An income layer cake - MoneySense

An income layer cake

Your retirement income will come from a variety of sources: government, pensions, your portfolio, part-time work, and maybe even your home equity. How can you keep your cash flow smooth and tax-efficient?


It’s easy to feel overwhelmed with questions about how to draw retirement income. When do you start collecting government benefits? Which do you tap first: RRSPs, Tax-Free Savings Accounts (TFSAs) or non-registered money? How do other sources of cash flow like employer pensions, annuities and home equity fit in? How do you make sure your income is reliable?

These issues are daunting enough when you consider them individually. But then there’s the burning overall question: How do you put it all together?

One good approach is called income layering. While there are several versions, the general idea involves using different sources or “layers” of income to make cash flow smooth, reliable and tax-efficient. Think of it as a layer cake of cash. The base (what I’ve called Layer 1) is composed of income that is highly reliable, but usually not tax-efficient or flexible, such as government and employer pensions, annuities, and income from part-time work (if it is reliable and steady). Then you add a more tax-efficient Layer 2: this includes sources of income that are less reliable but more flexible, like your investment portfolio. Finally, you top it all off with Layer 3: the equity in your home or other property, which you can tap late in life if necessary.

Many financial planners use a variation of this approach, including Douglas Nelson, author of Master Your Retirement, and Daryl Diamond, author of Your Retirement Income Blueprint. In what follows, we’ll show you how you can adapt these ideas to your own situation.

“It’s all about taking less risk, paying less tax, generating more income and connecting the dots in those pieces,” says Nelson, a portfolio manager with Nelson Financial Consultants of Winnipeg.

Income first

Nelson advocates an “income first” approach, placing the focus on generating a sustainable, tax-efficient cash flow that meets your spending needs. That in turn should drive your investment strategy, he says. Nelson suggests retirees aim to have at least their basic spending needs covered by secure sources of income in Layer 1, and says they shouldn’t rely on income from investments in Layer 2 to cover more than 30% of their total spending.

For retirees without good employer pensions, building a solid income base takes some effort. You should look at all sources, including the potential to work part-time, taking government benefits as soon as you retire, or purchasing an annuity. The income benefits of working part-time are obvious, but we’ll consider the other two opportunities in more detail.

Building a base

At one time you started Canada Pension Plan (CPP) and Old Age Security (OAS) at age 65 and that was it. Now you can start CPP anytime between 60 and 70, and OAS between 65 and 70. (Younger Canadians will eventually collect OAS between 67 and 72.) If you start early, you receive more payments, but each one is smaller. Start them later and you receive fewer payments for larger amounts.

There’s no huge advantage or disadvantage whatever your start date if you have average life expectancy. But if you have reason to expect an early demise, you should generally start your pensions as soon as possible. If you have reason to expect you’ll live to an exceptionally old age, then deferring might make sense. (For more details, see my article CPP: Less now or more later.)

Consider how this decision fits with your overall income needs. If you’ve recently retired and don’t have a lot of other secure income, you’ll probably appreciate a boost in guaranteed income. By shifting the timing of these government benefits you’ll provide a smoother flow of income as soon after retirement as possible…

For more on buying an annuity, portfolio options, making investment income more reliable and your home as a safety net, pick up a copy the February/March issue of MoneySense on newsstands now through March 31 or while quantities last. You can also buy it direct from your iPad.

David Aston, CFA, CMA, MA, writes about personal finance. You can share your retirement spending experiences by emailing He might include your experience in a future article.