Canadian Finance Blog

Posted: 11 Sep 2010 02:00 AM PDT

The following excerpt is from 10 Things I Wish Someone Had Told Me About Retirement, which teaches ten planning principles that incorporate investment planning, risk management and estate planning.

For most of our lives, we go to work and earn a paycheque. What happens in retirement when we stop working? Where will our income come from? There are the eight possible paycheques a retiree could receive in retirement. Most people will get at least one of these paycheques and many will get more than one. The most financially secure retirees will get income from multiple sources.

1. Pension Plans – If you have a pension plan, you already have a head start at replacing some of your working income in retirement. About 40% of Canadians who are still working participate in a pension plan, and 56% of retirees collect a paycheque from a pension plan. For these people, pensions will form the foundation of their retirement income. The value of a pension lies in the fact that the saving was achieved by employee and employer contributions. In effect, the individual was saving twice as quickly for retirement. In contrast, those who are not in pension plans would need to save the capital using their Registered Retirement Savings Plan (RRSP) room or other non-registered savings. Either form of savings can be converted to a fixed income or pension at retirement. For example, a 65-year-old couple without pensions would need to save about $200,000 of their own capital in order to create a fixed income (or pension) of $1,000 per month.

2. Canada Pension Plan – This is one of two paycheques that will come from the government. The amount you get from CPP depends on how much and how often you put money into the Canada Pension Plan based on your employment earnings. For 2010, the maximum payment you can get from CPP is $934.17 a month, or $11,210.04 a year. These figures apply if you take the income beginning at age 65. You can, however, take CPP as early as age 60 at a reduced rate. Not everyone is eligible for the maximum. Canada Pension reports that the average monthly CPP payment at 65 was $501.32 (2009). The difference can be due to lower average career earnings, late entry into the workforce or reduced payments due to early retirement. If you are interested in determining your own estimate of your CPP payments, call 1-800-277-9914 and press zero when prompted to talk to an operator. Canada Pension Plan is regularly reviewed and changed, if needed, to ensure that all Canadians can benefit at retirement.

3. Old Age Security – The second paycheque from the government is Old Age Security. It is a program that is funded out of general tax revenue. As a result, 99% of all retirees collect some amount of OAS. The benefit is based primarily on years of residency in Canada. Back in 1952, when OAS was started, it paid $40 a month, and payments began when the recipient reached age 70(Incidentally, average life expectancy back then was 67). In 2010, the maximum OAS payment is $516.96 a month, and recipients must be age 65 or older to collect. The average payment to a 65-year-old in 2009 was $498.53. There is no provision to take it any earlier than age 65. Other components of the OAS program include the Guaranteed Income Supplement and the Allowance for low-income earners. These supplementary benefits are affected by other sources of income and are recovered on the first dollar earned after Old Age Security is taken as income. For those who did not contribute to pension plans or CPP and arrive at retirement with no other income, the Guaranteed Income Supplement is an important element in providing Canadians with enough money for their basic lifestyles.

OAS Recovery (Clawback) – You may be aware that Old Age Security is subject to an annual income test based on Line 150 of your tax return. Line 150 includes all income before any adjustments. The test, conducted by the Canada Revenue Agency on each senior’s tax return, measures the amount of gross income over a specific threshold. In 2010, the threshold will begin at $66,733 of personal income. When income exceeds the threshold, the government introduces a reduction in the Old Age Security payment that begins on July 1 and ends June 30 of the following year. In effect, the reduction is an additional tax (or surtax) equal to 15% of each dollar earned over the threshold and is withheld from the Old Age Security payment in 12 equal instalments.

4. Other Pensions – Thousands of Canadians have pension funds on deposit with pension plans but have lost track of their contributions. This situation occurs when an employee terminates, leaves contributions on deposit and never approaches the plan for further information. In addition to pensions from a previous employer, you might have a potential pension at retirement if you were part of a military or police service, from an old insurance policy that provided annuity income at a specific age, survivor benefits from CPP if you survived your spouse, or foreign pension income if you worked and contributed to social security benefits in a different country for a qualified period of time. The bottom line is that no one is going to tell you about these forms of income unless you go looking. If your circumstances are uncertain, it may be worthwhile to dig a little.

5. Employment Income – A recent trend among older people is a return to work. Some retirees are starting their own businesses, consulting for their previous employers or working part-time. While those without pension income may work in retirement for the money, others work and earn income because they are bored or just want to keep busy. With studies showing that retirees today are more healthy and active than ever, it is not surprising that they would choose to work, if the opportunity presented itself. Economic pressures and social attitudes toward older workers prevented previous generations from re-employment. Today, working in retirement is very much accepted.

6. Self-Employment Income – There are two ways to work in retirement. You can work for yourself or you can work for someone else. There are some key differences between the two, which is why we break income from work into these two categories. There are two key benefits when you work for yourself – the ability to reduce tax on income earned in business, farm or rental by the legitimate expenses used to earn that income, and the freedom to engage in work at will. That freedom can be very nice but a concern with self-employment is that paycheques are difficult to plan. Alternately, while working for someone else may not sound as glamorous, at least you know you will get paid for the work you do.

7. Non-RRSP Investments – You can create another source of income if you have investments outside of an RRSP. Such investments might include savings, bonds, stocks or investment property. Any asset that you own outside of RRSPs may fall into this category. The income created from such investments might include interest, dividends and capital gains. Non-registered investments can be a good source of tax- efficient income since you don’t have to pay tax on your original capital. Funds withdrawn from an RRSP are taxed as income as you draw them out. Do not include your personal residences in this category unless you intend to create income by sharing space (i.e. room and board). You will always need a place to live, and to liquidate your house to supplement income is usually a last resort. In 2009, the Government of Canada introduced Tax-Free Savings Accounts (TFSAs). The capital contributed to the account is already tax paid. The advantage to a retiree is that the income earned will never be taxed on withdrawal. It is important to note that, at the moment, TFSAs are not income vehicles. Rather, they are accounts where you would withdraw funds as needed and replace those funds in the account according to rules.

8. Registered Retirement Savings Plans – Unfortunately government programs do not provide enough benefits to support most people fully in retirement. If you do not have a pension plan, you may need to utilize RRSPs as one of the best ways to save for retirement. While you work, you reduce your immediate tax by the amount of the allowable contribution and defer that tax owing until the funds are withdrawn. The trick in the planning is to find the point in your life when funds withdrawn from an RRSP can be taxed at a lower rate. At that point, an RRSP provides a tremendous amount of flexibility. You can convert it to a Registered Retirement Income Fund (RRIF) or an annuity to create a regular stream of income. The greater the value of your RRSP, the more potential income you will have at retirement.

This book was written by three three of Canada's foremost retirement and life educators – Rein Selles, Jim Yih and Tricia French. To buy the book, visit his website www.WealthWebGurus.com or through Amazon.ca.

Life Insurance Blog

Canadian Finance Blog

Canadian Finance Blog

0 Comments:

Post a Comment

Previous Posts