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What Is A Good Retirement Budget?
One of the most important aspects of your retirement plan is knowing how much you plan to spend during your retirement years. Knowing exactly what spending looks like in retirement is one of the most important (and sometimes the hardest to determine) parts of a retirement plan. Even small changes in spending can have a big impact on the success of a retirement plan, so making a good retirement budget is critical.
Depending on your level of spending, that last $10,000 in spending could incur marginal tax rates of 30-40%+. For example, going from $70,000 to $80,000 per year in spending will incur a high marginal tax rate on that extra spending. If we’re using RRSPs to fund part of retirement then we’d need to make pre-tax withdrawals of $14,286 to $16,667 just to support that last $10,000 in spending.
If there was no tax we could support that last $10,000 in spending with financial assets of around $250,000 (this varies from situation to situation but for simplicity we’ll assume a 4% safe withdrawal rate). But to support the taxes on those withdrawals we need much more. To support that last $10,000 in spending we need between $357,142 and $416,667 in registered assets!
This is why getting your spending assumptions right is very important when building a retirement plan.
This is where guidelines like the 70% rule can be very dangerous. It might be ok to use these rules of thumb when you’re 20-30 years away from retirement but when you’re 5-15 years away from your retirement date they can be very misleading.
To create a solid retirement plan we want to build a detailed retirement budget. We want a budget that is built from the ground up, category by category, and is based on facts. It’s more accurate to say how much you’ll spend in each category and then add it up versus using a general guideline like the 70% rule. Plus, it provides a great opportunity to review your spending and ensure it aligns with your values and goals.
There are a few key considerations when building a retirement budget.
Important Considerations When Setting Up A Spousal Loan
For households where two partners earning drastically different incomes certain income splitting strategies can provide a large advantage. Splitting income can lead to a large decrease in overall income tax. And an income tax reduction of even just a few thousand per year can quickly add up to become hundreds of thousands with compounding.
It’s important to note that Income splitting strategies aren’t for everyone. Some are easier to execute than others and some can even lead to higher income tax if executed in the wrong circumstances. It can be tempting to use every available strategy in an attempt to lower your overall income tax rate but certain strategies require careful consideration.
A spousal loan is one income splitting strategy that requires careful consideration.
The basic idea behind a spousal loan is relatively simple. The goal is that non-registered investments accrue investment income in the hands of the lower income spouse rather than the higher income spouse. But the CRA doesn’t just allow this to happen. A spousal loan needs to be set up to transfer cash from the higher income spouse to the lower income spouse.
The concept is relatively simple but there are some important considerations to review based on your particular situation before setting up a spousal loan.
Different Ways to Split Income With A Spouse
Splitting income is an interesting tax planning opportunity for couples. Because we’re taxed individually on our income it can be advantageous to split income and reduce the overall income tax bill for the household.
The goal of income splitting is to perfectly split the household income and the corresponding tax bill. Splitting income 50/50 is the ideal way to minimize the household’s income tax. However, the CRA doesn’t like this, and there are lots of rules in place to prevent income splitting in certain situations.
Income attribution is what happens when you split income that you shouldn’t have. Even if you didn’t earn that income it can still be attributed back to you and needs to be captured on your annual tax return.
For example, if the higher-income spouse gives the lower income spouse $10,000 to invest, any income earned on that investment is attributed back to the higher income spouse, even if it doesn’t get paid into their account and/or they don’t receive a T5/T3 tax slip.
Income attribution is a huge deal. It requires people to properly report their income. The onus is on the couple to split their income properly. If a household doesn’t properly split their income, and they fail to report income attribution, it can come back later in the form of an audit and/or fines & penalties.
The goal with income splitting is to avoid these attribution rules and legally split income to the extent it’s possible.
Income splitting isn’t for everyone but many people can benefit from at least some basic income splitting.