Do-it-yourself Tax Returns
I have seen too many seniors try to cheap out on tax advice. If the cost of a professional is too high, stop complaining about high tax – because you are not even exploring the possibility of savings.
Yesterday, Alex called from Nanaimo with great news, he’s finally retiring. He’s receiving a retiring allowance from his employer and wants some help in tax planning. A retiring allowance is money received on or after retirement in recognition of long service.
It can include payments for unused sick leave credits and/or severance packages and payouts. For tax planning, having funds designated as a retiring allowance regardless of your age qualifies for additional RRSP contribution amounts and does not affect your current contribution amounts. Companies can also offer the payout over two or more years so they don’t have to come up with the funds right away; then the employee can plan to take income over a few years to spread out any possible tax liability.
Alex began working with his company in 1983 and is about to receive $40,000 as termination pay, $2,500 for unused sick leave, and $1,500 for vacation pay. His retiring allowance is calculated as $42,500. He wants to know the best way to shelter the payout from a big tax hit. He was allowed to contribute to a RRSP in a combination of $2,000 per year before 1996 and an additional $1,500 per year of service before 1989. In Alex’s case he can transfer $35,000, tax-free, to a RRSP, plus any unused contribution room he has carried forward. His carry-forward was $9,000, so we were able to transfer the entire retiring allowance, tax-free, to his RRSP. If Alex wants to take it out one day after the transfer he can. He can now decide when to trigger the tax and how much.
Losing a job raises a lot of concerns, not to mention tax planning concerns. Will from Port Alberni came in the other day and asked me for some help on his company severance package.
First, we talked about negotiating to take his severance over two years to spread out the tax liability. Second, we made sure that he topped up his unused RRSP contributions. Severance income can often be offset with RRSP rollover based on eligible service. Using remaining severance payments to top up previously unused RRSP room can also be effective, especially over several years. Third, we discussed the possibility of withdrawing from RRSPs if necessary. When cash flow falls short of needs, withdraw RRSP accumulations in a lower-income year. Fourth, we took into account all the possible refundable tax credits to which he is entitled and offset income taxes payable with these amounts, even if that means projecting taxes forward a couple of years. This gives him a true net tax cost that relates to his cash flow timing.
It can sometimes be better to forego some tax credits available in the future in order to minimize taxes payable today. We also looked at making use of labor-sponsored tax credits. Since Will doesn’t mind higher-risk investments, he is interested in getting his tax bill down this year.
The final part of his planning came down to his pension plan. He had the option of transferring his pension plan to a locked-in RRSP or keeping it with his former employer. His is a strong, indexed pension; so this decision was relatively easy. It is difficult to beat an indexed pension plan, especially a strong one. We decided it was best to leave it with his employer. He’ll thank me in years to come, when his pension cheque increases each year. Will now has less tax worry when it comes to his severance.
There are costs and risks to a program of action, but they are far less than the long-range risks and costs of comfortable inaction. – John F. Kennedy
A wise man will make more opportunities than he finds. – Francis Bacon
Published with permission from Grant Hicks