Your retirement situation

Do you know your RRSP contribution limit for this year?

Every year, the government allows you to contribute 18% of your "earned income" for the prior year to an RRSP, up to a maximum amount for the current year less your pension adjustment (PA), if you participate in your employer's retirement plan. Unused amounts cumulate and remain available. This is what we call unused deductions. What's more, it is possible to defer the deduction on a contribution you made to your RRSP. This is called unused contributions. Your federal notice of assessment provides you with the following information:

• Your "2022 RRSP deduction limit" represents the maximum amount you can deduct in your tax return for 2022.
• Your "available contribution room for 2022" represents the maximum amount you can contribute to your RRSP in 2022.

It is important to distinguish between these 2 amounts to avoid overcontributions and the penalties they could generate.

RRSP contribution chart

If you do not participate in your employer's retirement plan, to have the right to contribute the $29,210 maximum to your RRSP for 2022, you will have to report earned income of $162,278 in your 2021 tax return.

"Earned income" is made up of employment income for salaried workers, net business income for self-employed workers, net rental income and taxable support payments.

Retirement benefits (private plan, QPP, OAS, life annuity purchased with a RRSP), dividends received by a business owner from his company, employment insurance benefits and investment income (interest, capital gain and dividends) do not constitute "earned income" and do not generate RRSP contribution rights.

When you contribute to an RRSP, your tax savings is based on your marginal tax rate. It is possible to contribute to an RRSP and defer the deduction to a future year, for example if your taxable income for the year would not be high enough to allow for significant tax savings. These undeducted RRSP contributions are identified in your notice of assessment under the heading "Unused RRSP contributions previously reported and available to deduct for 2022". Your "2022 RRSP deduction limit" minus your "Unused RRSP contributions previously reported and available to deduct for 2022" indicates how much you can contribute (your contribution room for 2022). If this amount is negative, you have no contribution room for 2022 and you may have made excess contributions.

The government permits surplus contributions of $2,000. You may have to pay penalties on any surplus over this amount (1% per month).

Have you evaluated your projected annual cost of living in retirement?

There are several ways to evaluate your cost of living in retirement.

The 70% rule

This rule stipulates that replacing 70% of your gross pre-retirement income should be enough to maintain the same standard of living. For example, annual retirement income of $35,000 will allow the retiree whose final salary was $50,000 to maintain the same standard of living in retirement. This rule has the benefit of being widely known on the market and by individuals, but it does not take into consideration the desired level of income or type of retirement. Still, it is a good starting point for discussion and reflection. In the long run, the results determined by this rule will benefit from further clarification once the retirement plans are clarified.

Tax approach

This approach seeks to maintain the same net income for the individual after retirement. The gross income required to maintain this net income is determined. This approach relies on the automatic disappearance of certain expenses, such as payroll deductions and retirement savings, and indiscriminately maintains all the others. This approach ignores the fact that many expenses may be reduced in retirement, such as:

• End of mortgage payments coinciding with retirement (be careful: if the mortgage is closed more than a year before retirement, you cannot necessarily consider this reduction, because between the end of the mortgage payments and retirement, it is likely that this sum of money was assigned elsewhere)
• Sale of a secondary residence
• Sale of one of the cars on retirement
• End or marked reduction of expenses related to children (end of studies, for example)
• End of expenses related to dependent parents (it is hard to predict this scenario accurately)

This approach tends to result in replacement income needs of more than 70%, especially for high earners.

Budget approach

This approach requires you to prepare a current budget, or at least a pre-retirement budget, and then to determine whether each material expense will be affected by retirement, either upward or downward. This approach takes a lot more work and requires more precision and detail, but when it is done well, it is far more accurate than the tax approach.

Do you know what your sources of income will be in retirement? Will that income be sufficient to support the lifestyle you want?

The main sources of retirement income are government plans (that is, Old Age Security and the QPP), RRSPs and private pension plans. Income from non-registered investments, rental income or part-time work can also be added. We will now briefly describe the government plans. Pension plans are described in another question.

Old Age Security (OAS) Pension

The federal Old Age Security program provides benefits to seniors in Canada. These benefits are not related to the pursuance of income-generating activities during the working lifetime. Access to OAS benefits, and their amount, depends on age and, in certain cases, on individual or family income.

People aged 65 and older who reside in Canada and are Canadian citizens or legal residents may be eligible. The monthly amount is the same for everyone, but those with a high net income must repay part or their entire OAS pension. People who have not resided in Canada long enough may get a partial pension.

As of January 1, 2022, the full Old Age Security pension is $642.25 a month or $7,707.00 a year. This amount is adjusted every 3 months to compensate for cost of living increases.

As of July 2013, people aged 65 may decide to defer receiving their OAS pension for up to 60 months, until they reach 70 years old. The monthly pension payment is increased by 0.6% for each month of deferral, up to a maximum of 36%. For example, Michel turned 65 in December 2021 and intends on waiting 4 years before applying for his OAS pension, which he wants to start receiving as of January 2026. He will be entitled to a 28.8% increase (0.6% x 48 months). If Michel is entitled to $642.25 per month, his increased monthly payment will be $827.22 (or $9,926.62 yearly), which means $2,219.62 more per year (in today's dollars).

As of July 2022, the pension amount increases by 10% when the pensioner reaches age 75. This increase is applied to the amount received, so the amount is greater when the pension has been deferred.

QPP

The Quebec Pension Plan (QPP) is a compulsory public plan for all Quebec workers (employees and self-employed workers) to provide them with basic financial protection. With the implementation of an additional plan, the QPP is now comprised of two plans: the base plan (current plan) and the additional plan.

The base plan aims to provide a retirement pension at age 65 equal to 25% of the contributor’s average pensionable earnings (indexed) on which contributions were paid during the contribution period. The base plan's contribution period starts at 18 years of age (or 1966, for those who were already 18 years old at that time) and ends the month before the pension begins, no later than the month preceding the contributor’s 70^th birthday.

The additional plan will be implemented in two stages, each taking effect gradually. The first stage, which starts January 1, 2019, introduces an additional pension equivalent to 8.33% of the Maximum Pensionable Earnings. The second stage starts January 1, 2024 and will increase the income replacement rate by 33.33% of an additional portion of pensionable earnings (14% of the Maximum Pensionable Earnings). Of course, the additional plan means additional contributions. If you are only a few years from retiring, these enhancements will have little or no effect on your QPP retirement pension. The QPP enhancements will be felt very gradually (1/40 per year) and will reach their peak for contributors who will retire in 2065, at age 65. Here are a few examples to illustrate (in today’s dollars):

Lise turned 60 on January 1, 2022. If she continues to earn more than the Additional Maximum Pensionable Earnings until she is 65, she will be entitled to a pension of about $882 per year from the additional plan, calculated with the parameter for 2022.

Valérie turned 44 on January 1, 2022. If she continues to earn more than the Additional Maximum Pensionable Earnings until she is 65, she will be entitled to a pension of about $3,853 per year from the additional plan, calculated with the parameter for 2022.

Although the normal age to start receiving the QPP retirement pension (both the base and the additional) is 65, it is possible to start receiving it at age 60 or to defer it until age 70. The pension is increased by 0.7% for each month of deferral after the age of 65, but it is reduced by 0.5% to 0.6% (depending on the amount of pension) for each month of anticipated pension payments before the age of 65. These are the maximum amounts for people who will receive their retirement pension in January 2022:

• $802.30 monthly starting at age 60, for a total of $9,627.60 per year
• $1,253.59 monthly starting at age 65, for a total of $15,043.08 per year
• $1,780.10 monthly starting at age 70, for a total of $21,361.20 per year

These amounts are indexed in January each year, to compensate for cost of living increases.

According to QPP statistics (document in French, table 34) on people who started receiving their pension in 2020, only 4.8% of men and 0.9% of women receive the maximum pension amount, and 22.8% of men and 13.3% of women receive 90% to 99% of the maximum pention amount.

You can check your QPP Statement of Participation online to see the amounts that you could receive when you retire.

Many factors come into play when deciding at what age you should apply for your QPP pension, such as your financial situation, your health and your contribution period.

RRSP

An RRSP lets you save money tax-sheltered during your working life. At retirement, you use the money saved to finance your needs.

Pension plans

There are several types of pension plans offered by employers. A defined benefit pension plan is a plan that determines in advance how much you will receive at the time of retirement. A defined contribution pension plan is a plan where the contributions paid by the employer and the employee are determined in advance. Unlike defined benefit plans, the amount of the pension payment is based on the accrued employer and employee contributions and the return achieved by the plan.

Other sources of income

You may also obviously have other sources of retirement savings – money saved in non-registered investments or in a TFSA, rental income or money from a holding company.

Do you belong to an RPP? What are its characteristics?

A registered pension plan (RPP) is a private pension plan offered by an employer. There are two main types of RPPs.

Defined benefit

A defined benefit plan pays a retirement pension for which the amount is set in advance, generally based on a percentage of the salary and the number of years of membership in the plan. For example, the plan could be that starting at age 65, the pension annuity will be 2% times the number of years of membership, times the average of the annual salaries in the last 5 years. This type of plan is financed by employee contributions, often set in advance, and by employer contributions. The employer contributions will have to be enough to live up to the plan’s commitments, that is, finance the promised pensions.

There are several terms and conditions, such as early retirement with or without reduction, indexation, benefits payable on death and benefits in the event of termination of employment. The conditions can vary significantly from one plan to another, so it is important to read your statement carefully and make sure you understand what you are entitled to.

Defined contribution

A defined contribution plan determines in advance the contributions made by the employer and the employee. Unlike defined benefit plans, the amount of the pension annuity depends on the contributions (employer and employee) accumulated on behalf of the participant and the return earned by the fund. The employees choose their own investments based on their own investor profile and risk tolerance.The Simplified Pension Plan (SPP) is a lighter version for the employer and is administered by a financial institution.

Group RRSPs, deferred profit-sharing plans (DPSPs) and Voluntary Retirement Savings Plans (VRSPs) are other ways for employers to help fund their employees' retirement. These too are capital accumulation plans and it is important to know that the choice of investments is in your hands. This is where your financial planner can help.

Will this income be enough to maintain the lifestyle you want?

Once you have identified and quantified all your sources of retirement income, you need to determine whether this income will be enough to maintain your expected cost of living at retirement, for the rest of your life.

Other factors have an important impact on your income and your cost of living. Investment returns, inevitable taxes, inflation, and life expectancy are all factors that have a major influence on the feasibility of your retirement project. For this purpose, every year the Institute of Financial Planning publishes a set of Projection Assumption Standards, as a tool for financial planners. These standards offer assumptions that can be used for long-term planning in order to make retirement projections or assess other financial needs. Returns for different asset classes and survival probability projections are included.

Take the time to analyse your financial situation thoroughly before you set your retirement date. Ask a financial planner for help to make the right choice. A financial planner can guide you through the retirement planning process.

Do you know about the various income splitting strategies in retirement?

Over the years, a number of measures have emerged to help reduce the tax burden in retirement.

Spousal RRSP

Contributing to a spousal RRSP is a very good way to split income in retirement.

Your spouse contributes to your RRSP but claims the tax deduction on his or her own tax return, exactly as if the contribution had been to your spouse's RRSP. The contribution reduces your spouse's unused RRSP deduction room, not yours. The money is deposited in your RRSP, which means you will pay the income tax at the time of withdrawal. This is a good strategy if your spouse has a higher earned income than you do right now and you think that your income will also be lower in retirement.

The contribution is a gift – that is, this money now belongs to you. This is important for common law spouses to remember, since the family patrimony rules do not apply to this type of union.

QPP retirement pension splitting

The purpose of splitting the QPP retirement pension is to reduce income taxes by splitting income with the spouse in the lower tax bracket. It consists of a real transfer of income from one spouse to the other.

Only the pension accumulated during the union can be split. It is not necessary for both spouses to have contributed to the QPP. If they did, both spouses will have to receive their pension to split the benefits in equal parts between them, which means they must both be at least 60. When pension splitting is requested, the pensions of both spouses are divided – it is not possible to split only one pension.

QPP splitting is also possible for common law spouses. A joint request will be required, while the request can be made by only one of the spouses for married couples.

The split is terminated at the end of the month in which one of the spouses dies. The surviving spouse will then receive the amount of pension he or she would have received without the split, as well as a surviving spouse’s pension.

Pension splitting

Since the 2007 tax year, Canadian residents can split their pension income with their married or common law spouse who is in a lower tax bracket and reduce the couple's tax bill.

This is a virtual transfer. When they are completing their income tax return, retirees can decide to transfer up to 50% of certain retirement income in the return of the lower-income spouse. For further details, please refer to the question on this issue in the tax section.

There are other income splitting techniques, but only the most common are described here. Speak to your financial planner about the other possibilities.