This is a guest post by invitation, from Graeme Hughes, PFP. Thanks to Graeme, this is a wonderful follow up post to The 3 Most Common Mistakes of Canadian Investors. Over to Graeme …
Canada’s tax and benefits system is a convoluted tangle of programs, rules and exceptions that can be a genuine challenge to navigate. Like all complex systems, having some knowledge of how it works often reveals opportunities to benefit. And as a taxpayer, it only makes sense to ensure that we are accessing all the benefits our tax contributions have made possible.
One of the greatest areas where this type of planning pays off is in structuring our early-retirement income to maximize pension benefits. Here we will be looking at two benefits in particular, the Guaranteed Income Supplement (GIS) and the Canada Pension Plan (CPP).
Accessing The Guaranteed Income Supplement
Often, the GIS is viewed as being strictly a benefit for seniors who are living in poverty. However, recent studies show almost a third of Canadian seniors are receiving this benefit, and it can add substantially to your total retirement picture.
The GIS is an add-on payment to Old Age Security (OAS). It provides a maximum monthly benefit of $907.30 for single OAS recipients, and $546.17 each for married and common-law OAS recipients. Benefits are income tested, and clawed back at a rate of at least $1 for every $2 of taxable income for singles, and at least $1 each for every $4 of combined income for couples. The clawback rates are variable depending on total income, and more detailed tables can be found here.
The GIS is a non-taxable benefit, and OAS amounts are not included in the income calculation. Once annual income reaches $18,408 for individuals, or $24,336 in combined income for couples, the GIS benefit drops to zero.
How To Maximize The GIS If You Have Modest Savings
Knowing this, if I were a retiree with modest savings and no employer-sponsored pension, I would be tempted to ensure I reached age 65 without any RRSPs. Given the GIS clawback would apply to taxable RRSP withdrawals, the RRSP becomes a very inefficient way to fund additional retirement spending.
For example, if I am a single retiree, aged 65 or older, and I receive 70% of the maximum CPP amount ($808/month), I will be entitled to an additional $363 per month in GIS payments, along with my $607 OAS benefit (assuming 100% OAS eligibility).
While that may not seem like a lot of money, the GIS benefit represents 20% of my total income. For every dollar I take from an RRSP, I am going to lose at least 50 cents of that GIS benefit, and that would be a waste of my precious savings.
However, this clawback does not apply to TFSA withdrawals or withdrawals from non-registered accounts, since they are non-taxable. Keep in mind that in non-registered accounts, any interest, dividends or capital gains that are earned would result in GIS clawbacks, but these would likely be much more minor unless the balances are sizeable.
So for many retirees, it may be beneficial to liquidate their RRSPs prior to age 65, or shortly after 65, and move the proceeds to a TFSA first, with any excess amounts going to a non-registered account. This will maximize the value of the money they have worked hard to save, and optimize their entitlement to government benefits.
Of course, the tax consequences of liquidating RRSPs need to be carefully considered and compared to the GIS benefits likely to be gained. The larger the RRSP balances, the harder this strategy is to justify.
How To Benefit From The GIS If Your Retirement Savings Are More Substantial
The GIS options become even more interesting for retirees that have larger amounts of savings and limited sources of retirement income outside of government pensions. In this case, appropriately structuring your affairs can provide a real advantage in increasing the longevity of your retirement assets.
Here’s another example. If we have a couple planning to head into retirement, at age 65 they would be entitled to combined OAS/GIS payments totaling $2,307 per month, if they have no other taxable income. That’s $27,684 per year in income, 47% of which is non-taxable GIS benefit. That’s a pretty healthy start to funding their retirement.
Ideally, this income could then be topped up from non-taxable TFSA or non-registered account withdrawals, as needed to meet spending needs. CPP payments can now be deferred until age 70 and RRSP withdrawals until age 72. During this period, little or no tax would be due on these income streams, and government benefits would be fully maximized.
Currently, a couple can have combined contributions of $127,000 in their TFSAs. Even without accounting for any investment returns, that would support 5 years of income at $25,400 per year. Added to their combined OAS/GIS amounts, that would equate to total income of $53,084, with potentially no income tax to pay. That’s not bad at all.
The Benefits Of CPP Deferral
An additional benefit to this strategy comes from the planned deferral of CPP benefits to age 70. That deferral would mean a 42% increase in the benefit amount (plus inflation adjustments), as opposed to taking CPP at age 65. For someone planning on receiving 70% of the maximum CPP amount at 65, that would increase their benefit from $808 per month to $1,147. That’s an extra $339 per month, per person, that no longer has to be funded from investments.
Assuming a safe withdrawal rate of 4%, that means that after age 70 you essentially need $102,000 less in retirement savings, per person, to generate the same income stream provided by the enhanced CPP amount.
Even if you are not targeting receipt of the GIS benefit, arranging your retirement income to defer CPP benefits until age 70 removes a significant amount of both investment return risk as well as longevity risk, as a larger portion of your later retirement years will be covered by safe, guaranteed, inflation-protected government benefits.
Of course, CPP deferral is not for everyone. You need to have sufficient assets to supplement your income as required from age 65 to 70. You also should have at least an average life expectancy to make the enhanced CPP amount pay off over time.
Further, the more conservative you are as an investor, the greater the benefits of CPP deferral, since the lower investment returns you are likely to realize make longevity risk a greater consideration.
Be Aware, And Do Your Homework
Of course, given the constraints of time and space, this is not a comprehensive assessment of the retirement planning opportunities presented by both the GIS benefit and the deferral of CPP benefits.
There are other features of these programs to be considered, along with significant tax considerations and the uniqueness of each individual’s circumstances. But being aware that these opportunities are available, and that they apply largely to people going into retirement without significant sources of income outside of government pensions, can help you decide if they might be an appropriate solution for you.
If it seems like these approaches may result in a financial advantage for you, do your homework, and get qualified help if you need it. Maximizing your access to government benefits could drastically change your retirement outlook for the better.
Graeme Hughes is an accredited Financial Planner with 23 years of experience in the financial services industry. During the course of his career he completed hundreds of financial plans and recommended and sold hundreds of millions of dollars of investment products. He believes that financial independence is a goal anyone can aspire to and is passionate about helping others to live life on their own terms.
Note: Graeme also operates the wonderful blog The Money Geek.