Q: I have reached retirement. During my work career, I saved in an RRSP, TFSA and a holding company. I have read your magazine for many years and thought you may be able to provide me with a list of people that can advise me on tax efficient methods to draw from my holding company and other vehicles. My accountant is using dividend payments from the holding company and I would like to have advice on if this is the only method and/or the recommended method. I am age 66 at this time.—Bob
A: Many retirees have different accounts that they can use to fund their retirement. Your situation is a little more complex since you have a corporation, Bob. But I’d also argue that the corporation provides you with more flexibility.
You can certainly pay dividends from your holding company to fund your retirement, but the key is how much should come from the corporation relative to other sources? And beyond that, which investments should you hold in which accounts?
Business income earned and subsequently retained in a corporation, like your holding company, is somewhat tax-deferred. This is because only corporate tax is payable, while personal tax only becomes payable once you take the money out of the corporation. But once you have retained earnings in a corporation and invest those savings, the story changes.
Generally, for most people, the tax rate on investment income earned in a corporation will exceed their personal tax rate. As a result, it may be advantageous to pay some or all of the investment income earned out to yourself personally as a dividend, or more if you need the funds to support your personal cash flow.
One-half of any capital gains you earn in your corporation result in a notional “capital dividend account” and the balance of this account can be paid out to you personally with no income tax implications. So this is a good potential source of dividends and your capital dividend account should be monitored.
If you funded your corporation with a significant amount of capital initially, you may be able to withdraw this amount tax-free. Likewise with any shareholder loans you may have made to the corporation.
Investment income earned in a corporation will typically be taxed at a rate that is more or less in line with the top personal income tax rate for your province of residence. But if you then pay out this investment income to yourself personally, the corporation receives a tax refund and the personal tax you pay on receipt of the dividend is generally less than the amount of the refund, meaning you come out ahead on a net basis. So many retirees with holding companies will pay out their corporate investment income and potentially capital depending on cash flow needs, Bob.
That said, you have to take into account the impact on your government benefits like Guaranteed Income Supplement (GIS) and Old Age Security (OAS) from any withdrawals from any accounts, including your holding company. Increasing your income may reduce your entitlement to these government benefits.
One of the good things about TFSA withdrawals is that they are tax-free, unlike holding company or RRSP withdrawals. But you need to balance your lifetime withdrawals from all sources. If you opt for the most tax deferral and draw your TFSA down first, it could mean you’re taking larger taxable withdrawals from your RRSP and holding company in later years and paying more tax in the long run, at the expense of some short-term tax savings. So I would generally advise someone like you, Bob, to develop a long-term retirement plan that helps identify the best way to fund your retirement from a tax perspective for the rest of your life, at least based on conservative assumptions.
A process like this also helps you determine how much you can afford to spend or what rate of return you require on your investments. It may be more or less than what you think and having this perspective can allow you to budget appropriately and manage your investment asset allocation in retirement. It also helps you understand what your time horizons are for various accounts and the underlying investments in those accounts.
With all of this overlaid upon your investments, you can then determine which investments are best held in which accounts from a retirement funding perspective, as well as a tax perspective. Holding the same investments in the same allocation across your accounts is rarely the best approach from a tax perspective. And since fees and taxes are probably the areas where you have the most control, being aware of tax implications can help you to increase your net investment returns.
In summary, Bob, having multiple accounts can seem like a bit of a dilemma in terms of planning your retirement funding or managing your investments. But try to look at it as an opportunity to leverage the Income Tax Act to your advantage, armed with a little information of how much money you need and when from which accounts. It will also enable you to be a better informed investor.
Who is the right person to help you plan your retirement funding? It’s hard to say. Some accountants may be well equipped. Some investment advisers may be able to help as well or may have access to internal experts at no cost to you. But your best bet may be a seasoned financial planner who can build a comprehensive retirement plan. MoneySense’s directory of fee-only planners (specifically the fee-for-service list) may be a good starting point.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.