Should you withdraw from non-registered investments or the TFSA in retirement?
Let’s say you are a high-income retiree with $10,000 of stock purchased for $5,000. If you sold the shares for a capital gain of $5,000, the tax payable could be $1,250 (assuming 25% taxes). If the alternative was a tax-free TFSA withdrawal, that might seem like the better option at first. However, withdrawing the equivalent of $8,750 from your TFSA, to return the same $8,750 after tax as selling $10,000 of non-registered stock, forfeits future tax savings in that TFSA.
Considering a Canadian stock paying a 2.5% dividend, the annual tax savings in a TFSA could be $87.50 (for the same high-income retiree, assuming 40% tax on Canadian dividends). Is it worth paying $1,250 in capital gains tax today to sell the non-registered shares to save $87.50 a year in tax on dividends in a TFSA?
Dividend tax savings are not everything, however. If we assume 4% capital growth for the stock, there may be an additional $87.50 of deferred capital gains tax saved per year. Is it worth paying $1,250 in taxes today to save $87.50 in taxes per year and $87.50 in deferred taxes per year?
It should be mentioned that $87.50 in dividend tax savings and $87.50 in deferred capital gains tax savings will accrue over time. And a tax dollar saved today is worth more than a dollar saved 10 years from now because of the time value of money. So the math is not as simple as calculating that after eight years there will be more tax savings by keeping the TFSA shares invested.
Some general rules to follow
There can be a break-even calculation based on a ton of different factors, Catherine, including:
- Your current and future tax rates
- Your investment risk tolerance
- Your age
- Your life expectancy
- Your spouse’s life expectancy
Generally, I would consider non-registered withdrawals over TFSA withdrawals in the following circumstances:
- You are in a high tax bracket.
- You may be in a higher tax bracket in the future.
- You or your investment advisor frequently sell and buy back shares.
- You have money in your non-registered account.
- You have modest capital gains in your non-registered account.
- You are relatively young.
- You have a relatively long life expectancy.
- You have a spouse with a relatively long life expectancy.
At the end of the day, Catherine, there are no perfect rules for decumulation in retirement, and you need to consider a whole host of factors. Using financial planning software, you can try modeling different scenarios to see the potential impact on after-tax retirement income and after-tax estate value.
In some cases, it may make sense to prioritize TFSA withdrawals over non-registered withdrawals, especially if you have large deferred capital gains on your non-registered investments. Deferring those capital gains at all costs could be a bad choice, however, especially if it means having positions concentrated in just a few stocks, which makes your portfolio less diversified. So touch your TFSA and defer your non-registered capital gains tax cautiously, if at all.