Given the complexity of retirement income, clients can find themselves caught in tax traps.Feodora Chiosea/iStockPhoto / Getty Images
The deadline for filing taxes in Canada for 2026 is April 30. As the big day approaches, Globe Advisor and Globe Investor have teamed up to offer advice on how to maximize returns, find credits and avoid an audit. The full series can be found here.
It’s a big change when clients shift from accumulating wealth while working to unwinding savings for use in retirement.
There’s no standard playbook where advisors can say, “Everybody should do this,” says Daryl Diamond, chief retirement income strategist with Dynamic Funds and author of Your Retirement Income Blueprint.
“It really depends on what clients are trying to do with their retirement and what income sources they have to work with,” he adds.
Some clients have a half-dozen sources from which to build retirement income, he says, and each of those can have “unique features, rules and restrictions.”
Given the complexity, clients can find themselves caught in these retirement income tax traps.
Delaying taxable sources for too long
Many clients delay drawing upon registered retirement savings plans (RRSPs) to preserve capital for later in life.
“While paying less taxes in the early years of retirement may feel like a windfall, that may create larger income and tax problems down the road,” says Doug Nelson, senior wealth advisor and co-lead of Precision Wealth Family Office in Winnipeg.
Mr. Nelson says these clients risk having significantly higher income from taxable sources – such as registered retirement income funds (RRIFs), Canada Pension Plan and Old Age Security – later in life, resulting in more taxes paid than necessary.
Strategic early withdrawals to just below the next highest tax bracket can help avoid this trap. Money that isn’t required immediately can be deposited into a tax-free savings account (TFSA), creating a pool of tax-free capital for emergencies and large purchases, he adds.
But grinding down registered money early is not always the best strategy, says John Waters, vice-president of tax consulting services at RBC Wealth Management in Toronto.
“It’s a trade-off because you’re losing the tax-deferral benefit of the RRSP, but you’re withdrawing income early to be taxed now, presumably at a lower rate,” he says.
The ideal window for early RRSP withdrawals is between the ages of 65 and 71, he adds.
“But there really needs to be a significant difference in the tax rates, because the tax-deferred growth within the registered accounts is quite beneficial.”
Underfunded TFSAs
Some clients enter retirement with large amounts in taxable registered accounts and pensions after focusing on RRSP contributions to reduce high employment income while working.
But that might have come at the expense of funding the TFSA – a missed opportunity for tax-efficient income flexibility in retirement, Mr. Nelson says.
Withdrawing more RRSP money early to fund the TFSA can be particularly beneficial for couples.
“When one spouse passes away, the other will likely have less total income, but more taxes to pay,” Mr. Nelson says.
In that regard, the TFSA can be the “great equalizer,” he adds.
The estate tax trap
Deferring registered withdrawals can create a large tax bill for the estate. That’s where permanent life insurance may be useful, Mr. Waters says.
As long as the client is still insurable, and premiums are affordable, this strategy allows clients to move capital that would be taxable upon death – or, potentially, while alive – to an insurance product with a tax-free benefit upon death, he says.
Skipping the basics
Mr. Diamond says the best-laid retirement income plan can be thrown asunder if clients are unaware of the basics of its design.
He offers the following example: An advisor gets a call from a client who says, “I need $25,000 after tax.” The advisor asks if it’s an emergency, and the client answers, “No, I just bought a boat.”
Clients don’t need to understand all the details of an income plan, but a basic understanding helps them navigate big spending decisions, and they can consult their advisor before making a large purchase that could lead to paying more taxes than necessary.
That’s another reason to set aside money that can be accessed tax-efficiently, just in case, Mr. Diamond adds.
The ‘unknown knowns’
Advisors don’t always realize what can hurt clients’ plans. One example is not knowing about other sources of capital: do-it-yourself investment accounts, business accounts and locked-in retirement accounts.
“Tax season is a good time to talk to them about planning,” Mr. Waters says, as clients’ finances and taxes are already on their minds.
Regular reviews aimed at full discovery of income sources – including a spouse’s assets – and changes in lifestyle help ensure plans are as tax-efficient as possible.
Mind the clawback
The OAS clawback is a 15-per-cent additional tax that clients often loathe, Mr. Waters says.
He says the “biggest weapon in the arsenal” to avoid clawback is pension income-splitting.
Layering tax-efficient income, such as dividends and capital gains from non-registered investments and TFSAs, can also help avoid exceeding the income threshold for clawback of $95,323 in 2026.
OAS clawbacks should not drive the plan’s overarching strategy, though, nor should exceeding the income threshold be perceived as entirely negative, Mr. Diamond says.
“If you’re at a point at which some OAS is being clawed back because personal income is too high, it’s likely those lost pension dollars are not needed to sustain retirement.”