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tax matters

My father was telling me that he's enjoying his retirement years. He gets discounts at the theatre, speed limits are no longer a challenge for him, his joints are pretty good at predicting the weather and his secrets are safe with his friends because none of them can remember what he's told them. It's all good.

As a senior, he'll stand to benefit from some changes that were introduced in the 2015 federal budget this week.

If the truth be known, the budget included two specific changes that could meaningfully impact your retirement – for the better.

The challenge is to figure out how these changes should impact your saving for retirement. Let me explain.

The changes

The budget introduced changes to both tax-free savings accounts (TFSAs) and registered retirement income funds (RRIFs). Specifically, the contribution limit for TFSAs was increased from $5,500 to $10,000 for 2015 and future years (as an aside, this limit is no longer indexed to inflation as it was in the past). It means you'll be able to set aside more inside a TFSA over time.

In fact, under the new limit the value of your TFSA over a 20-year period of time could be as much as 82 per cent higher. For example, if you were to invest $5,500 in your TFSA for the next 20 years and were to earn 7 per cent on your money, you'd end up with $241,258 at the end of that time. By contributing $10,000 annually instead, your TFSA jumps to $438,652 in value at that same rate of return.

As for RRIFs, there's a minimum withdrawal you must make each year, but that amount has been reduced, which can allow you to leave more in your plan for longer. This will allow a deferral of tax in cases where you have other sources of income as well and don't need to withdraw more than the minimum from your RRIF.

Take an example where, at the end of the year in which you turn 71, you have $300,000 in your RRIF. Under the old rules, you would have $132,633 left at the end of the year in which you turn 90, if you make the minimum withdrawal every year, assuming a 5 per cent return annually. Under the new minimum withdrawal requirement, you'd have $193,434 left at the end of that same time. That's 46 per cent more in your RRIF in this example.

The task

You have a task at hand here. It's important that you take the time to figure out how much money you'll need waiting for you on the day you retire (and from what sources), and how much you need to save or invest annually to accumulate that amount. If you're not able to do this math, make sure you visit a professional who can. Maybe you're already on course to have sufficient resources in retirement – but do you know for sure?

Your needs in retirement could be met by different sources of income in those years. These most commonly include: (1) employment or self-employment earnings, (2) non-registered investments (which can include securities, rental properties, and more), (3) RRSP or RRIF investments, (4) TFSA investments, (5) employer pensions, (6) government pension and benefits (Canada Pension Plan and Old Age Security benefits come to mind), (7) lifestyle assets you're willing to sell to make ends meet (a home or cottage, for example) and (8) inheritances you know you'll receive (unfortunately the timing and amount of inheritances is not often known, so relying on these may be a bad idea).

The approach

When I helped my father figure out his own retirement plan, we took a five-step approach: First, we figured out how much after-tax income he needed to make ends meet annually in retirement. Second, we determined how much after-tax income he could expect from his various sources (see the list above). Third, we then figured out how much additional after-tax income he would need annually (it's simply the difference between the figures from steps one and two). Fourth, we figured out what pool of money he would need at the time of his retirement, to provide that additional after-tax income. Lastly, we figured out how much he needed to save annually to create that pool of money.

The tricky part is that income from different sources are taxed differently. RRIF withdrawals are fully taxable, while TFSA withdrawals are tax-free, giving rise to different amounts of after-tax income. Still, there's good news this week; the 2015 federal budget created more flexibility now in how you can structure your sources of income for retirement. More on this in the weeks to come.

Tim Cestnick is managing director of Advanced Wealth Planning, Scotiabank Global Wealth Management, and founder of WaterStreet Family Offices.

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