The Benefits Of Retirement Planning

Retirement planning is complex and includes many important considerations like retirement spending, income tax planning, income splitting, maximizing government benefits, deciding when to take CPP and OAS etc. etc.

All of these individual parts work together to create a great retirement plan. They are so important that even a small mistake can mean lower retirement spending or a higher chance of running out of money in the future. It could mean $10,000’s in extra tax or $10,000’s in reduced government benefits.

With a typical retirement plan spanning 30-40+ years it’s easy to understand how small change in assumptions can have a big effect on a retirement plan.

There are also many small decisions to consider when planning retirement, like when to convert RRSPs to RRIFs, when to start CPP, when to start OAS, how much to draw from investment assets, which investment assets to draw from first etc. etc.

In this post, we look at some of the important parts of retirement planning. What they are, what you should consider, and some additional resources to help.

Creating A Solid Retirement Budget

One of the most important factors when creating a retirement plan is… spending. Having the wrong assumptions for retirement spending can dramatically increase the chance of running out of money in the future.

Missing just a few important spending categories can easily add $5,000 to $10,000 per year in retirement spending. Imagine you forgot to budget for property tax? Or new vehicles? Or home repairs? Or something else? This extra spending in retirement means larger withdrawals from investment assets, higher tax payments, and an increased chance of running out of money.

The result of being even slightly “off” on retirement spending can be devastating.

One tip to help ensure you’ve made the right assumption for retirement spending is to do a “trial run” of your retirement budget in the 12-months leading up to retirement. By pretending to live on a fixed income it will quickly become apparent if your retirement budget is realistic or not.

A “trial run” of retirement spending is important. Before retirement, when savings rates are high, the surplus cash flow that goes into investments can provide a large sense of security. Then in retirement, the transition to a fixed income can sometimes feel like a shock. Doing a trial run of retirement spending helps bridge this transition.

Rather than wait until retirement, test out your retirement budget now, before retirement. Direct all income into a separate high-interest checking account and then pay out a monthly amount aligned with your retirement budget. You’ll quickly know if that monthly amount is reasonable or not.

One of the big benefits of planning for retirement is that spending expectations are solid. Create a good retirement budget before retirement.

Reducing Tax Liability

Income tax is typically the largest “expense” in retirement. Fortunately, there are many opportunities to reduce income tax in retirement. Planning for retirement can help take advantage of tax planning opportunities.

There are income tax credits like the pension income tax credit and the age credit.

There are also decumulation strategies to help reduce tax liability in retirement and within the estate.

There is also income splitting opportunities for couples.

The combination can easily improve a retirement plan by $10,000+ to $100,000+.

If you don’t have a tax plan for retirement, you may be losing thousands.

For example, one of the worst-case scenarios is when a retiree dies with a large RRSP or RRIF. Their spouse or beneficiaries are left with a large RRSP or RRIF that will be taxed at a high marginal tax rate. In a worst case scenario, a $500,000 RRSP/RRIF could lose $250,000+ to income tax in the estate.

It’s important to ensure RRSPs don’t get too large. It’s also important to ensure tax advantaged accounts like TFSAs are being used (especially for couples).

Increasing Government Benefits

Planning for retirement also means planning for government benefits. Old Age Security (OAS) is one government benefit that millions of retirees have access to, but there are many more benefits that could improve a retirement plan.

The largest, and most generous government benefit in retirement is the Guaranteed Income Supplement (GIS). GIS is worth $11,000 to $13,000 per year but has high “clawback” rates of 50% to 75%. Any taxable income (other than a few exemptions) will trigger these clawbacks.

With nearly 1 in 3 retirees receiving GIS benefits this is an important part of retirement planning.

A bit of careful planning can help increase government benefits by $10,000+ to $100,000+. We’ve created financial plans where government benefits go from $0 to over $100,000 just by doing some strategic planning.

Here are a few things to keep in mind when trying to maximize government benefits like GIS…

• RRSP/RRIF/LIFs are bad
• Small pensions are bad
• TFSAs are good
• CPP should start at age 60 or age 70 (depending on the situation) but not in between
• Employment income has a special exemption below $5,000 per year
• Strategic RRSP contributions can help maximize benefits

Anticipating Retirement Income Sources

There are many different sources of retirement income. It’s important not to ignore any of these potential retirement income sources. They all work together to support retirement spending…

• Investments in RRSP/RRIF/LIRAs
• Investments in TFSAs
• Investments in Non-Registered
• Canada Pension Plan (CPP)
• Old Age Security (OAS)
• Guaranteed Income Supplement (GIS)
• Defined Benefit Pensions
• Rental Income
• Retirement annuities
• Part-time or full-time employment income

The tricky thing about retirement planning is that not all retirement income sources start or stop at the same time. Some will start at different times or be reduced in the future (like bridge benefits for defined benefit pensions). The benefit of retirement planning is that all these income sources can be planned year-by-year and can work together to support retirement spending goals.

Not only that, but each source of retirement income is taxed differently. It’s important to not only understand when each type of income phases in, and out, but also how the type of income will impact income tax payable each year.

Deciding When To Take CPP and OAS

Another important benefit of retirement planning is deciding when to take CPP and OAS benefits. There are many factors to consider when deciding when to take CPP and OAS. Some important questions to ask yourself are…

1. Can you expect a long and healthy retirement?
2. If CPP is delayed, when will you reach breakeven, is this a realistic assumption for longevity?
3. If OAS is delayed, with its smaller actuarial adjustment, when will you reach breakeven, is this a realistic assumption for longevity?
4. Are there enough financial assets to delay CPP or OAS?
5. Will delaying CPP add more “zero earning years” to the CPP calculation and will this create a drag on future CPP benefits?
6. Will starting OAS at 65 mean OAS clawbacks?
7. Does delaying CPP to 70 increase the chance of running out of money in early retirement?
8. Should CPP start early if investment returns drop suddenly (e.g. during a recession)
9. How does delaying CPP affect CPP survivor benefits for couples?
10. Is there a large capital gain expected between 65 and 70 that could make delaying OAS more attractive?

Deciding When To Convert RRSPs to RRIFs and LIRAs to LIFs

Another important factor when planning for retirement is deciding when to convert RRSPs to RRIFs and LIRAs to LIFs. These conversions must happen by the end of the year you turn 71, but often, it can be beneficial to convert early. Here are a just a few things to consider…

For couples, converting from RRSPs to RRIFs and LIRAs to LIFS can allow more income splitting opportunities after age 65.

RRIF and LIF income after age 65 will qualify for the pension income tax credit.

Minimum RRIF and LIF withdrawals at any age do not require withholding tax.

RRIF withdrawals often avoid the partial deregistration fees that will impact RRSP withdrawals.

Avoid Running Out Of Money In Retirement

Retirement planning is very hard because there is a very real risk of running out of money in the future. Drawing too much from retirement assets, experiencing a poor series of investment returns, going through a period of high inflation, all these things can result in a retirement plan running out of money in mid-retirement.

It’s important to have clear targets for both retirement spending, investment assets, and investment returns for each year of retirement.

If spending is too high this can still be ok if overall investment assets remain on track during a period of high investment returns.

If investment returns are below target this can also still be ok if spending gets reduced to help decrease the draw on investment assets.

Having clear targets for spending, investment returns, and investment assets year-by-year can help a retiree understand if they are on track with their retirement plan or not.

Maximizing Spending In Retirement

Last and most important, retirement planning is all about maximizing retirement spending. Why spend less during those early retirement years only to die with millions?

Lower taxes, higher government benefits, income splitting, these all help support higher spending in retirement.

But there are still unknowns like investment returns and inflation rates. If investment returns are on track, and inflation rates are reasonable, why limit retirement spending.

Spending more in early retirement is tricky however, spending too much could mean running out of money in the future, spending too little could mean dying with millions in the bank.

It’s important to test different levels of retirement spending so that a retirement plan can adapt to changing circumstances.

Start by planning for your target retirement spending, but then also test your “max” level of spending in retirement. Your “max” level of spending has a low success rate. It’s only reasonable to achieve “max” spending during periods of average or above average investment returns. But it represents the maximum level of retirement spending you plan can support.

Having this upper guardrail for your retirement spending provides the freedom to spend more in early retirement if everything is on track.

Retirement Planning

If your goal is to maximize your retirement, maximize spending, minimize income tax, maximize benefits, and ensure you never run out of money in the future, then retirement planning is a must.

Retirement planning encompasses large factors like retirement spending, with small tactical decisions like RRSP to RRIF conversion.

A good retirement plan creates clear year-by-year benchmarks to help ensure your retirement plan stays on track.

A great retirement plan highlights the impact that poor investment returns or high inflation rates can have on the plan. It also highlights what to do if investment returns are average or above average in retirement.

Retirement planning provides the peace of mind knowing that you have a rigorous plan supporting your retirement goals.

See this retirement case study for more details.