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How to withdraw funds tax-efficiently in retirement

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Physicians often have a variety of sources of income to draw on when they retire, such as a registered retirement savings plan (RRSP) or registered retirement income fund (RRIF), tax-free savings account (TFSA) and non-registered accounts as well as government pensions. If you have a medical professional corporation, you would have a corporate account too.

When close to retirement, or newly retired, you might wonder: Should you take your government pension earlier or later? What’s the most tax-efficient way to withdraw funds when you retire? Should you first deplete your RRSP or TFSA, and then withdraw from your corporate account and non-registered accounts?

Everyone’s goals, financial situation and family considerations are different. Retirement income strategies need to be carefully tailored with that in mind. The best order and best mix for withdrawing funds in retirement starts with your goals and circumstances.

For instance, if your main concern is having enough income through retirement, you might want to reduce risk and draw from your most aggressive investments first, leaving your most stable investments for last. If your priority is to grow your net worth, you might leave your TFSA for last. (See “What’s the best order for drawing your retirement income”)

In this article, we’ll look specifically at how to adjust for the impact of taxation. Here are the potential sources of income, the tax implications on withdrawal and strategies you could employ.

Sources of retirement income

Canada Pension Plan/Quebec Pension Plan

  • How it works: Typically, you would start receiving Canada Pension Plan (CPP) or Quebec Pension Plan (QPP) payments at age 65. However, you can take it as early as age 60 and get a reduced monthly amount; or delay it to age 70 and get a higher monthly amount.  
  • Tax implication: Payments from the CPP/QPP are fully taxable.
  • Strategy: According to a research paper published by the National Institute of Ageing, Canadians who are in reasonable health will get the most from their CPP or QPP by delaying their benefits. The CPP/QPP is the safest retirement income, it adjusts for inflation and it lasts for life.

Old Age Security

  • How it works: Old Age Security (OAS) is paid out monthly, starting at age 65. You can delay starting payments for up to 60 months after you are 65. The longer you delay, the larger your pension payment will be each month. But at age 70, there’s no more advantage in delaying.
  • Tax implication: OAS payments are fully taxable. There is an additional clawback of 15% of income over $79,845 (2021) until the full OAS is repaid.
  • Strategy: RRSPs that have grown very large and require high minimum RRIF withdrawals could work against preserving your OAS. Dividend income you earn from your corporation (especially with the gross-up) can also be a factor. Deferring your OAS payments can help by increasing the threshold where it is fully clawed back.

RRSP/RRIF

  • How it works: Throughout your life, you may have contributed to an RRSP and received a tax deduction. At the end of the year in which you turn 71, you must convert your RRSP to a RRIF or annuity or collapse your RRSP entirely. Most people convert to a RRIF and start withdrawing a mandatory minimum percentage based on their age.
  • Tax implication: All money that is withdrawn from your RRSP or RRIF is fully taxable. RRSPs generally work best when tax rates at withdrawal are lower compared to the tax rates at contribution.
  • Strategy: Deferring withdrawals as long as possible is popular for good reason. However, for large RRSPs, drawing earlier may be a better tax strategy. That’s because a large RRSP means large mandatory RRIF withdrawals, and you could end up paying more tax than if you drew on it over the years. Note that one way to keep your RRIF withdrawals low is to base the minimum withdrawal calculation on your spouse’s age, if they’re younger. Your MD Advisor* can help you decide how much to withdraw.

TFSA

  • How it works: You can put money in a TFSA at any age if you have the contribution room, currently $6,000 a year. Someone who has never contributed to a TFSA but has been eligible to contribute since its introduction in 2009 can contribute up to $75,500 in 2021.
  • Tax implication: All earnings and withdrawals from a TFSA are tax-free.1 TFSAs generally work best when tax rates at withdrawal are higher than when contributions are made.
  • Strategy: You might want to think of your legacy here. Physicians’ estates are often in a high tax bracket, so beneficiaries will pay a lot of tax on things like RRIFs, which are fully taxable. TFSAs, on the other hand, can be left to beneficiaries tax-free. So tax-wise, it would be best to continue to maximize your TFSA contributions into growth investments during retirement — even where doing so does not minimize current tax.

Non-registered account

  • How it works: Non-registered accounts, also called taxable accounts, are often used by those who have maxed out contributions to their RRSPs and TFSAs. It’s best to allocate your most tax-efficient investments to non-registered accounts.
  • Tax implication: All earnings are subject to tax at different rates, depending whether it’s interest, dividends or capital gains. Withdrawals of capital are not taxed, since it’s money you invested. Capital losses may be carried back three years or forward indefinitely.
  • Strategy: If there isn’t a better investment opportunity, leaving funds in your non-registered accounts for as long as possible and not realizing gains is likely the best tax strategy.

Corporate investment account

  • How it works: Funds in your corporate investment account can be invested in various assets, such as stocks, bonds and mutual funds. The earnings these assets generate is called “passive” income. 
  • Tax implication: Passive income is highly taxed. But when it’s passed to you as a shareholder, some of that tax is recoverable, and your personal taxes will often be reduced in recognition of tax paid by your corporation. Corporate assets and income must be distributed, usually as a dividend, in order to be spent. The appropriate type of dividend varies depending on circumstances including portfolio decisions and personal taxes. Generally, dividends result in more tax than withdrawals from your non-registered account but less tax than RRSP withdrawals.
  • Strategy: Smoothing tax consequences over time often works better in the long term than simply minimizing current tax. So before optimizing tax for your current year, use retirement and estate projections that factor in taxes to set your long-term strategy. 

What’s the best order for withdrawal?

Any guidelines on “withdrawal hierarchy” that you find on the Internet or through the media are likely geared to a general audience. So they’re probably simplistic and mostly focused on current tax savings.

That’s why it’s important to work with your MD Advisor: withdrawal decisions should be based on your particular goals and circumstances as well as your tax situation.

When considering tax impacts, remember to take the following into account:

  • Your expected income and tax bracket, particularly how it changes over time.
  • Any household tax opportunities such as pension splitting, spousal RRSPs, the pension income credit and income sprinkling.
  • Taxes payable at your death and how to minimize these for your heirs.

Remember, though, that the ultimate goal is to find the right balance so that you can enjoy your retirement. Your MD Advisor can run projections to see what’s best for your particular situation and determine the best strategies for you.

* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.

1 Withholding taxes by foreign governments may still apply. For example, the Internal Revenue Service levies a withholding tax on dividends from U.S. companies held by Canadian resident investors.

The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice nor is it intended to replace the advice of independent tax, accounting or legal professionals.