Debt & Taxes

Written by Doug Dahmer  |  April 19, 2016

For nearly 25 years I have been working with clients to help them maximize the life span and utility of their financial resources. I suspect you are tired of hearing it, but let me state the obvious, and then add a caveat. The obvious: It starts with a lot of early preparation. The caveat: This preparation must be guided by those who truly understand the differences between accumulating money and living off that money.

Those who specialize in helping those in their spending years understand that the key to success is to get people consciously engaged in what they want the second half of their life to look like. In other words, 1) what do you want to do? 2) When do you want to do it? and 3) How big do you want to do it?

This forward knowledge is like the picture on the box top of a jigsaw puzzle: an indispensable tool to successfully connect the pieces of the puzzle to create the conclusion you desire. Knowing well in advance how much our clients’ need, and when they will need it, provides the cash flow patterns that enable us to develop the optimum drawdown plan. This is a year-by-year prescription specifying how much cash to withdraw and which asset portfolios (RRSP, OPEN, TFSA, Corp Holding Acct) to source it from.

As a Retirement Income Specialist, I am particularly interested in the variability of future annual cash flow needs. How in some years the trip, or new car or assisting with a grandchild’s education requires substantial additional lump sum cash contributions. Successful tax planning starts by embracing the annual fluctuations in our demand for cash flow and rejecting the common premise that life after work can be funded by a consistent annual cash flow. This is important because it is in the valleys of the lower spend years, between the years of peak cash flow demand, that we find the greatest tax saving opportunities. Put another way – it is the forward preparation for future high cash flow demand years that allows us to avoid the tax traps.

The goal of tax planning strategies as you approach and enter your drawdown years is very different from those of your saving years.  Those who succeed, from a tax perspective, stop the relentless tax deferral on a year-by-year basis, which was the prevalent strategy during their accumulation years. Instead, they prepare themselves to avoid future tax traps and minimize the taxes paid over the balance of their lives. This often means going against the grain and paying more taxes in earlier years, to avoid paying substantially more taxes in later years.

We design our annual cash flow sourcing models to properly integrate with the ideal time for you to start collecting your government retirement benefits (CPP and OAS). Mess up on when to start collecting these benefits and you will miss out on a huge amount of the money you are otherwise entitled to.  (see for more information)

My clients are pretty well organized and have grown tax aware over time. I encourage them to play our online ‘Retirement Tax Game’ until the light goes on and I hear them say, “Oh, I get it now.” Once they get the basics of tax minimization, they have set themselves up to extend the life and size of their retirement assets and build sustainable retirement income for life.

Through all this, one of the least understood and utilized tools in tax management is the deployment of short-term debt, most often in the form of a ‘Secured Line of Credit’. Most people in their retirement years believe that debt is something to get out of, not into.  I counter that debt can be used as a powerful, wonderfully flexible, strategic tool to significantly reduce your income tax.

The use of short-term debt is a primary Rx to avoid tax traps created by bringing too much money into your taxable income in a given year.  When you are restricted to RRSP investments as your primary, flexible source of cash flow, debt can be used to spread out the withdrawals keeping taxable income below OAS claw back lines or even worse entering into higher marginal tax brackets. It is the lump sum purchases where this tactic is most beneficial such as car purchases or major renovations like a new roof, new windows, or furnace. And don’t forget those large ticket vacations on your bucket list like a trip to Australia/ New Zealand or an African Safari.

If these lump sums are to be funded all in one year from cash flow sourced from RRSPs or RRIFs – anticipate paying far more in taxes than would otherwise be necessary. In general, I suggest that you would be far better off to pay 2.5% to 3.5% in interest payments for a few years than be forced into a 41% marginal tax bracket from a 32% rate – and not to mention the 15% claw back of your old age security.

This is the kind of added value a trained Retirement Income Specialist brings to the table. There are hundreds of thousands of dollars to be saved or lost over your lifetime. Forward planning based upon informed guidance can definitely have profitable outcomes.

Plan poorly and I guarantee you will pay for it.

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