How much have you really saved for retirement?

Before you turn off the employment highway, it’s a good idea to make sure there’s nothing lurking in your financial blind spot. When some people transition into retirement, they’re amazed at how differently their various savings, investments and retirement plans are taxed. These differences can add up to hundreds of thousands of dollars, meaning it can be expensive to be blindsided by unforeseen taxes.

To give you an idea of the potential impact of taxes, here’s what could happen to $50,000 in different kinds of accounts:

Tax-free savings account (TFSA)

There’s no income tax payable on withdrawals from a TFSA. Because you contributed to your TFSA with after-tax dollars and the government doesn’t tax growth within your account or your withdrawals, the entire $50,000 is yours.

But, be careful. If you hold any U.S. stocks that pay dividends in your TFSA, you have to pay some tax. Under the Canada-United States Tax Convention (the “treaty”), dividends on U.S. stocks held by Candian resident investors are subject to 15% withholding tax, deducted automatically at source. (This isn’t the case for such dividend income received within RRSPs and RRIFs, where the treaty between the U.S. and Canada currently applies.)

Registered retirement savings plan (RRSP)

RRSP contributions are deducted from your taxable income when you claim them, reducing the tax you pay, but withdrawals are subject to income tax. How much tax you pay at withdrawal will depend on your income in the year you withdraw the money and where you live in Canada. You may be paying less tax in retirement since your income is likely to drop once you stop working, but you could easily be looking at a tax bill somewhere between 25% and 55%. To learn more, see the Canadian income tax rates for Individuals - current and previous years.

Registered retirement income funds (RRIFs), life income funds (LIFs) and locked-in retirement accounts (LIRAs)

Rather than pay all the income tax due on the contents of your RRSP or LIRA when you close it down, you can purchase an annuity or that money can be directly transferred into a RRIF or LIF where your savings are taken out gradually – subject to annual minimum withdrawal requirements for RRIFs and annual minimum and maximum requirements for LIFs). That helps you pay tax gradually. As in an RRSP, the investment growth within a RRIF, LIF or LIRA isn’t taxable until you withdraw it from the fund, but then it’s fully taxable at your marginal rate based upon the amount withdrawn.

Non-registered investments

Examples of non-registered investments are: savings accounts, stocks, segregated fund contracts and mutual funds in non-registered accounts and income properties. Because you’ve already paid income tax on the money you used to buy these investments, you don’t have to pay tax on it again. But any investment growth within these accounts is taxed. For example:

• Interest income from sources such as savings accounts, bonds or guaranteed investment certificates is fully taxable at your marginal rate.
• Dividend income from shares in companies may provide you a tax credit, which could lower the tax you pay on such income.
• 50% of capital gains income from selling non-registered investments for more than you paid for them is taxable at your marginal rate in the year of sale. If you sell the non-registered investments for less than you paid for them, the loss you realized can offset the gains realized in the year and if there is a balance remaining, the loss can be carried back up to three years to offset gains realized in those years or carried forward.

Not being familiar with how your savings, investments and retirement plans are taxed can be a dangerous blind spot. If you don’t keep in mind that the size of your investment portfolio and your investment returns are reported in pre-tax dollars, you may find that your nest egg after taxes is smaller than you think.

It’s also important to know how your retirement savings are taxed when you’re working out how much you withdraw each year from your retirement nest egg without running out of money prematurely. If you follow the common guideline that says you can safely take out 4% of your savings each year (assuming a balanced portfolio), remember that it assumes pre-tax dollars. You’ll actually have less in your hand after tax.

So, what’s next? Well, it’s a good idea to check your retirement blind spot today by booking a meeting with an accountant and an advisor to assess your own specific situation. Prospr advisors can help you review your retirement plans and help make sure your investments match your goals.

Book an appointment. We’re always here to help!

 

This article is meant to provide general information only. Sun Life Assurance Company of Canada does not provide legal, accounting, taxation, or other professional advice. Please seek advice from a qualified professional, including a thorough examination of your specific legal, accounting and tax situation. The values and rates presented are not guaranteed.