The complexities of income tax at retirement can come as a shock to pensioners, but most plan sponsors are providing limited assistance in helping their retiring employees deal with these issues.
“In our experience, much of the communication and education provided by employers/sponsors or their plan record keeper focuses on basic retirement and investment knowledge, not necessarily on tax issues,” says Debbie Patton, a consultant in the investment and retirement practice at Accompass Inc. “Recently, there has been more focus on providing information related to decumulation, but again, there is more focus on the products that are available to members with respect to the payout phase, as opposed to tax issues associated with collecting retirement income.”
But even the simplest retirement scenarios can be complicated from a tax perspective. “The big thing that happens is that income sources shift, which requires a different mindset with regard to the tax consequences,” says David Rotfleisch, a tax lawyer at Rotfleisch & Samulovitch Professional Corp.
To begin with, many income sources, such as investment income, the Canada Pension Plan and old-age security, may not be subject to corresponding source deductions, leaving retirees with an unexpectedly significant tax bill at the end of the year. And in cases where an income source, like a pension plan payment, is subject to source deductions, the availability of investment or other income not subject to these deductions could mean the source deductions won’t cover all the tax liability.
The upshot is that retiring employees have important decisions to make. These include when to start collecting CPP and OAS, which affects both the amounts they’re entitled to and their overall tax bill.
Making the right decision, then, frequently involves a confusing consideration of annual income streams both before and after retirement, income splitting opportunities between spouses and when investment income will start to flow.
Dealing with registered retirement savings plans can also be a conundrum. Plan members can convert their RRSPs to more tax-advantageous registered retirement income funds but must do so no later than age 71. Still, RRIFs have mandatory minimum annual withdrawal requirements. “RRIF withdrawals constitute taxable income, and you’re going to pay tax whether or not you need the money,” says Rotfleisch.
The extra income could not only create higher marginal tax rates for retirees, but also trigger clawbacks of government benefits, especially the guaranteed income supplement. “One of the truisms of social policy is that the people who are worst off are those with modest incomes because they don’t qualify for government assistance,” says Richard Shillington, a statistician and consultant who focuses on seniors’ issues.
Indeed, a recent study from Ryerson University’s National Institute on Ageing noted RRSPs benefit higher-income Canadians much more than they do those with lower incomes.
According to Rotfleisch, higher income individuals with borrowing power may be able to minimize RRSP- or RRIF-derived income by resorting to tax-planning strategies like “RRSP meltdowns.” This strategy focuses on using interest deductions on investment loans to offset taxes on RRSP withdrawals made in advance of retirement.
But that doesn’t work as well for lower-income plan members. “The worst thing anyone can do if they’re eligible for GIS on retirement is to have an RRSP,” says Shillington. “Lowincome seniors will almost certainly be better off with [tax-free savings accounts].”
Why not TFSAs?
While RRSPs have the advantage of deferring tax payments into the future, which TFSAs don’t do, the deferral may not be as important to low-income seniors, especially those who want to avoid clawbacks or maintain their eligibility for government benefits, like the GIS, after they retire.
These individuals might find it more advantageous to maximize their TFSA contributions, which is currently $6,000 annually and indexed to inflation going forward. Unlike funds withdrawn from RRSPs, funds withdrawn from TFSAs — including the investment growth component — aren’t taxable, and contribution room after withdrawals can be restored.
Meanwhile, the Institute for Research on Public Policy has suggested that employers, especially pension plan sponsors, could help encourage their low-income earners to save for retirement by offering group TFSAs, which would come along with the benefits of an employer-sponsored plan, including the fiduciary responsibilities imposed on plan sponsors, and economies of scale, including the benefits of pooling.
“As well, it would help if employers contributed to TFSAs in the same proportion that they contribute to RRSPs,” says Shillington, who authored the study.
All this said, TFSA offerings aren’t entirely unknown to sponsors. Benefits Canada’s 2019 CAP Member Survey found 18 per cent of plan member respondents participate in a TFSA through their employer; however, 65 per cent are in a group RRSP.
“We have seen employers offering a group TFSA as a voluntary savings vehicle in addition to an RRSP or pension plan, but not as the primary retirement plan,” says Patton.
The difficulty is that even plan sponsors that do offer tax guidance deal with it only in a rudimentary way, though that isn’t to say they necessarily ignore the issues. “We have worked with many clients who offer pre-retirement sessions that contain a tax component,” notes Patton.
In one of the pre-retirement sessions that Accompass hosts for its employer clients, employees are given access to an online tax calculator to show the effect of federal and provincial taxes. The consultancy also uses resources from the federal government’s website to introduce some of the tax deductions, credits and opportunities for income splitting that might apply to an individual’s personal situation.
For its part, the Ontario Municipal Employees Retirement System offers plan members a retirement income estimator through its website. This allows retirees to add in income from personal savings, CPP and OAS, then provides them with a snapshot of their estimated after-tax income before and after retirement.
The site also features a basic primer on estate planning as a tax reduction strategy, information on pension income splitting and advice on making full use of available tax credits and deductions to maximize net income.
The Alberta Teachers’ Retirement Fund Board focuses on information as opposed to planning, according Paul Michna, its manager of corporate communications. “We do provide some tax information to our members, but this is specifically related to the tax treatment of defined benefit plans and related transactions.”
From a defined contribution plan perspective, Western University offers workplace educational workshops, which include information on dealing with the tax advantages of making voluntary contributions beyond the minimum required by its plan. And Allstate Insurance Co. offers seminars that cover the benefits of tax-deferred investments.
While employers aren’t allowed to provide financial advice to their employees, they can encourage plan members to seek appropriate advice from third parties. “Employers and sponsors should recommend that members obtain independent financial planning and tax advice from qualified professionals in addition to using information provided by the employer/sponsor and/or plan record keeper,” says Patton.
Julius Melnitzer is a Toronto-based freelance writer.