Retiring on a Low Income: Three (Big) Challenges Canadians Face

Many Canadians will have modest incomes in retirement, but mainstream retirement planning advice often focuses on people with higher incomes. This advice can be unsuitable for people retiring with lower incomes, because following it can lead to paying more tax in retirement, receiving smaller benefits from government programs, or both.

Compared with other Canadians, low-income retirees face unique challenges, including:

• difficulties in getting good advice, and the risks of getting inappropriate—or no—advice,

• the outsized importance of tax planning and the need to start early, and

• the challenges inherent in retiring on a low income in a low-information environment.

What is retiring on a low income?

We can start with what is missing. Canada has no defined retirement age, no static single definition of retirement, and no formal category outlining “low income.”¹

Instead, we have public retirement income programs designed for Canadians with low taxable incomes, principally the Guaranteed Income Supplement (GIS), a component of the Old Age Security (OAS) program. These programs set their own eligibility criteria, meaning retirees are eligible for payments based on program-defined income and age thresholds, not whether their incomes fall within one or more of the “official” designations of low income used in Canada, or even whether they are working or not.²

Practically speaking, then, “retiring on a low income” in Canada can be understood as retiring with eligibility for GIS. For 2019, this means (for a single retiree) taxable income below $18,240 per year.³

Challenge 1: It’s hard to get good advice-and the risks of bad advice are high

Although Canada’s population is aging, with more and more waves of Canadians moving into the retirement stage of life, the mainstream financial services industry remains overwhelmingly focused on the accumulation side of the retirement income problem, providing advice geared towards those with surplus dollars to save.

What this means in practice is that someone anticipating retiring on a low income will be challenged to find appropriate advice that helps to maximize their GIS benefits in retirement. This issue has been noted over and over by organizations working with low-income Canadians. For example, a 2012 research report by the Canadian Centre for Financial Literacy found that “expertise from financial institutions and professionals may be inadequate, incomplete, or incorrect” when applied to low-income clients.⁴

In addition, sometimes advice for maximizing GIS is targeted towards retirees with low taxable incomes, but other available wealth in Tax-Free Savings Plan (TFSAs), Registered Retirement Savings Plan (RRSPs), or principal residences. Although these are “low-income retirees,” they are not “low-wealth retirees” as they have a fallback of other assets that can be tapped as required. Advice for “low-income, high-wealth” retirees will be different from advice for those who do not have private assets they can use to provide (non-taxable) income in retirement.

Challenge 2: The importance of tax planning and the need to start early

Many Canadians believe their tax rates will be higher before retirement, when they may be working, than when they are living on lower incomes from their retirement savings. This view is often accurate when discussing marginal tax rates, or the rate a taxpayer pays on the next dollar of income. At older ages, however, when income may be lower than during previous decades, a retiree’s marginal tax rate may go down—but their marginal effective tax rate may go up.

The concept of the “marginal effective tax” rate goes a step beyond the marginal tax rate by comparing the amount of tax paid on an additional dollar of income, taking into account not only income tax payable, but also the impact of tax deductions, credits and income-tested government benefits such as GIS.

In retirement, pension income from Canada Pension Plan (CPP) and Quebec Pension Plan (QPP), interest in non-registered investment accounts, and withdrawals from RRSPs and Registered Retirement Income Funds (RRIFs) are fully taxable. Withdrawals from TFSAs are not taxable, and refundable tax credits such as the Goods and Services Tax (GST) and Harmonized Sales Tax (HST) credits are not taxable. In addition, OAS benefits, social assistance benefits, and up to $3,500 of employment income per year are all not counted when GIS benefits are calculated.

For lower-income retirees, whose income may include a high proportion of income-tested government benefits, marginal effective tax rates on taxable income are usually higher than those they face during the years before retirement. This is caused mainly by the GIS clawback rate, which can be as high as 50 or 75 percent or even higher, depending on whether a retiree is single or has a spouse or common-law partner.⁵

In order to avoid benefit reductions and clawbacks, low-income retirees should aim to ensure their income needs can be met, as much as possible, from income sources that do not reduce their GIS benefits. Meeting this goal usually requires deliberate and informed planning and actions before age 60, and during the years between age 60 (when eligibility for the Canada and Quebec pension plans begins) and age 72 (when an RRSP must be annuitized, producing monthly taxable income, or converted to a RRIF with mandatory taxable withdrawals).

In particular, because withdrawals from an RRSP are included in taxable income, if a future retiree expects to be eligible for the GIS after age 65, it is likely that the optimal retirement savings account is the TFSA and not the RRSP. Making this choice, however, requires that the future retiree—or the person advising them—understands the impact of the RRSP-versus-TFSA choice both now (when contributions are made) and later (when withdrawals are made), and is not swayed by the perceived benefit of the “tax refund” associated with an RRSP contribution.⁶ It also means that eking out another percentage point of investment return is much less important than allocating savings appropriately between various types of accounts available to provide income in retirement.

(Note that once age 65 has been reached, however, RRSP contributions might become the most appropriate account for surplus dollars for the low-income retiree, in what policy advocate John Stapleton calls the “parallel universe” for low-income seniors.⁷)

Challenge 3: Low income + low information = complexity multiplier

Nobel laureate Bill Sharpe has called retirement income planning “the hardest, nastiest problem in personal finance.” Retiring on a low income adds another layer of complexity and challenge. For the retiree with little or no private savings, who has nowhere to go for good advice, or receives bad advice and has no additional assets they can use to avoid or soften the blow of GIS clawbacks, a misunderstanding of the rules and their consequences can make an already-difficult situation harsher.

If you, or someone you know, is expecting to retire on a low income, you can help them best meet their financial goals for and in retirement when you understand how many different elements—public and private retirement income accounts and programs, and the taxation of different kinds of income in Canada—interact to impact cash flow in retirement. That, in turn, can help make a hard and nasty problem easier and kinder.

Alexandra Macqueen, CFP has been working with Innovation Fellow at the Metcalf Foundation and social policy expert John Stapleton of Open Policy Ontario (www.openpolicyontario.com) to create a course for those working in financial institutions on the challenges of retiring on a low income. Contact her at info@pensionacuity.com.