Maximizing Government Benefits to help retire before 30.
All the information below is from Daren at TheRichMoose.com. I reposted his information on my blog (with permission), because it is so important to pass along the message that maximizing government benefits is extremely important in order to accelerate your financial freedom date. Just taking a few hours to implement the information below can save you 36 plus years of going to work. I say 36 years because I have used most of the strategies below in order to become financially independent at the age of 29 (age 65 traditional financial independence – 29= 36 years sooner)! The premise of FIRE is being intentional about your spending and educating yourself in how money and taxes work. This post takes advantage of the latter. I hope you enjoy, and make sure to check out Darens blog.
From Darens blog post:
“As a Canadian you are probably familiar with government benefits. You likely pay plenty of income tax—along with consumption taxes, fees, and other government revenue streams—while many of the lucrative benefits that your taxes fund seem out of reach.
With some careful planning and creative approaches to your personal financial management, you can structure your finances to take advantage of benefits you probably thought you could never qualify for. This is particularly true if you carefully manage your spending.
You could legally gain thousands of dollars a year in government benefits, offsetting taxes paid and helping you achieve a more secure financial future. Your savings will go farther and your investments will grow larger.
Contents of Government Benefits Guide
1. Reducing Your Expenses
2. Structuring Your Income for Benefits
3.Maximizing the Canada Child Benefit
4.Guaranteed Income Supplement Strategy
5.Old Age Security Clawbacks
6.Canada Pension Plan
Reducing Your Expenses
Many people think our tax system is designed to penalize high income earners. They are only partially correct. Earning a high income and being sloppy with your financial practices will lead to punitive tax rates with very little to show for it.
If you take a closer look, our tax system really is designed to punish people who spend a lot of money. If you earn a high income and you spend it all, you can very easily find yourself paying absolutely ridiculous amounts of money in tax.
For example, if you earn $300,000 a year in Nova Scotia you will pay $128,800 in federal and provincial income tax, $3,600 in CPP and EI, and $5,000 in property tax. That leaves you with $162,600 to spend. If you spend that money (buoying your local economy and employing many people in the process), you will pay a further $20,000 in sales tax and a few thousand in your share of corporate taxes which are embedded in the goods and services you buy. Add in high fees for federal, provincial, and municipal services, gas taxes, alcohol taxes, and a few more small revenue streams. You could easily find yourself paying a total tax bill approaching 60% of your total income!
You can drastically reduce your tax bill if you are reduce your spending. This is true even if you earn $300,000 a year and live in a high tax province like Nova Scotia.
Here are some tips to help you control your spending:
1Housing—In many cases it is better to rent than it is to buy a home after you factor in all your ownership costs. You can also reduce costs by living in a smaller home that is energy efficient and close to where you work and spend your free time. Renting a properly-sized house can effortlessly save you thousands of dollars a year.
2Transportation—Make efficient transportation choices by getting out of a personal vehicle and exercising a bit. Plan to bike or take public transit by being smart about where you choose to live and work. It is completely unnecessary to have two or more large vehicles and drive everywhere you go. Every kilometer you drive in a newer, large car costs you $0.60 or more in total ownership costs. If you need to own a vehicle, drive a basic model smaller car or SUV.
3Debt Costs—Have a plan to eliminate any debt that is not tax deductible. Every dollar of interest that you pay from your net income is a tax your bank has on your income. Many Canadians spend thousands of dollars a year on interest for personal loans, mortgage interest, credit card debt, and student loans.
4Clothing—The average Canadian family spends close to $4,000 per year on clothes. This can be drastically reduced by trimming down your closet to only the clothes you actually wear, purchasing gently used clothing, and wearing clothes until you wear them out.
5Food—Purchase good quality ingredients and learn to cook at home in your kitchen. The best way to reduce food costs is to limit eating out to once per week, shop on sales, and buy fresh individual ingredients. Avoid prepackaged, prepared, or delivered meals.
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Structuring Your Income for Benefits
Proper structuring of your personal income is not always an option. But if it is, you should take full advantage of it. Standard employment income is difficult to control and shelter from taxation. This may not have a large impact on lower income Canadians, but it certainly affects higher income earners.
Many higher income Canadians can become incorporated small businesses. As an incorporated individual, you would operate as an independent contractor rather than an employee. Being independent and incorporated can provide greater control in diversifying your income streams to become less dependent on a single employer, you can save paying EI taxes, you may deduct certain business expenses, and you can invest within your corporation.
While there are certainly many advantages to incorporation, the primary benefit of being an incorporated contractor is that you can have a lot of control over your personal income. You can match your personal salary or dividends directly to your spending level and hold surplus earned funds within your corporate structure. This money can be used to fund investment in active businesses, or can be invested passively in a corporate investment account as a type of corporate retirement portfolio.
Another benefit is the ability to split income with your family. Rules in this area have changed, so be careful to do this correctly! You can pay your spouse and children a fair wage for their labour. Common roles can include bookkeeping costs, marketing, and administrative tasks. Even if you shift a small amount of money to your spouse, you can significantly reduce your family tax bill and increase your eligibility for certain benefits.
Splitting income with your children by paying them a fair wage for work they do can be a great way to encourage healthy financial practices at a young age. For example, they can save a portion of the money they earn to fund their higher education, or even begin saving for financial independence at an extremely young age. Compound interest is powerful: a 20 year-old with $75,000 saved and invested can grow that to $1,000,000 by age 65 without adding another dime.
There is a difference between incorporating as a consultant, having a passive corporation, and controlling a corporation that owns an active business. If at all possible, you should try leverage your excess consulting income into buying or starting an active business. This will give you access to additional tax benefits such as the small business capital gains tax deduction.
There are many nuances to incorporation. It is well worth the money to hire an accountant and corporate lawyer to go over your options, discuss potential advantages or disadvantages for incorporation in your situation, and choosing a proper corporation structure and share setup. Paying a little money now for good advice can save you a substantial amount of money in the future.
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Maximizing the Canada Child Benefit
The Canada Child Benefit (CCB) provides tax-free payments to parents of children under the age of 18. To collect the CCB, you must file a tax return and be the primary caregiver who lives with a child.
The CCB is a non-taxable benefit that is based on a somewhat complex calculation, tilted to benefit lower income families. There may be additional top up payments based on your province, but these provincial benefits are generally calculated in a similar manner.
In order to maximize your child benefits, you should understand the key income numbers that matter for the calculation. All of the numbers shared below are based on your family net income for the prior tax year and is adjusted at the end of June for each year. Family net income is the net income earned together for couples, or individual income for single parents who are no longer living with a spouse or common-law partner.
Maximum Annual Benefit per Child
•Child aged 0 through 5: $6,639 (in 2019)
•Child aged 6 through 17: $5,602 (in 2019)
Family Net Income Clawback Rates
•For one child, reduction is 7% of income between $31,120 to $67,426, reduction is 10.2% of income over $67,426
•For two children, reduction is 13.5% of income between $31,120 to $67,426, reduction is 19.2% of income over $67,426
•For three children, reduction is 19% of income between $31,120 to $67,426, reduction is 27% of income over $67,426
•For four or more children, reduction is 23% of income between $31,120 to $67,426, reduction is 32.5% of income over $67,426
Clearly there are two main family income levels to be aware of. A family with a net income below $31,120 gets the maximum benefit in addition to eligibility for other benefits such as GST/HST credits and most provincial programs. Once family income exceeds $67,426 the benefits are reduced significantly. If you have children, these benefit clawbacks are a form of taxation in addition to your standard income tax. A family with four children earning more than $67,426 per year can be taxed at extremely high effective marginal tax rate (32.5% + federal income tax rate + provincial income tax rate).
The key with this calculation is understanding what forms your net income. The number Canada Revenue Agency uses is your Line 236 income on your tax return. To understand your Line 236 income, I have included a short guide that applies to most Canadians.
Add the following:
•Line 101—Employment income
•Line 104—Other employment income (tips, commissions, etc.)
•Line 119—EI and other federal benefits
•Line 120—Canadian dividends (grossed up amount!)
•Line 121—Interest income and foreign dividends
•Line 127—Net capital gains (only 50% included!)
•Line 128—Support payments received
•Line 129—RRSP withdrawals
•Line 130—Other Income
•Lines 135-143—Self-employment income
Deduct the following:
•Line 206—Pension adjustment
•Line 207—Pension/RRSP contributions
•Line 212—Annual union/professional dues
•Line 214—Child care expenses
•Line 219—Moving expenses
•Line 220—Support payments made
•Line 221—Carrying costs and interest expenses
•Line 222—Self-employment CPP contributions
The net result is your Line 236 income.
To maximize your CCB benefit payments, there are some simple tricks you can use.
1Make the maximum pension and RRSP contributions you are allowed to make. After adjusting for increased CCB payments and your tax refund, your RRSP contribution return can be well over 60%.
2Avoid high dividends in your non-registered account as this income is grossed up 38% for publicly traded Canadian stocks.
3If you need to collect investment income from your non-registered account, realize some capital gains instead as the calculation only includes 50% of the total gain.
4Obtain an investment loan so that you can reduce your income with carrying costs and interest expenses.
5Use a corporation and only pay yourself a small salary that is required to cover your expenses, after adjusting for child benefit payments you are eligible to receive. Do not pay yourself with dividends as these are grossed up 16%.
6If you have a corporation, consider paying yourself a very minimal salary and funding the rest of your spending by selling some non-registered investments or even using your TFSA account.
Do not underestimate the potential tax-free income you can receive from structuring your income for maximum benefit collection. For example, a family in Alberta with three young children who is in the lowest net income category could potentially receive CCB & provincial benefit payments of $25,000 per year. Add that to a tax-free income of $31,000 and they can spend $56,000 per year.
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Guaranteed Income Supplement Strategy
The Guaranteed Income Supplement (GIS) provides tax-free payments to low income seniors who are also collecting Old Age Security (OAS). To collect OAS and GIS, you must file a tax return and reside in Canada. You also need to meet certain residency requirements.
The GIS benefit is calculated based on your individual or combined (for couples) Line 236 income earned in the prior tax year. The calculation does not include OAS benefits. Since you can collect OAS and GIS starting the year you turn 65 and to maximize your benefits you can have no other taxable income starting in the year you turn 64, you need to plan ahead carefully to maximize this benefit.
Ideally, you want to structure your holdings so that you have no net income on Line 236 of your tax return (and your spouse’s tax return) other than OAS income. Every dollar in net income you earn results in a 50% clawback of your GIS benefit. Once your net income reaches $18,408 (in 2019) as a single person or $24,336 (in 2019) as a couple, you will no longer receive the GIS top up.
The combined benefit can be quite lucrative. A retired couple, both eligible to collect the full benefit, can receive $27,672 (in 2019) per year completely tax free. Approximately half of that amount is OAS and the other half is the GIS supplement.
If you collect on this strategy for five years, you can reduce your net portfolio withdrawals by approximately $70,000 (OAS portion not included). Instead of making large withdrawals, your portfolio can continue to grow for a few more years.
Further, by deferring CPP to age 70, you can collect an additional $5,700 per person every year for the rest of your life. At a 5% withdrawal rate assumption, that is equivalent to having an extra $230,000 in your portfolio as a couple.
It is only realistic for most people to execute this strategy for several years from the year they turn 65 to when they turn 70 and begin collecting CPP. In order to maximize your GIS benefits, you can take a number of preparatory actions in your personal finances.
•Make sure your TFSA is fully funded and has grown as large as possible. As they are not reported, TFSA withdrawals are your easiest form of income to pay for expenses that exceed your OAS and GIS benefit income.
•Avoid stocks or ETFs which pay large distributions in your non-registered account. Dividends you receive are grossed up 38% when counted on Line 236 income as the dividend tax credit does not adjust your tax owing until Line 425.
•To eliminate the need for realized capital gains on your non-registered investments while executing the strategy, purchase a new fund that does not pay any distributions for a few years before you turn 64. This ensures your cost base will be close to your selling price for the few years while you collect GIS.
•If you can, take advantage of low-tax capital gains harvesting in the years before you turn 64.
•Consider obtaining a HELOC on your house while you are still working. One way to fund your retirement expenses while you collect GIS is to borrow the money you need at a low rate from your HELOC.
•If you have investment income, take out an investment loan so you can deduct the interest costs against your investment income.
•Defer your CPP benefit to the month you turn 70 years old. This reduces a form of taxable income and will boost your CPP benefit by 42% from the baseline amount. The maximum annual CPP pension you could receive is $19,326 (in 2019) per person.
•Wait to convert your RRSP to a RRIF until you turn 70 and can no longer collect the GIS (since your CPP income will likely by higher than the maximum GIS income level).
•If you are in a pensionable career, consider retiring early so you can withdraw the pension and invest it in a LIRA and RRSP instead. Do not convert your LIRA to a LRIF until you turn 70.
•If you want to continue working, incorporate and keep all of your earnings within the corporation.
While not an option for everyone, creating a personal financial situation where you can collect the maximum GIS benefit for five years is very advantageous. The strategy has the same financial impact as having a portfolio that is hundreds of thousands of dollars larger. It will increase your safety, reduce your risk failure, and reduce your portfolio withdrawal rate.
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Old Age Security Clawbacks
The Old Age Security benefit (OAS) is a taxable benefit Canadian seniors can collect starting in the year they turn 65. Unlike the Guaranteed Income Supplement which is designed specifically for low income Canadian seniors, OAS is designed to be collected by all but the wealthiest Canadian seniors.
The OAS structure is quite simple. You collect the full benefit of $7,289 (in 2019) per person every year and this is adjusted annually for inflation. However, if your Line 234 income exceeds $75,910 (in 2019) as an individual, you will have to refund 15% of your excess income to repay OAS until your OAS benefit is reduced to zero.
As with the GIS benefit calculation above, be very aware of the implications of earning a large amount of Canadian dividend income from your non-registered account. Dividends are grossed up 38% before the Line 234 income. This means every $10,000 of dividends you receive will appear to be $13,800 when calculating your benefit.
If you have a large portfolio, there are a number of ways you can reduce your tax costs and ensure you still receive the full OAS benefit. Read my RRSP Guide for reducing taxes on RRSP withdrawals and Non-registered Investment Account Guide for tax tips on investments in these accounts.
If there is no way for you to keep your Line 234 income below $75,910 (in 2019) beginning in the year you turn 64, consider deferring your OAS benefit. Every year you defer your benefit, your OAS payments will increase by 7.2% up to a maximum of 36% after five years of deferral.
OAS is not an independently funded pension. It is funded from general federal revenues and, while perhaps unlikely for political reasons, there is a chance the program will be reduced or eliminated if government revenues come under pressure. Take as much of the benefit as you legally can while it’s here, but don’t count on it by reducing the amount of money you have saved. At current rates the OAS benefit is worth around $290,000 in an investment account for a couple. As long as you collect OAS, allow that extra money you have saved to grow.
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Canada Pension Plan (CPP)
The Canada Pension Plan (CPP) is a taxable Canadian federal pension program. There is an independently managed pension fund account, worth approximately $392 billion, that underpins the CPP benefit program. Every Canadian who has contributed to the CPP can take a benefit starting at age 60.
The amount of your CPP benefit is dependent on how many years you contributed to the plan, your salary in the years you contributed to the plan, and your age when you begin taking the benefit. There are also considerations for disabled people and survivors pensions.
CPP is structured so the standard benefit is taken when the recipient turns 65. You can take CPP early starting at age 60; however, every month you take CPP before your 65th birthday will reduce your monthly benefit by 0.6% for the rest of your life. On the other hand, if you defer your benefit after you turn 65, your CPP benefit will increase by 0.7% per month for the rest of your life. There is no benefit in deferring CPP beyond 70 years old.
The common wisdom is to take CPP as soon as possible, or to simply take the default benefit when you turn 65. It can be beneficial in many circumstances to take CPP early, or defer CPP as long as possible.
Here are a few situations where you should consider taking CPP benefits at age 60:
•If you are no longer working and have contributed to CPP for less than 39 years.
•If you are in poor health (reduced life expectancy) and are no longer working, but you are not eligible for CPP disability benefits.
•If you have substantial investment accounts and will take smaller withdrawals from these accounts, allowing your wealth to compound and grow.
•If you can benefit from a smaller fixed CPP payment, reducing your tax bill on withdrawals from RRSP accounts and other investment accounts.
There are also a few situations where you should consider deferring CPP benefits:
•If you can structure your affairs so that you will be eligible to collect GIS benefits.
•If you are still working, in good health, and your CPP benefits are likely to be taxed at a high rate.
•If you have a long life expectancy and a small investment account.
If you are in extremely poor health and under the age of 65, you could be eligible for disability benefits under the CPP program. Taking the disability benefit will provide you with monthly income before 65 and still keep eligibility for standard CPP payments for the rest of your life starting at age 65.
You can avoid contributing to CPP if you are self-employed with a corporation and pay yourself through dividend payments rather than a salary. This could be a tempting proposition for business owners who might be wary of the reliability of future CPP benefits or those who believe CPP does not provide a good return on investment. Be careful with this approach! CPP provides a moderate return for a safe annuity investment, it is currently very sustainable, and there are certain benefits such as disability payments that could be costly to insure with a third-party. Only very disciplined investors with ample financial cushion should consider avoiding CPP contributions.
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