After years of saving for retirement, you finally realize your dream of enjoying your hard-earned money. Decumulation, or drawing down your retirement accounts, requires a plan to ensure you can live your best life in retirement. Creating a strategy will help determine which account you should take the money from first.
Setting Retirement Goals
Retirees often have three objectives:
- Ensuring they don’t run out of money
- Minimizing their investment risk
- Paying as little tax as possible
Here’s how you can accomplish all three to live the life you want and preserve your nest egg.
Develop a Spending Plan
Before you retire, review your current expenses and determine which ones you’ll eliminate when you’re no longer working. Some expenses that might decrease in retirement are transportation costs, clothing, meals out, and memberships.
However, the lifestyle changes retirement brings could replace or exceed these expenses. A spending plan is valuable because it allows you to calculate how much living the retirement of your dreams will cost. You might travel more, pursue expensive hobbies, or financially help family members. Having a good idea of your retirement expenses will show you how much income you’ll need.
You may need more than your retirement income to meet your lifestyle needs. Three ways to increase your income are to reduce expenses, go back to work, or begin drawing down your investments. Reducing investment risk can help preserve your portfolio so you’ll have access to the money for many years.
Minimizing risk
Outliving your money is a genuine retirement fear. Reducing risk in your investment portfolio can help preserve your assets. You want to earn a decent return but not put your capital at risk. It could be beneficial to withdraw the funds from your aggressive investments and leave your conservative ones to continue growing steadily.
Retirement income and taxes
Once you have a monthly or annual estimate of your expenses, find out how much income you’ll be getting and how that income will be taxed. Company pensions, the Canada Pension Plan and Old Age Security are subject to income taxes.
Earnings from investments are taxed at different rates. Understanding these rates can give you a sense of control over your financial situation. You’ll pay a higher tax rate on interest income than on dividends or capital gains. Knowing this can help you make informed decisions about your investments.
Registered Retirement Savings Accounts and Registered Retirement Income Funds allow money to grow tax-free while in the plan. When you withdraw it, it’s taxed as income, and there are no preferential tax rates for dividends or capital gains.
The Tax-Free Savings Account offers tax-free investment growth while the money is in the plan, and it’s not subject to any type of taxation when you withdraw it.
Ways to reduce your taxes
So, what does all this mean? Knowing your income and expenses is essential to minimizing your tax burden. If, for example, you have money in RRSPs but are not collecting CPP or OAS yet, you could choose to delay CPP and OAS and collapse your RRSPs. This way, you could reduce your tax burden because you’re not paying income tax on your RRSP withdrawals, CPP and OAS at the same time.
Some retirees decumulate their RRSPs to reduce their estate taxes for their beneficiaries. Any money in an RRSP or RRIF will be taxed as if you withdrew it when you passed away. The taxes owing will reduce the amount of money your beneficiaries receive. Due to this, you may want to empty those plans first so the taxes owed are paid before you pass away.
Another possibility is to leave your RRSP money in the plan and let it grow tax-free until you are 71. Once you’re 71, you must convert it to a Registered Retirement Income Fund or purchase an annuity, and begin withdrawing it.
A RRIF allows you to choose a payment structure that works best for you, such as monthly or annually. Plus, if you don’t need the money, you can deposit it to your TFSA if you have room and let it grow tax-free.
There are a lot of variables to consider when deciding which account to take money from first in retirement, but you don’t have to navigate this complex terrain alone. A financial planner can work with you to develop a retirement spending plan. Financial planners have access to sophisticated planning tools to customize your optimal withdrawal strategy, reassuring you that you’re making the best decisions for your retirement.
We’ll Help Your Develop the Right Plan
As you’ve seen, the account to take money from first in retirement depends on many factors, such as your income, tax rate, spending habits, and estate plan. Our advisors at MDL Financial Group have been helping clients maximize their investment plans in retirement for over 30 years to reduce their risk, minimize their taxes, and not outlive their money.
We’ll develop a customized financial plan based on your specific circumstances to ensure you can live your retirement your way. Contact us online to book an appointment and get started on your retirement journey.
If you liked this article, here’s three more you might be interested in:
https://mdlfinancialgroup.ca/all-you-need-to-know-about-the-rrsp-contributions/
https://mdlfinancialgroup.ca/5-popular-reasons-people-dont-save-for-retirement/
