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?
Posted by Tim Stobbs on September 22, 2015
Okay, are you sick of this never ending federal election campaign in Canada? Goodness knows I am already. Yet perhaps the single thing that is pissing me off the most during this campaign is the idea of ‘let’s blame the rich’ theme. Or really more actually I’m not terribly impressed that a few of the proposals out there are to roll back the latest TFSA limit increase since ‘only the rich can use them’.
I okay with general idea of fairness. After all no one likes to be screwed over in life and it does make entirely sense to me to have progress tax brackets that increase as income goes up. After all if I am earning more I can easily pay a bit more to help out those that don’t earn much. I don’t consider that unfair, but rather practical.
Yet rolling back the TFSA limit increase because only the rich can use is a damn crappy reason. Um, news flash people…those how have built business, got high paying jobs and actually save some money to get rich…the system wasn’t fair to begin with.
For example, RRSP contributions are based on last years income up to 18% (to a given maximum), so the reality is that is actually worse for lower income people. Since the more you earn beyond perhaps $40,000 a year it gets easier to save that amount. Meanwhile the TFSA limit is equally to everyone over 18. Even when it means the lower income people can potentially save a MUCH higher percentage of their income as compared to a person making $100,000/year. Case in point the $10,000 limit of $40,000 is 25% of their income, which is WAY higher than the RRSP percentage. Yet for the $100,000 income person the $10,000 TFSA limit is only 10%.
Then when we get to investment gains those that save also get some extra breaks, capital gains are only taxed at half of your marginal tax rate and Canadian dividends also benefit from a significant tax break. The dividends are such a good break that if you earn less than $44,000/year they actually end up being tax free.
The system is built around encouraging people to save and invest, so those that do are rewarded by paying less tax. Fairly simple right? Yet it amazes me that people want to blame the rich. Did you ever consider the fact the ‘rich’ may have started off just like you but rather than spend their money they decided to save it instead. They learned a bit about investing and made ever more money. It was often a hard long road, but after a number of years and the miracle of compound interest they are doing well.
Compared to those at my age and savings I’m likely considered rich or top 20% at least. Yet the money just didn’t appear in my accounts in a puff of smoke…I got a degree and then a good job. Then I saved for a decade straight likely spending less money than you did last year…that is why I have a net worth of over $750,000. So go ahead and take away the TFSA limit increase for all I care…just stop blaming me for your problems and perhaps start to save something yourself.
Posted by Tim Stobbs on September 16, 2015
I was thinking about something the other day that I had trouble putting into words, but now after considering it for a while I’ll take a stab at it. If you were to ask me what is the hardest part of working to early retirement? I would typically give answers about planning or something else, but personally I find the most difficult thing to deal with is the waiting game. You know you are leaving work in “X” months, “Y” days and 34 minutes…not exactly, but you get the idea.
Now for years that “X” was such a large number I was effectively been able to ignore it, yet recently when it dropped under the 24 month mark my brain suddenly realized…oh my god….it will soon be here. I can’t tell you how weird it was to finally be able to feel the fact I am now playing the waiting game. All the savings plans are done, the transfers are good to go and I just have to check in once in a while to adjust things but generally speaking the money side of the house is on automatic mode. Yet the feeling of being close to freedom is so hard to wrap my head around that I ended up like obsessing about it for a week.
This of course made me realize that I just can’t obsess about it for two years…hello I still need to live life in the meantime. So what the hell do you do when you have already done a huge amount of planning towards something and now you are just killing time until it arrives? Well this is where I realized I needed to reassess a few things in my life and start making some changes.
For example, it occurs to me now that I don’t have to care what anyone thinks of me at work anymore. I don’t particularly give a damn if I have a horrible performance review. I’ve always been fairly ‘don’t care what others think’ mode at work but I suddenly realized how badly I can crank up that feeling if I so desire. For example, I can get lazy as hell do the bare minimum not to get fired go through a bad performance review and then get put on a plan to bring my performance back up for a year and then screw around with that just long enough to reach my goal. I can easily string that out long enough to just leave at the end and still be getting a pay cheque. Unlike most of the people of my company I have actually read the HR polices and understand them so I could play that game for a while if I so desired. This effective means I could: stop turning on my alarm and show up whenever the hell I please each morning, ignore direct orders for things by dragging my feet on projects I don’t want or generally turn into that co-worker every hates. Please note: I don’t plan to do this…after all I don’t want to turn into a a total ass; I’m just realizing my scope of freedom just got way wider. I don’t need a raise anymore or a bonus to finish my savings plan.
I can stress how weird it is to actually feel this and know it. I’ve understood on a basic level for a while that I’m never getting a promotion again (hell I told them not to bother), but now I feel the idea that I don’t have to kiss up to anyone ever again around here. There is no gain in it for me anymore. I realize that losing my job would in effect be an inconvenience. I won’t be worried about it, but rather annoyed I would have to update my resume and plan the interview game again.
Yet of course this isn’t a positive way to deal with all that emotion so instead I’m starting to funnel that energy into other more productive things like:
- Working out exactly how to take out my money from various accounts in retirement the most tax efficient way possible.
- Considering alternatives for income sooner than later. Like working more on turning some of my writing into some finished books. Did I want to consider starting a small consulting business? Also considering jobs where I would like to work part-time for a while as a transition out of the workplace (and provide some buffer to my plan).
- Make a better effort to hang out with family & friends a bit more.
- Finding good books to read.
- Evaluating my habits and where I should being doing less of some things and more of others.
In short, building a better life so when the clock runs out at my full time work I’ll be out of the gate and hitting the ground running in retirement. So retirees…how did you spend you last few years while the clock ran out? Any tips to share?