Retirement on a low income

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Retirement on a low income is often defined as qualifying for the Guaranteed Income Supplement (GIS).[1][2] About a third of people who get Old Age Security are eligible for the GIS, representing about 2 million Canadians that are retired on a low income.[3] Millions more are younger than retirement age and can engage in retirement planning, despite their low incomes.

Retiring on a low income is quite different than for higher income people in terms of saving strategies before retirement, of sources of income during retirement, and so on. Much of the "conventional wisdom" and mainstream financial advice is wrong or partly wrong for low-income people.[1][2]

"It’s almost as if potential low-income retirees live in a different world, where their situation is the polar opposite to what is faced by most retirees".
— John Stapleton, Open Policy Ontario[4]

This article gives on overview of the typical main sources of income for low-income seniors, presents the most appropriate savings vehicles and those to avoid (before retirement), mentions tax-reduction opportunities, and ways of unlocking home equity.

Main income sources during retirement

Government programs

The main sources of retirement income for low-income seniors are typically government programs like OAS and the GIS. Those are available starting at age 65, and one must ask for OAS to also get the GIS. The OAS program also offers an "allowance" for spouses or common-law partners of pensioners who receive GIS who are aged 60 to 64. Finally, an allowance is available for widowed spouses or common-law partners who are aged 60 to 64.

GIS clawback

Because GIS is a poverty-reducing measure, GIS clawback rates are in the 50-75% range.[5] This means that low-income seniors can have very high marginal effective tax rates (METRs), which include regular income taxes and the GIS clawback.

Income higher than before retirement?

When the Canada Pension Plan (CPP) or Québec Pension Plan (QPP) retirement benefits are added, it is possible that a low-income senior will earn more during retirement than before[1], i.e. their Income replacement rate could be greater than 100% or close to 100%. Mainstream advice assume people earn less when they retire.

This means that low income seniors may be exposed to more taxation than the same people before retirement.[1] This is why the pre-retirement advice for low-income people is so different.

Savings vehicles and tax reduction opportunities, before retirement

Prioritize TFSAs

Before retirement, saving in a Tax-Free Savings Account (TFSA) is a much better idea than using a Registered Retirement Savings Plan for people on low incomes.[1] This is because TFSA withdrawals after retirement do not affect GIS and do not constitute taxable income.[2] RRSP or Registered Retirement Income Fund (RRIF) withdrawals, in contrast, are taxable income and can lead to GIS clawbacks.

RRSP withdrawals

So if a RRSP has been accumulated, it might make sense to progressively reduce it (and transfer the amounts left after tax to a TFSA if possible) over the 5-10 years before age 64 (GIS benefits at age 65 are based on income at age 64).[6]

See this calculator to check if this applies to you.

Capital gains

Similarly, crystallizing capital gains in non-registered investment accounts before retirement might be considered.[6] Again the idea is that the pre-retirement action causes short-term pain (taxes) but helps avoids the GIS clawback that could be caused by triggering capital gains after retirement.

Taking CPP/QPP early

With the same logic of maximizing GIS, it might be relevant to think about taking CPP/QPP early, at age 60 rather than age 65 or 70.[1][7] Taking CPP/QPP early means a lower monthly pension than taking it at the normal age of 65, but the retiree gets this pension sooner, and might obtain more GIS after age 65.

This does not apply to people on social assistance or disability however.[1]

RRSP contributions after retirement

Although TFSAs are clearly superior to RRSPs before retirement, small RRSP contributions can be useful between the ages of 65 and 71 for low-income seniors. This is a more advanced strategy that requires careful planning.

Maximizing GIS

GIS recipients that have a bit of other income, such as CPP/QPP, see GIS clawbacks at 50-75% rates. Making RRSP contributions after retirement would reduce their income for GIS eligibility calculations. The money for these RRSP contributions could ideally come from a TFSA or non-registered account, and just enough should be contributed to the RRSP to maximize GIS every year.[8] Then at age 71, instead of turning the RRSP into a RRIF, the retiree would withdraw the entire RRSP balance, pay the tax due, and put back what's left in the TFSA, if room is available. Although no GIS would be paid at age 72 (the following year), and extra taxes have been paid along the way, the strategy is still cash flow positive over the full age 65-72 period, because GIS has been maximized.[8]

Getting some or more GIS

OAS recipients with incomes beyond the GIS clawback zone, or within it, could also consider making RRSP contributions between the ages of 65 and 71.[1] This will give them access to some, or more, GIS. The easiest case to understand is for somebody with retirement income just above the GIS clawback zone. If they make no RRSP contributions between ages 65-71, they will get no GIS, and the same applies afterwards. Wheareas if they do make RRSP contributions after retirement, they will get some GIS for several years; they will pay more taxes down the road due to eventual RRSP or RRIF withdrawals, but "far less than the extra funds" obtained.[1]

Home ownership as an income source

If a low-income senior owns a home, and needs additional cash flow, unlocking some of the equity in that home may help.[9] Ways to do that include downsizing the home to free-up capital; selling and renting; or using a HELOC or a reverse mortgage.

GIS recipients

[citation needed]

If eligible for GIS it is generally preferable to own than rent as a GIS recipient’s housing costs will typically be reduced, allowing for more margin in their other spending. Moreover if selling their home in order to rent, it is likely the proceeds won’t entirely be sheltered in their TFSA and the resulting investment income on the unsheltered part of the proceeds will reduce their GIS entitlement going forward. Earning less income while spending less on housing is preferable to having more income and higher expenses as a GIS recipient. The implied rent that is not paid by owning their home can’t be taxed or used in the calculation of their GIS entitlement. There is an inherent advantage in owning a paid off home versus renting when receiving GIS.[10]

Downsizing allows the cashing out of some home equity while allowing for lower housing cost, without direct impact on GIS entitlement if the proceeds can be sheltered in a TFSA. If downsizing is not an option then a HELOC or reverse mortgages could be considered. They also don’t increase taxable income and therefore don’t impact GIS while maintaining lower housing costs than in the rental scenario.

See also

References

  1. ^ a b c d e f g h i Open Policy Ontario, Low income retirement planning booklet July 2022, viewed January 7, 2023 (Open Policy Ontario is a social policy consultancy).
  2. ^ a b c Alexandra McQueen, Retiring on a Low Income: Three (Big) Challenges Canadians Face, Canadian MoneySaver, February 2019 edition, viewed January 7, 2023.
  3. ^ Employment and Social Development Canada, Evaluation of the Guaranteed Income Supplement - phase 1 summary report, January 2019, viewed Jaunary 8, 2023.
  4. ^ Ellen Roseman, How to plan for retirement on a low income, Toronto Star, updated February 6, 2014, viewed January 7, 2023.
  5. ^ Alexandre Laurin and Finn Poschmann, Who Loses Most? The Impact of Taxes and Transfers on Retirement Incomes, CD Howe Institute, November 13, 2014, viewed January 8, 2023.
  6. ^ a b Owen Winkelmolen (a financial planner), Low Income Retirement Planning, viewed January 7, 2023.
  7. ^ Alexandre Laurin, Kevin Milligan and Tammy Schirle, 2012, Comparing Nest Eggs: How CPP Reform Affects Retirement Choices, CD Howe Institute, Commentary 352, viewed January 8, 2023.
  8. ^ a b Owen Winkelmolen, How RRSP Contributions Affect Your Government Benefits, undated but first blog post comment in 2021; viewed January 8, 2023.
  9. ^ Jason Heath, Planning for retirement with little or no savings to draw on, MonseySense, October 26, 2022.
  10. ^ Owen Winkelmolen, Two (Less Obvious) Financial Benefits Of Owning A Home, undated, viewed July 1, 2023.

Further reading

External links

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