What’s In Your Retirement Bucket?
Updated: Sep 16, 2021
Part of planning for retirement is determining where your income will come from. This is called the “bucket approach”. This is important as it will determine where and how much you will need to save in order to meet your goals. If you are a Canadian citizen, worked in Canada, and contributed to the various registered savings programs listed below, these common savings sources will be available in your retirement to convert to income.
- RPP - registered pension plans through your employer.
- RRSP - registered retirement savings plan.
- TFSA - tax-free savings account.
- CPP - Canadian pension plan, available following your 59th birthday
Further to these programs, the following income supplements are available to every Canadian, when, and if, you qualify:
- OAS - old age security, available at age 65
- GIS - guaranteed income supplement at age 65 if you are collecting OAS and your annual income is lower than $18,445.
Registered pension plans come in two forms in Canada, a DBP (defined benefit plan) and a DCP (defined contribution plan). The DBPs are becoming more uncommon in Canada, and the vast majority of employers who offer pension plans, now offer DCPs. A DBP is basically a pool of employee investments, managed by the company, and paid out in the future based on the length of time you were in the plan and the amount you paid into it. The DBP payments are made for life, indexed to inflation, and resemble fixed annuity payments. A DCP is basically a self-managed plan, with an investment company used by the employer, and is subject to rules that limit the amount that can be withdrawn annually in retirement. Both these plans commonly allow an employee contribution up to 2% of your income, are matched by employers, and the employer contributions may increase up to 6% with increased length of service. If you are lucky enough to be offered a company pension plan, use it. They are sheltered from tax, compound quickly with the employer matches and long term vesting, and are great vehicles for securing future retirement income.
Registered retirement savings plans are a common savings programs available to all Canadians who have a SIN, earned income, and filed a tax return the prior year. Every year the Government sets limits for RRSP contributions. For 2020 the limit is $27,230 and you have until Mar 1 every year to contribute to acquire the tax benefit for the prior year. For example, if you purchase an RRSP by Mar 1, 2021 it will apply to the 2020 tax year. The contribution amounts will be or must be adjusted downwards if you contribute to a company pension plan (PA - pension adjustment) or group RRSP through your work benefits. You can find your personal contribution limit on your annual tax assessment statement, or by visiting your account in myCRA. If you contributed to a group RRSP you will need to subtract this amount from your allowance as CRA will not make this adjustment on your tax assessment. If you cannot contribute to an RRSP, those amounts carry forward and accumulate, and you can make them up any time. You do not want to overcontribute as you will be charged 1% per month by CRA on the overage. RRSPs are designed to reduce your taxable income when filing your taxes, and in doing so you are returned the taxes you paid on this income. RRSP contributions and growth are also tax sheltered until withdrawn. They are intended to be withdrawn in retirement, preferrably at lower tax rates than when you purchased them as this is how they will benefit you the most. RRSPs lose a bit of their luster if you plan to retire in the same tax bracket you purchased them in, though they still shelter your investment growth from tax during accumulation.
TFSAs (tax-free savings accounts) were introduced in Canada in 2009 and availble to every Canadian 18 years of age with a SIN. They are pretty self-explanatory. Any money invested into a TFSA is totally tax free. They grow tax free and can be withdrawn tax free. The investment growth and income are not taxed... ever. The lifetime allowance for TFSAs if you started the program in 2009 is $74,500, and the contribution limit for 2021 is $6000 per individual. However, if you turned 18 and/or acquired a SIN following 2009, your lifetime allowance will be reduced to the number of years you qualified for the program. The annual allowances have been subject to change over the years, so always check to ensure you do not overcontribute, as overcontributions are subject to the same penalties as RRSPs. Some believe TFSAs should be maximized before buying RRSPs. Obviously both programs provide slightly different benefits. RRSPs return tax money to you every year you take advantage of them, and TFSAs eliminate tax completely.
CPP, or the Canadian Pension Plan, is a pension plan administrated by the CPPIB (Canadian Pension Plan Investment Board) and available to Canadians who contributed to it during their working years. The benefit you realize it based on how long and how much you contributed to the plan. You are entitled to take your CPP at any age between 59 and 70, and the longer you delay taking it, the more you will receive monthly. If you take CPP at age 65, the maximum benefit in 2021 is $1203.75 per month. The amount of benefit gained by delaying it can be significant, up to 30% more for every 5 years delayed. However, each individual must decide what is best for them depending on life expectancy, income needs, and/or tax efficiency. This source of income is pre-tax, so you must account for taxes on top of the payments received, You can have tax withheld at source by request at a Services Canada office. Taxes will not be withheld automatically. CPP is indexed to inflation, which provides a nice hedge against rising costs. This is another consideration towards delaying and maximizing this benefit.
OAS, or old age security, is another government benefit available to all Canadians when they turn age 65, providing they have lived in Canada for a minimum of 10 years after the age of 18. The amount you receive will depend on how long you have lived in Canada after age 18. Typically, you will be eligible for the maximum amount if you lived in Canada and contributed for 40 years. The maximum OAS payment for 2021 is $615.37 per month. If you earned more than $129,075 in individual net income, you will not qualify to receive OAS (it will be completely clawed back), and if you earn more than the net world income threshold for the year ($77,580 in 2019), OAS payments will start to be clawed back incrementally up to the non-qualifying amount through a recovery tax. Normally you do not need to apply, and OAS will start being paid at age 65. However, you have the option to defer it up to age 70 and get more as a result, but you must decide this early and do so at a Services Canada office prior to payment because these payments will very likely start automatically. They cannot be stopped once they start. OAS is also indexed to inflation and taxable, so also must be accounted for and considered in your plan.
GIS, or the guaranteed income supplement, is a non-taxable benefit available to every Canadian citizen residing in Canada 65 years old or older, is currently receiving OAS, and is making less than the threshold net income limits set by the program to qualify.
* your income is below $18,648 and if you are single, widowed, or divorced ($919.12 per month)
* your income plus the income of your spouse/common-law partner is below:
* $24,624 if your spouse/common-law partner receives the full OAS pension ($553.28 per month)
* $44,688 if your spouse/common-law partner does not receive an OAS pension ($919.12 per month)
* $44,688 if your spouse/common-law partner receives the allowance ($553.28 per month)
These amounts vary with the various income limits and/or your household utilization of other programs like OAS and GIS. Typically the CRA will inform you if you qualify for this program and the amount of benefit you can receive, based on the previous tax year. These payments are reviewed annually. This payment is also indexed to inflation, but will never be reduced if the index drops negative. If you have had a change in income or refute the benefit amount, you can write Service Canada within 90 days to be considered for adjustments.
With the bucket approach to retirement income you first need to determine all your income sources, build them up over many years, and envision the money from those investments trickling into a common income bucket at 3-4-5% a year as required. Generally, the more money you have in your accounts, the lower the withdrawal rate percentage you will require to maintain your income goals or inversely, the more you have available if you want to take a higher income. However, you must consider taxation and your planned expenses in the final equation. You may need to think about what options you have to minimze your taxes and expenses to maintain some comfort against market risks or rising costs. It really becomes a balancing act between income and expenses. I’ve listed the more common sources in Canada, each with their unique rules and benefits. You may have other investment sources like rental income, unregistered savings, etc. The payments from your accounts and investments into your “income bucket” will come from both an ongoing accumulation of the distributions and cashed in shares from the source accounts. As you draw shares down, the distributions will shrink accordingly. If you have done a really good job saving, you may want to draw down your registered investments first, and delay taking your CPP & OAS as long as possible to get a higher monthly payments. You can find more info on these sources in the following link.
*** What’s in your retirement bucket? ***