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John Natale, Assistant Vice President, Tax and Retirement Services at Manulife

Manulife Financial

Many retirees do not use all available methods to reduce their taxes and maximize their after-tax income. Three effective ways of doing this involve pension income splitting, making use of systematic withdrawal plans (SWPs), and reducing the amount of income reported on line 234 of the tax return, says John Natale of Manulife Investments.

Pension income splitting

When possible, couples should consider transferring eligible pension income to the lower-income spouse, says Mr. Natale, Assistant Vice President, Tax and Retirement Services at Manulife.

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For those under 65, only income received directly from a pension plan or other registered income received because of the death of a spouse qualifies for pension income splitting.

For people 65 and over, income from other registered plans such as Registered Retirement Income Funds (or RRIFs), and annuities purchased with an RRSP and Deferred Profit Sharing Plans are also eligible for income-splitting. Generally, income from non-registered investments will not qualify with the exceptions being income received from a Guaranteed Interest Contract (GIC) provided by an insurance company and the interest element of non-registered annuity contracts.

Electing to have up to 50 per cent of eligible pension income transferred to the lower-income spouse can reduce the overall family taxes, and minimize the clawback of income-tested benefits like Old Age Security (OAS) that kicks in when income reaches a certain level.

RRSPs must be collapsed by December 31 of the year an individual turns 71, and may be converted into a RRIF, which allows individuals to spread out the income over the rest of their life.

Consider a simple example where the higher-income spouse has annual pension income of $80,000. With pension income splitting, up to $40,000 of the pension income could be reported by the lower-income spouse and depending on his or her tax rate this can result in thousands of dollars of annual family tax savings.

Although a couple's combined gross income doesn't change with pension income splitting, reallocating that income can have a profound impact on what a couple keeps after taxes, Mr. Natale says.

Systematic withdrawal plans

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An SWP is a way to receive scheduled income through different investments such as stocks, mutual funds or segregated fund contracts. Regularly – every month or quarter – a number of available shares or units will be sold to help generate retirement income. In a market moving upward, the investment can still grow. SWPs can be an effective income tool overall and Mr. Natale recommends exploring the tax benefits of certain types of SWPs.

"Non-registered investments such as equities, mutual funds or segregated fund contracts can provide tax-efficient revenue streams," Mr. Natale says. "When you do a partial redemption, a portion will be capital gain and a portion will be a return of capital."

For example, say an investment of $50,000 increases to $100,000. The growth, $50,000, makes up 50 per cent of the market value. So for every dollar withdrawn, 50 per cent is capital gains, of which only half is taxable, and 50 per cent is an investor's own money coming back and therefore not taxable. That can substantially reduce the effective tax rate, Mr. Natale says. A GIC, in contrast, would have to earn a significant amount of interest to generate the same amount of after-tax income.

Reducing line 234

When you complete your tax return, you list all income sources, then all deductions. That gets you to line 234 – your income, less deductions, but excluding tax credits. If the income reported on line 234 is too high, some valuable government benefits and tax credits, such as OAS and the Age Credit, can be clawed back or even forfeited. In some cases, that's thousands of dollars in benefits.

Mr. Natale describes two methods to lower the amount on line 234. First, carefully structure non-registered income for more favourable tax treatment. For example, you have to report 138 per cent of eligible dividend income and 100 per cent of interest income you earn from GICs and bonds. Instead, consider the benefits of prescribed life annuities where, depending on your age, you might have to include just 15 per cent of the payments on your tax return. Or make withdrawals from a mutual fund or segregated fund contract, where, assuming a positive rate of return, only a portion of the payment is capital gains (see the SWP strategy).

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Another strategy aimed at increasing deductions applies if you are turning age 71:

  • Make a lump sum final contribution to your RRSP, if you have unused room, before converting it to a RRIF. The resulting deduction does not have to be used in that year’s tax return but instead can be used at any time in the future – whenever it is most beneficial in reducing taxable earnings in retirement.

Many Canadians who reach retirement age are not aware of or do not understand all of these opportunities, Mr. Natale says, especially if they don't have an advisor. By taking advantage of the best tax strategies, people can boost their bottom line even when they're no longer working, he says.

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