Years ago, I built a spreadsheet to calculate how much money I would need to retire. I would update it regularly. One of the biggest factors in knowing ‘when you have enough to retire’ is to look at your spending habits and determine how much you want to spend in your retirement years. For example, in today’s dollars, I have estimated that I might need about $33,000 annually to retire.
However, one factor in my spreadsheet that I just glossed over, was the average tax rate during retirement. During my working years, my average tax rate is about 23%. In the spreadsheet that I created years ago, I also blindly used the same 23% tax rate during retirement.
That meant that during my retirement years, I would need an income of $42,850 at 23% taxation in order to obtain the $33,000 in after tax dollars that I require.
But, I now realize that my average tax rate in retirement will probably look much different than it does during my working years.
Example 1: Retirement income
I pulled up the 2015 Taxtips.ca calculator for Ontario, and entered a breakdown in today’s dollars, an example of how I might receive my future retirement income.
RRSP withdrawal: $10,000
Cdn dividends: $5,000
Income/interest: $17,000 (this includes $13,000 from CPP/OAS)
Capital gains: $5,000
The calculator states that with 37,000, I would pay approx. $3,700 in taxes, leaving $33,300 for retirement income. This is an average tax rate of 10 %.
I now see that I don’t need nearly as much money as I originally thought I needed.
i.e. $42,850 @ 23% versus $37,000 @ 10%
Example 2: Early Retirement income
The news gets even better, if you are saving for early retirement. i.e. The years before you receive CPP (at age 65) and OAS (at age 67) from the government.
Here at Avrex Money, to reach “Financial Independence” as soon as possible, we are maximizing our RRSP/TFSA accounts and are pouring further savings into a non-registered account.
In order to bridge the time between early retirement and receiving CPP/OAS payouts from the government, I’ll need to withdraw money from my RRSP as well as selling dividend stocks from my non-registered account.
Once again, using the Taxtips calculator, I entered another scenario of how I might earn income in my early retirement years.
RRSP withdrawal: $15,000
Cdn dividends: $10,000
Capital gains: $5,000
The calculator states that I would pay approx. $2,000 in taxes, leaving $33,000 for retirement income. This is an average tax rate of 5.7 %.
In this early retirement example, I would only need $35,000 @ 5.7% tax (versus $42,850 @ 23% in the original calculation) to receive the $33,000 that I require for retirement income.
The Average Tax Rate in retirement can drastically affect the calculation of how much money you require in order to retire. In my examples above, I discovered that I only need to allow for 5.7% taxation in early retirement and 10% taxation during the normal retirement phase.