Normally, being a public employee with a decent-ish DB pension plan, I would say it's not ideal to contribute to RRSPs first. After the RRIF post, you can see how a fully taxable pension income and massive RRSP income is a recipe for tax disaster.
After the Pension Adjustment, I would be able to contribute a maximum of about $6,000 a year in my personal RRSP. If I do that from the time I'm 25 until I'm 65, I've got a $1,000,000 personal RRSP account that will generate $50,000 a year until I die.
Then add in my pension of $75,000+ after 40 years of service to my community and I'm getting taxed at some ugly rates. After all sanity lost during 40 years of this work, I'm grimly staring at OAS clawbacks, big mandatory RRIF withdrawals when I turn 71, and huge tax bills.
Fortunately there's another way. If my spending is low I can still max my RRSPs (and TFSAs of course), collect the juicy tax return at higher rates now, and pay super low tax rates on withdrawals later.
Enter early retirement...
Cutting That Tax Bill Way Down
Early retirement to me means retiring before the age of 60. At 60 years old we can collect CPP payments and other seniors benefits—so not really special to me. When you retire before 60, you must be able to live off your investments because nothing else is coming in.
This also means you have full control over your tax situation and can use this time to deplete your RRSP at relatively low tax rates. If your RRSP withdrawals are under $25,000 per year, your effective tax rate is around 10%. Add in some Canadian dividend income from your Cash/Margin Account and your tax bill can actually be reduced in many provinces!
Let's pretend I'm single, earn a flat $100,000, live in BC, and don't contribute to a pension plan. I spend $40,000 a year. At my salary level, I can contribute 18% of my gross income to my RRSP, plus $5,500 to my TFSA, plus $16,500 to my Cash/Margin Account.
As soon as I meet the 30x Rule, I am going to pull the plug. If I invest in a Growth/Balanced Portfolio (around 6% annual returns after inflation) over all those years, it's going to take me 18 years to save enough for retirement. I start saving at 27 years old so I retire from work at 45 years old.
At 45 years old, my RRSP will be worth $581,000, my TFSA will be worth $177,400, and my Cash/Margin will be worth $480,200 for a total combined value of $1,238,600. At 30x this will generate $41,266 in safe income each year. We'll estimate my Cash/Margin account holds ETFs which pay $14,000 in Canadian dividend income each year.
In B.C., I pay negative tax rates on the Canadian dividends up to $45,900 total income. I want to deplete my RRSPs first, so I will set up my account to withdraw $26,000 annually from my RRSP ($40,000 spending - $14000 dividend income). On this income, I will pay just $2,165 a year in tax (5.4% blended rate).
To cover the tax liability and maintain my $40,000 spending level, I can withdraw some money from my Cash/Margin account and realize some Capital Gains Income which is likely to be very minimal as gains only make up about one-third of each withdrawal (the other two-thirds is taking my contribution back).
By using this strategy, I was able to benefit from a 35% tax return on my RRSP contributions while paying just 6% tax on withdrawals later. A huge tax savings!
During my working years, I reinvested the $6,320 tax refund. This sped up my retirement by about 2 years—or more than 10% thanks only to tax savings.
Again, it's even more efficient when you're married or common-law as you can set up a Personal and Spousal RRSP to split income very evenly and keep taxable income low. You also benefit from contributing to two TFSA accounts instead of one.
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