How to maximize disability benefits and minimize taxes in retirement

Disability, income splitting and tax reduction

Rob’s wife is unable to work due to a chronic illness. He’s trying to plan for tax reduction in retirement on their registered accounts.

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Q: My wife has been diagnosed with a chronic condition known as Fibromyalgia, so she can’t work anymore (she’s 49). My plan is to retire at 65 (I’m 57) and we plan to have about $1 million saved in registered accounts (about 85% in my name).  Can you recommend a tax efficient approach to drawing down the registered funds so that it reduces the impact on other benefits like OAS?

– Rob

A: There are a bunch of different considerations here, Rob, so bear with me, as this will be one of my longer Ask a Planner answers. Before I jump right to income splitting in retirement, I think there are a few other pertinent points.

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I assume if your wife was entitled to any short-term or long-term disability benefits through a workplace or private disability insurance policy, you have already pursued those. But I want to make sure you have also considered other government and income tax benefits that are available now, long before retirement.

Get the most out of disability benefits

The Canada Pension Plan (CPP) offers a disability benefit to people who have contributed to CPP and cannot work on a regular basis. In order to qualify, her Fibromyalgia must be both severe and prolonged. According to Service Canada: “Severe means that you have a mental or physical disability that regularly stops you from doing any type of substantially gainful work. Prolonged means that your disability is long-term and of indefinite duration or is likely to result in death.”

Benefits will depend on your wife’s historical contributions, but for perspective, the average benefit as of October 2018 was $955 per month and the maximum benefit for 2019 is $1,362 per month.

Your wife may also qualify for the Disability Tax Credit, which provides both a federal and provincial non-refundable tax credit on her income tax return. Her Fibromyalgia must be a severe and prolonged impairment that impacts her ability to perform basic activities of daily living or requires life-sustaining therapy. She may or may not qualify depending on the specifics of her condition.

The tax credit will save her $1,262 of federal tax for 2019 and between $405 and $1,494 of provincial/territorial tax depending on where you guys live, Rob. If she doesn’t have enough taxable income to have to pay tax on her own tax return, she can transfer the credits to you to claim on your tax return.

READ: Family caregivers are missing out on help from the taxman

Furthermore, if she does qualify for the Disability Tax Credit, you may be able to contribute to a Registered Disability Savings Plan (RDSP) account for her. Contributions are not tax-deductible like they are with your own Registered Retirement Savings Plan (RRSP) contributions, Rob, but an RDSP may be an even better option than an RRSP for some people.

I say, “for some people”, because RDSP contributions attract matching grants from the government until the year someone turns 49. If she’s 49 now, I assume she turned 49 in 2018, and that may have been the last year for her to receive a government grant. For those age 49 and younger, the government grants can be up to 300 per cent of your contribution, as compared to RRSP deduction tax refunds, which can be up to 54 per cent at most.

In your case, Rob, absent the government grants, an RDSP may be beneficial if you guys have maxed out your Tax Free Savings Accounts (TFSAs).

Whether you should contribute to an RRSP, TFSA or RDSP will depend on several factors that I won’t bother going into here. First, figure out if your wife qualifies for the Disability Tax Credit and if you can in fact contribute to an RDSP.

Another consideration is that you mention that about 85% of your estimated future $1 million in retirement savings will be in your name. You could always consider opening and contributing to a spousal RRSP in your wife’s name, Rob. The contributions are based on your RRSP room; the deductions go against your income; but the withdrawals in retirement, subject to conditions, are taxable to your wife.

READ: Spousal RRSP or TFSA: The best option for a retired couple

Some people discredit the benefit of spousal RRSPs for income splitting in retirement given those over the age of 65 have been able to split up to 50% of their Registered Retirement Income Fund (RRIF) withdrawals with their spouse or common-law partner for the past 11 years. That may be so, but what if tax rules change, however unlikely? A spousal RRSP could still be a good option, just in case.

Some other considerations, Rob, are based upon what happened to your wife. You guys probably didn’t expect her to become disabled and be unable to work. What happens if the same things happened to you? If you can’t split your registered plan withdrawals until 65 years of age, maybe that’s even more of a reason to consider contributing to a spousal RRSP, in case you can’t or don’t work that long.

Beyond that, there are other ‘what if’s’ to consider. What if you become disabled, and your wife is disabled already? Do you have adequate disability insurance in place? Should you be considering critical illness insurance? Or worse, what if you die? Do you have enough life insurance?

Minimizing tax when drawing down RRSPs

Now that I’ve gone off on a massive tangent, Rob, I’ll go back to your original question about drawing down your RRSPs in retirement and minimizing tax. Eight years from now, when you’re 65, you may consider options like converting your RRSP to a RRIF upon retirement but deferring your Canada Pension Plan (CPP) and Old Age Security (OAS) pensions. These pensions can be deferred until age 70 and increase by 8.4 per cent and 7.2 per cent per year of deferral respectively. This may help you increase your government-guaranteed, inflation-protected pension income, while allowing you to draw down your retirement accounts in the interim for income. Whether this is a good decision for you will depend and should be considered when you do retire.

Avoiding a clawback of OAS benefits should be easy with only $1 million in registered accounts, frankly, but it’s not to say there can’t be changes to the clawback limits between now and then. As it stands, you need to have more than $77,580 in income in 2019 to have your OAS pension reduced, which probably wouldn’t apply if CPP, OAS and $1 million in RRSPs are your primary retirement income sources, and you can split RRIF withdrawals 50% with your wife.

READ: Why it’s still worth it for high-income seniors to apply for OAS

I’d act based upon what you know now, and that includes determining eligibility for disability benefits, the Disability Tax Credit, and an RDSP. Consider a spousal RRSP, and then decide whether to contribute to an RRSP, TFSA, RDSP, or all three. And make sure you’re insured properly in the event another unfortunate event derails retirement plans for you and your wife.

My lengthy response to your relatively simply question, Rob, helps highlight a major challenge with financial planning. People often ask me one-sentence questions, and my answer is frequently, “it depends”, because there can be so many other factors to consider beyond just an initial question.

Financial planning is kind of like a “Choose Your Own Adventure” book – for those who remember the popular children’s series from the 70s, 80s and 90s. There are so many considerations, and the more you can do to educate yourself or to get answers to those questions, the more confident you will feel in making financial decisions.

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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.