement Savings Plan (RRSP)

A Group RRSP is quite similar to a DC pension plan in that it is employer-sponsored and often involves contributions from both the employee and the employer. They both involve investment risk which is borne entirely by the employee. Finally, implicit in the bearing of investment risk is that the account balance determines the retirement benefit.

 

A Group RRSP is, however, a simpler plan for retirement savings. They are less expensive to administer, there are no rules about unlocking, and they are much more portable, allowing the employee to transfer the Group RRSP to a personal RRSP upon leaving the employer.

 

At retirement, the retiree has the choice of converting the Group RRSP into a Registered Retirement Income Fund (RRIF), purchasing an annuity, or using some combination. If the balance is small, perhaps because only a few years were spent with the employer who offered the Group RRSP, the retiree may also elect to simply withdraw the entirety of the balance. It will, however, be fully taxed in the year of withdrawal.

 

Deferred Profit-Sharing Plan (DPSP)

Unlike the plans discussed so far, the DPSP is only funded by the employer. The nature of this plan is such that if an employer’s profits for the year are poor, the amount contributed to the plan can be easily reduced, unlike the situation with a registered pension plan. There is a maximum as well, which is half the Money Purchase limit. A Money Purchase Plan is another term for a Defined Contribution Pension Plan. For 2024, that works out to $16,245.

 

At retirement, an employee has the choice to transfer the accumulated assets into a RRIF or to purchase an annuity, or a combination of the two.

 

Pros of Employer-Sponsored Plans

• Defined Benefit plans provide steady predictable income for the remainder of your life.
• Defined Contribution plans allow the employee to have some control over investment choices and are more easily transferrable if you leave your employer.
• Group RRSPs often provide for the employer to match employee contributions and since contributions are deducted from the paycheque before tax is calculated, the employee receives an immediate tax benefit.
• Deferred Profit-Sharing Plans are funded solely by the employer which means increased savings without a reduction in net income. DPSPs are tax-deferred accounts, allowing for increased compounding.

 

Cons of Employer-Sponsored Plans

• Defined Benefit plans may have less portability than other plan types, which can complicate matters for employees who change employers several times throughout their careers. Furthermore, employers may manage the plan poorly, resulting in a funding shortfall, which could lead to reduced benefits for retirees and/or increased contributions from employees.
• Defined Contribution plans require the employee to choose an investment portfolio which may lead to poor returns. Related to this, there is no guaranteed retirement income, which means potentially greater financial insecurity.
• Group RRSPs may lack portability depending on the policy of the employer. Like any other RRSP, withdrawals from group RRSPs are also subject to withholding taxes, limiting the practical availability of funds if the employee wishes to access them before retirement.
• Deferred Profit-Sharing Plans depend on company profits, meaning potential variability of savings. Employees also have less control over investment choices compared to other retirement savings plans.

 

Personal Savings and Investments

Personal RRSP

Registered Retirement Savings Plans (RRSPs) are tax-advantaged retirement savings accounts that allow individuals to contribute up to 18% of their earned income from the previous year, up to an annual limit set by the government ($31,560 for 2024). Contributions are tax-deductible, meaning they reduce taxable income in the year they are made. Investment growth within the RRSP is tax-deferred until withdrawal. Withdrawals are taxed as ordinary income and are generally subject to withholding taxes, except for specific programs like the Home Buyers’ Plan (HBP; $60,000 as of the 2024 budget) and the Lifelong Learning Plan (LLP; $10,000 per year, $20,000 in total), which allow for penalty-free withdrawals under certain conditions. RRSPs must be converted to a Registered Retirement Income Fund (RRIF) or an annuity by the end of the year the account holder turns 71, with mandatory minimum withdrawals beginning the following year.

 

Spousal RRSP

Spousal Registered Retirement Savings Plans (Spousal RRSPs) allow one spouse (the contributing spouse) to contribute to an RRSP in the name of the other spouse (the annuitant). Contribution limits are based on the contributing spouse’s RRSP deduction limit. Contributions are tax-deductible for the contributing spouse. Withdrawals from the Spousal RRSP are taxed as income for the annuitant spouse unless attribution rules apply: if withdrawals are made in the same year as the last contribution or in the previous two calendar years, the amount is attributed back to the contributing spouse’s income. Spousal RRSPs must be converted to a Spousal RRIF or an annuity by the end of the year the annuitant spouse turns 71, with mandatory minimum withdrawals starting the following year. To avoid attribution following conversion to a RRIF, the annuitant spouse should not withdraw more than the mandatory minimum until the attribution period has passed.

 

Tax-Free Savings Account

Tax-Free Savings Accounts (TFSAs) allow individuals to contribute up to a government-specified annual limit ($7,000 for 2024), with unused contribution room carried forward indefinitely (up to $95,000 if eligible since 2009). Contributions are made with after-tax dollars, but investment growth and withdrawals are tax-free. There are no taxes or penalties on withdrawals, and the withdrawn amounts are added back to the individual’s contribution room in the following year. Although TFSAs are not specifically retirement plans, they are valuable for retirement planning due to their tax-free growth and withdrawal benefits. Indeed, they are preferred over RRSPs for low-income retirees since withdrawals have no impact on qualifying for income-tested benefits.

 

Non-Registered Account

Non-registered accounts in Canada are investment accounts without contribution limits. This allows individuals to invest freely in various assets such as stocks, bonds, exchange-traded funds (ETFs), and mutual funds. Interest, dividends, and realized capital gains generated within the account are subject to taxation in the year the income is received. Withdrawals from non-registered accounts can be made at any time without penalties but may trigger capital gains tax if investments are sold for a profit. Although not specifically designed as retirement plans, non-registered accounts are valuable for retirement planning as they provide liquidity, flexibility in accessing funds, and opportunities for tax-efficient investing, helping retirees manage their income and tax situations effectively.

 

Pros of Personal Savings and Investments

Personal RRSPs provide immediate tax benefits in the form of tax deductions and also allow for tax-deferred growth of the investments within the account. Furthermore, investors can choose from a wide range of investment options. If using a RRIF at retirement, only the amounts withdrawn during a given year are taxable; the balance of the assets remaining in the RRIF continue to be tax-deferred.

 

Spousal RRSPs, in addition to the benefits of personal RRSPs, can facilitate income splitting in retirement, helping to lower the overall tax burden for the couple. That is, the contributing spouse gets the tax deduction while the lower-income spouse who owns the spousal RRSP, pays the tax, presumably at a lower rate, once converted to a spousal RRIF.

 

TFSAs provide tax-free growth and tax-free withdrawals, as the name indicates. As a result, withdrawals can be made at any time for any reason without tax implications, including possible reductions in benefits available to retirees over age 65. In addition, unlike pension plans or RRSPs, there is no age limit at which a retiree must begin to withdraw from the accumulated assets.

 

Non-registered accounts have the benefit of not having a government-imposed limit on the amounts that can be invested, providing a degree of flexibility not available in other account types. This also means that a retiree can continue investing in this account type regardless of age. Furthermore, this account type uniquely provides for the ability to offset capital gains with capital losses if an investment goes wrong. This gives the non-registered account an advantage if an investor wishes to invest in more speculative assets.

 

Cons of Personal Savings and Investments

Personal RRSPs, including RRIFs, are taxed as ordinary income, regardless of the form in which the income was generated (interest, dividends, or capital gains). As noted already, at age 71, regardless of a retiree’s need, the RRSP must be converted to a RRIF or an annuity, generating taxable income, which limits flexibility in retirement income planning.

 

Spousal RRSPs or RRIFs have the same limitations as personal RRSPs but in addition, the holders of spousal RRSPs/RRIFs need to attend to the attribution rules to avoid a higher tax bill than would otherwise be required.

 

TFSAs, regardless of a retiree’s age, maintain an annual contribution limit. If retirees have been able to maximize contributions during their working years, they may have insufficient room, leaving more of their income exposed to taxation in future years. There is also the lack of an immediate tax deduction when funding a TFSA versus an RRSP. However, if the retiree is above age 71, this is a moot point, since contributions to RRSPs are no longer possible.

 

Non-Registered Accounts, because they lack any special registration, are subject to taxes on interest, dividends, and realized capital gains, which can impact net income and increase tax burdens in retirement. In addition, the variability in investment income may lead to uncertainty in retirement planning, complicating budget management.

 

Employer/Personal Hybrid Plan

Locked-In Retirement Account (LIRA)/Locked-In Registered Retirement Savings Plan (LRSP)

Locked-in Retirement Accounts (LIRAs – generally provincial pension jurisdiction) or Locked-In RRSPs (LRSPs – federal pension jurisdiction) are specialized retirement savings accounts designed to hold pension funds from defined benefit or defined contribution plans when an individual changes employers or retires. These accounts can be funded by pension plan transfers, typically from a workplace pension plan, including the commutation of a Defined Benefit plan, and allow account holders to invest at their discretion within the regulations. At retirement, LIRAs must be converted into a Life Income Fund (LIF) or a similar vehicle, which provides a regular income. As noted before, LIFs have minimums like RRIFs, but they also have maximums in keeping with the concept that these are funds from a pension that is intended to last for the retiree’s lifetime. Unlocking provisions may be available under certain circumstances, such as financial hardship or reaching a specific age. These provisions vary by jurisdiction.

 

Pros of Locked-In Accounts

• Secured retirement savings. Locked-in accounts preserve pension funds for retirement, protecting the retiree from early withdrawals even when they do not consider their income needs in retirement.
• Tax-deferred growth continues within a locked-in account even though no new contributions can be made.

 

Cons of Locked-In Accounts

• Withdrawal restrictions are the other side of secured retirement savings. Depending on the jurisdiction, withdrawal limits are strictly limited.
• Limitations on investment flexibility also arise, although they are probably not a concern for most. For example, a personal RRSP can theoretically hold land or shares in a small privately owned business, but these are not available within locked-in accounts.

 

Is There An Order In Which These Accounts Should Be Withdrawn?

With such a wide array of potential income streams, what should a retiree do? As always, the unique circumstances of a retiree or a retired couple will guide the decisions that are made. However, if we try to set up an “average” retired household, we might approach the question something like this.

 

Household

Male/female married couple, Michael and Frances, age 65.

 

Health/mortality

Expected lifespan at age 65: 89 (male), 91 (female), and 94 (survivor of a male/female couple).

 

Net Worth (Financial Assets Only)

 

 

This represents a not uncommon married couple in my experience who at age 65 have already received some inheritances from their deceased parents.

 

Sources of Retirement Income

 

 

Excluding the Chequing/Savings accounts, I have assumed a steady annual return of 3% after inflation from each of these accounts, spending them down to zero by age 94, which is 29 years from their current age of 65. While the LIF and RRIF accounts have mandatory annual minimum payments, I have simply assumed the same annual payment throughout.

 

These accounts are taxed differently. The LIF and RRIF payments are simply taxed as income, the TFSAs are not taxable at all, and the non-registered account is taxed as a combination of interest, dividends, and capital gains.

 

Also excluded from the table above are CPP and OAS payments. If taken at 65 and assuming average payments from CPP and full payments from OAS, the figures are as follows:

 

 

Adding together the couples’ employer-sponsored and personal retirement assets to their government assets we arrive at:

 

 

Being mindful of the argument that is frequently made that retirees should prioritize spending down registered accounts to allow for the increased payments from CPP (0.7% per month delayed), I have calculated one more table with the scenario of CPP being delayed until age 70. I did not project a delay in OAS, however. One of the results of spending more from the registered accounts in the first five years is that there is less per year available from those sources between ages 70 and 94.

 

 

Nevertheless, the result is an increase in income from age 70 onward by more than $2,000 per year ($125,671 – $123,584).

 

A Possible Income Pattern in Retirement

While I cannot suggest that this is the solution for every household, my inclination for the priority of sources for retirement income would be as follows:

 

At Retirement

• Registered Accounts: employer-sponsored pension, RRIFs, LIFs
• Non-Registered Accounts
• Old Age Security

 

At age 70 (or anytime past age 65)

• Canada Pension Plan

 

At an indeterminate time later

• TFSA
• If the TFSA is not needed to meet your spending needs, consider reserving it for your beneficiaries.

 

 

This is the 254th blog post for Russ Writes, first published on 2024-07-15

 

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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.