No one likes paying more taxes than necessary. However, you need to be careful in your quest to minimize your tax bill. In this video, we examine two scenarios: one where you withdraw from your TFSA first and the second where you withdraw from your RRSP. It’s important not to lose sight of the long-term plan.
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The Plan to Keep Taxes Low
Imagine you are 65 years old, receiving CPP and Old Age Security, and you have the following savings:
- $700,000 in RRSPs
- $250,000 in a non-registered account
- $120,000 in a TFSA
Let’s also assume you only need about $3,500 per month to live comfortably in retirement.
With government benefits covering part of your income, you could choose to draw the rest from your TFSA. This keeps your taxable income low, and might even qualify you for extra government benefits like GIS.
Following this strategy, your taxes stay close to zero for the first several years. Taxes do rise once minimum RRIF withdrawals kick in at age 72, but overall, you pay just over $278,000 in total tax during retirement.
Sounds great, right? Maybe not.
A Better Long-Term Strategy
Let’s compare that to a different approach. Instead of prioritizing your TFSA, what if you started withdrawing from your RRSP more aggressively, targeting a taxable income of $71,000 per year?
This strategy results in higher taxes early on, over $362,000 in total before factoring in your estate, but it reduces your RRSP balance more quickly. By the time you reach the end of your plan, there is little or nothing left in your RRIF to be taxed in your final year.
Now let’s compare the full picture.
The Real Cost of the “Low-Tax” Strategy
In the first scenario, you minimize taxes during your lifetime but still have a large RRIF when you die. That remaining balance is added to your final tax return, which can trigger a tax bill of over $400,000 at death.
All in, you end up paying almost $683,000 in total tax.
In the second scenario, your tax bill during life is a bit higher, but you avoid the large end-of-life tax hit. Your total taxes are around $394,000.
That is a difference of $288,000 in favor of the second approach.
Final Thoughts
Yes, keeping taxes low while you are alive might feel good. But your retirement plan should account for more than just the next year or two. If you have a large RRSP, the most efficient strategy might involve paying more tax now to avoid a much bigger bill later.
If you want to make sure your withdrawals are structured in the most tax-efficient way possible, visit our website and book an appointment with us.
