This is the first post of Jonathan Chevreau’s new column, Retired Money, which will explore smart ways to draw down income in retirement and semi-retirement.
Welcome, MoneySense readers. We often focus on saving for your golden years, but while retiring rich is half the battle, the next step of your journey is keeping more of your money in retirement. To start, we will look first at a couple of tax credits that will likely be unfamiliar to most full-time workers.
The first is the $2,000 annual pension credit, which first appeared on my personal tax return when I did my calendar 2015 taxes. This permits you to deduct from your taxes payable a tax credit on the first $2,000 of pension income received.
The second is the age tax credit, which I have yet to experience since in order to receive it you have to be aged 65 or older at the end of the tax year. (I just turned 63). The age tax credit is income tested, so higher-earning individuals may find this clawed back. As one advisor puts it, “Not many get the age credit. I hope you don’t get it.” (Since that would mean my retirement income was low).
The age tax credit is a non-refundable tax credit claimed on line 301 of the personal income tax return, according to taxtips.ca. (Non-refundable tax credits can only be used to reduce federal or provincial taxes to zero, which means that if you have no taxable income they won’t generate payments from governments.)
Even if you qualify, the most the federal tax credit would be worth in 2016 is $1,069, and probably less since it’s phased out between incomes of $35,927 and $83,427 (2016 figures). The tax credit is calculated using the lowest federal tax rate of 15%. The federal age amount for 2016 is $7,125 (it was $7,033 in 2015), and is reduced by 15% of income exceeding those thresholds.
The pension tax credit is much more likely to be used by higher-income earners. Federal tax savings on $2,000 would be $300 (15%), and depending on the province, you can expect a bit more. According to Tim Cestnick, president of Waterstreet Family Offices, in 2015, combined annual total tax savings would be between $350 and $700, depending on the province you lived in.
You can receive the pension credit earlier than 65, as long as you have received certain types of eligible pension income, typically an employer-provided Defined Benefit pension. Note that CPP, OAS and GIS payments do NOT help generate the pension credit, nor do retiring allowances or lump-sum withdrawals from RRSPs.
According to a BMO Wealth Institute report titled Mind your taxes in retirement, those lacking corporate pensions can create eligible pension income by beginning to convert a registered plan to its maturity option at age 65 rather than waiting till 71.
In practice, this means converting at least some of your RRSP into a Registered Retirement Income Fund (RRIF) long before 71, the age when RRSPs have to either be cashed out, annuitized or converted to a RRIF. RRIF income received at or after age 65 qualifies for the pension income tax credit and has an additional advantage that couples can elect to split pension income.
According to BMO, you can start taking advantage of the pension credit at 65 by transferring $14,000 from an RRSP to a RRIF, making sure to take out $2,000 each year between age 65 and 71. “Depending on your marginal tax rate, this pension tax credit will reduce or eliminate the incremental tax otherwise owing on the additional $2,000 of qualifying income annually, to the extent that you are not otherwise taking advantage of this credit with other income,” says BMO in a document titled RRIFs – Tips and Considerations.
Pension splitting also lets senior couples double up on the pension credit. If you’re at least 65, you can split up to 50% of your RRIF income with your spouse. If that spouse is also 65 and has no other income that qualifies for the pension credit, by income splitting and allocating $2,000 each year of RRIF income to your spouse, your spouse can also qualify for the $2,000 pension income tax credit. This will be obtained after filing your tax returns, so for the couple together, they will now have $4,000 in pension tax credits between them.
According to fee-only advisor Jim Yih of RetireHappy.ca, unused pension income credits can be transferred to a spouse or common-law partner. He suggests “the ability to transfer this credit should be explored in circumstances where one spouse is earning pension income in excess of $2,000, and the other spouse is not otherwise fully utilizing his or her pension income credit.”
Jonathan Chevreau is MoneySense’s Retired Money columnist and can be reached at firstname.lastname@example.org.