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How to manage your retirement in the most tax-efficient way

When you reach your retirement years, there are tough decisions to make. For example, how are you going to spend your time?

If you're like 70-year-old Charlotte Chambers, from Florida, you'll play tackle football. That's right. Ms. Chambers, who is 5-foot-4 and 140 pounds, is a defensive back for the Orlando Starz of the Independent Women's Football League. She's one tough great-grandmother.

"You better hit me [first], because I'm laying you out," is her mantra. When interviewed, the Starz chief executive officer said: "Last year, I thought I should tell the other teams to go easy and not hit her too hard. But now I'm afraid she's going to hurt somebody."

So, football in retirement it is.

But there's another important decision to make: When drawing on your investments for income in retirement, should you withdraw from your registered retirement savings plan or your non-registered investments first?

Some cash

If you ask me, it makes sense to create a cash cushion of two to five years of living expenses. Set aside the money in safe, liquid investments like money market funds, treasury bills, term deposits, Canada Savings Bonds, or guaranteed investment certificates. This way, you'll know where to find the cash you're going to need for your living costs, which will better enable you to tolerate more volatility.

Make sure you've set aside this cash cushion before creating the rest of your portfolio in retirement. With each passing year, you should replenish your cash cushion. That's the time to consider whether you should be drawing down your RRSP or non-registered assets first.

Some guidelines

Consider the following guidelines when making your decision.

Defer tax as the general rule. If you're really unsure of what to do, deferring tax is almost always a good idea. This will generally mean that it makes sense to liquidate your non-registered investments first. How so? When you sell your non-registered investments, you're taxed on the capital gain -- the growth -- of the investments, not on the full value of the assets. By contrast, any amount you withdraw from your RRSP is fully taxable. By leaving the RRSP untouched, you'll pay less tax today.

Consider the size of your plan. There could be a downside to leaving your RRSP intact if your plan is significant in size. Why? Eventually you'll have to make withdrawals, and they'll be larger withdrawals if you leave your RRSP untouched.

For example, suppose you're age 60 and your RRSP is worth $800,000, and it grows at 8 per cent annually until age 69. Your plan will be worth $1,599,204 in the year you make your first mandatory withdrawal. That withdrawal will amount to $76,122 (creating a marginal tax rate of about 43 per cent). By comparison, if you withdrew an amount annually from age 60 to 69 equal to the lowest federal tax bracket ($36,378 in 2006), you'd have about $1.1-million in your plan in the year you make your first mandatory withdrawal. That withdrawal would be about $52,990 (creating a marginal tax rate of about 32 per cent). When you consider that the clawback of Old Age Security benefits starts at $62,144, there may be more value in keeping the size of your RRSP at bay.

Consider any tax preferences. If you're able to make withdrawals from your RRSP in a very tax-efficient manner because of tax preferences you might have available, such as non-capital losses, non-refundable tax credits, flow-through share deductions, interest deductions, or other items, then making RRSP withdrawals won't be so punishing and could make sense.

Tim Cestnick is a principal with WaterStreet Group Inc. and author of Winning the Tax Game among other titles.

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