What Account Should You Spend First In Retirement?

When you convert assets to income for your retirement, which should you spend first? If you have an account that is tax preferred (your non-registered account), one fully taxable (your RSP account), and one tax free (the TFSA), and are all compounding at the same rate for your retirement, I recommend for simplicity purposes to spend the taxable money first.

The TFSA should be the last of your retirement funds that you touch to maximize tax-free growth as much as possible. As each person’s situation is different there may be reasons to use a combination depending on how much money you need and when you need it. A proper analysis will be able to show your net worth and tax implications of drawing down your assets from some buckets before others.

Should I Contribute To An RSP Or A TFSA?

A suitable answer for your situation won’t come from a book. A suitable recommendation will come from a proper analysis of your financial picture. I have software to explore which is the best option for you and it will depend on your exact tax bracket now and the expected one you will be in when you need this money.

Three awesome ideas:

  1. Explore corporate class series of investment funds for your nonregistered account to shelter some income as capital gains.
  2. Don’t save but instead invest in your TFSA – all the gains and future income become tax-free.
  3. Shift your income producing investments from your nonregistered account to a permanent life insurance product. For this you must first have a need for life insurance.

These next two options for business owners are advanced strategies to fund your retirement, in excess of what an RSP allows you to do. Consider them if you feel you may need more of a retirement income than what your RSP contribution limits can afford you.

  1. Army of one … IPP. Is it something you should be doing?

The IPP or Individual Pension Plan is a very good way to increase your pension savings. It is considered a defined benefit pension plan because you have a designed benefit that is payable to you at retirement and your company contributes the needed amounts to get you there. To make this option worthwhile it is best used by people over 40 years old who have a corporation and are taking a salary income of at least $100,000. There are substantially higher tax savings for the corporation when it earns more than $500,000.

Advantages are:

  • Contributions could be materially higher than RSP limits, allowing you to compound more money and have a larger pension in retirement.
  • Contributions are tax deductible to the company but not a taxable benefit for the member.
  • The company takes on the risk if underfunding happens and can make additional contributions.
  • You have an income that is outside the company and the amount of income is guaranteed.
  • You have a level of protection from creditors.
  • You may be able to contribute extra funding for past service.
  • IPP income benefits can be split between spouses.

Disadvantages are:

  • There are start-up and ongoing costs to administer it, actuarial valuation every three years and regulatory filing fees every year.
  • Since it is a pension, it is locked in until retirement.
  • If there is a shortfall because of poor performing investments, the company is required to fund the deficit.
  • The company is obligated to make contributions even in years with little profits.
  • Because of the amount of funding, you may not have any available room to contribute to RSPs.
  • You may not be able to income split with your spousal RSPs.
  1. Retirement Compensation Arrangement (RCA). Can this be suitable for you?

An RCA is a structure that a company can use to contribute towards the retirement of some of its key employees. Its value is for high income earners (over $250,000). It can be used by business owner parents who set up an RCA and add the kids to it when they start working for the business. The parents can take out their income when they retire or leave the bulk of it inside the RCA. These assets can then stay in the family for generations.

Advantages are:

  • The company gets an instant deduction when it contributes to an RCA.
  • The company does not need to incur the same valuation expenses as with an IPP.
  • There is no required retirement date to begin withdrawals as with RSPs.
  • The company can retain key employees, by making the vesting lenient or restrictive. If restrictive, and an executive leaves the company before their benefits vest, then their benefits can be put back into the company or to the remaining members.
  • The company is able to move money outside of the company to reduce income to qualify for the small-business deduction rate.
  • If you retire as a non-resident, you can reduce your overall taxes.
  • Potential protection from corporate and personal creditors.

Disadvantages are:

  • You have to have a 50 percent refundable tax rate in the beginning.
  • As with an RSP, there is no value to the preferred tax rate for capital gains and dividends.

The main candidates for an RCA are shareholders in private corporations. It can also be used for executives or professional athletes in Canada.

As with any of these strategies discussed, because of tax issues and complexity, this is not for novices, and you will need independent advice and legal, tax and actuarial help, in addition to help from an experienced financial planner.

Ask yourself:

  • How important is it for you to reduce your taxes?
  • When is it important for you to reduce your taxes, now or later?

The last question that begs to be asked at the end of this chapter is, “Mr./Ms. business owner, would you be interested in sitting down with me to implement some of these ideas so I can help you save tax?” Reach out to me at Jessie@jessiechristo.com and let’s have a conversation.

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