Posted by Tim Stobbs on September 30, 2015
Of course the title of this post is misleading…of course I pay some tax right now…actually a LOT of tax when you get right down to it. Overall the number shifts around but in the end we pay about 20% income tax after using ever tax credit and deduction we can claim (based on total income for my wife and I – mine being almost all the taxes paid). So when it comes to retirement planning reducing your tax bill can go a very long way to shortening your retirement savings goals. After all if you pay less tax in retirement you need to save less in advance to retire in the first place. So how on earth do you keep your tax rate in retirement hovering around zero? Well that are a few different ways to get close to zero in Canada, but to be honest a zero dollar tax bill is difficult to get down to.
The first one is likely the most straight forward and hard to do depending on your spending. Your basic income tax deduction allows you to pay no tax on the first $11,327 you earn for federal tax in 2015 (I’m going to assume your provincial rate is equal to or higher than that number for this post, but please do check here). So a couple can take in $22,654 in wages and/or RRSP withdrawals and pay no tax on it. So if you are willing to keep to a low spending rate this gets fairly easy to do. Just a note, yes you will pay a withholding tax on an RRSP withdrawal, but it will be refunded when you file taxes the following year if you stay below this limit. Oh, and please note…I’m not including Canada Pension Plan (CPP) deductions in this post since in my mind it isn’t a tax but rather a pension contribution.
Of course, even my spending budget is more than $22,654 so get more money out tax free you next stop will likely be the TFSA. After all this account rocks, you put in after tax money and any growth you take out is tax free. Nice deal, especially for young people who can potentially mainly skip the RRSP and put everything for their retirement dollars in this account. Obviously the draw back here is for older folk who don’t have much savings in these accounts. In our case, my wife and I plan to take out about $6000/year from these accounts during our retirement years. So adding that to the basic deduction amount I can pull out $28,654/year tax free.
Yet that is still slightly short of our target spending of $30,000/year. So am I out of tricks? Of course not, the last particular trick lies in the fact for lower income earners that you can often get dividend income completely tax free. For example, if you clicked on that previous link and checked out Saskatchewan’s marginal tax rates you would have noticed for 2015 the tax rate for eligible dividend income is actually -0.03% for up to $44,028. Yes, the tax credit is actually worth just slightly more than the amount you get (hence the negative rate), so it is possible to get some eligible dividend income tax free. The key here is to know what your particular province allows you to do. For example, Ontario is even richer on the tax credit so while the limit is a bit lower at $40,922 but has a rate of -6.86%. Nice eh? Of course the downside is during your working career you will pay more taxes on this dividend income, but once you drop your income down in retirement you should be paying less.
Now the fine print…this works well in broad theory, but if you play a tax calculator (like these) you might find it doesn’t work out just perfectly. After all if you have some working income during your semi-retirement years you may end up paying some Employment Insurance premiums and CPP contributions. This also tends to break down when you get higher income levels. So once you push past that eligible dividend limit you start paying more taxes. Sorry, that are limits on how well you can play this game.
So have you tested your income plan to see how much tax you will be paying in retirement yet? If not, I would suggest giving it a try. It can be educational. Or if you are retired how low did you get for your income tax bill?