Retirement is a time to enjoy the fruits of your labor. For many Canadians, it also brings a new focus: understanding just how much tax is being paid. The truth is, not all retirement income is taxed the same way. Knowing these differences can help you keep more of your income and make smarter planning decisions.
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The Scenario
Imagine you’re 66 years old, retired, and living in Ontario. You receive $8,560 in Old Age Security and $9,600 in Canada Pension Plan benefits, giving you a base income of $18,100. You want to explore how adding $72,800 in extra income would affect your tax bill—while keeping your total taxable income just under the OAS clawback threshold of $99,995.
Withdrawing from an RRSP
Withdrawing $72,800 from your RRSP means the full amount is added to your taxable income. This brings your total income to $99,997 and results in a tax bill of approximately $19,936. While simple to execute, this strategy is one of the least tax-efficient.
Withdrawing from a RRIF
Using a RRIF instead results in similar taxable income, but these withdrawals qualify for the pension income tax credit. This reduces your tax bill slightly to $18,995, making it marginally more efficient than an RRSP withdrawal.
Triggering a Capital Gain
Selling investments in your non-registered account and realizing a $72,800 capital gain results in only half of that amount being taxable. Your income rises to around $54,500, and your tax bill is significantly lower—approximately $7,363. This makes capital gains more efficient than either RRSP or RRIF withdrawals in this scenario.
Receiving Eligible Dividends
Eligible dividends from Canadian companies are grossed up by 38 percent before being added to your taxable income. Receiving $72,800 in eligible dividends results in a total taxable income of about $118,600—triggering a partial OAS clawback. The combined tax and clawback cost totals around $8,707. While this is more efficient than an RRSP withdrawal, it is less favorable than a capital gain.
Earning Interest or Foreign Dividends
If the $72,800 came from GIC interest or foreign dividends in a non-registered account, the entire amount would be fully taxable. This leads to a high overall tax bill, similar to an RRSP withdrawal, with no available tax credits to offset the impact.
Withdrawing from a TFSA
Withdrawals from a Tax-Free Savings Account (TFSA) are not included in taxable income. In this scenario, you would only report your OAS and CPP, keeping total income low enough to avoid paying any tax. You might even qualify for the Guaranteed Income Supplement. This is the most tax-efficient option in the short term.
The Big Picture
While TFSA withdrawals offer excellent tax savings today, they are not always the best long-term strategy. Leaving large RRSP or RRIF balances untouched can lead to significant tax consequences later in retirement, especially at death.
Comprehensive retirement planning should consider your entire retirement timeline, balancing today’s tax efficiency with future obligations.
Final Thoughts
Understanding how different types of income are taxed in retirement can help you reduce your lifetime tax burden, increase your after-tax income, and make more informed withdrawal decisions. The right strategy depends on your unique situation, goals, and timing.
