Selling your dental practice and moving into retirement is often the biggest decision of your career. For many Ontario dentists, income will likely remain close to the highest tax rate level well into retirement. At high income levels, the goal is to reduce total income taxes paid over your lifetime, including likely a large tax bill at death. The following top 10 tax tips highlight key planning areas that can help to manage taxes after you retire.
Consider a typical scenario as follows:
| Dr. X, aged 64 | |
| Value of dental practice | $3,000,000 |
| Investments in Holdco | $750,000 |
| Excess cash in PC | $500,000 |
| RRSP value | $1,500,000 |
| TFSA value | $400,000 |
| Non-registered investments | $800,000 |
| Personal vacation property | $1,000,000 |
| Spouse | Mr. X, makes $80,000/year working as office manager |
| Children | 2 adult children in university |
Use Lifetime Capital Gains Exemption (LCGE) strategically
Proper planning can allow you to save significant taxes when you sell your PC shares. Early removal of excess cash/investments from PC is important to ensure you qualify for LCGE. Share structure planning (e.g., adding eligible family members as shareholders) can also be helpful. It is also possible to lock in the benefits of the LCGE even before your planned practice sale, through a strategy called estate freeze.
In our scenario, Dr. X has too much excess cash in PC, which prevents her from claiming the LCGE if she sells the practice today. To qualify for the LCGE, she needs to remove excess cash at least 2 years prior to sale through a complex tax reorganization. She can also consider adding her 2 adult children as equity shareholders during the reorganization. This may allow the 2 children to each claim LCGE if the practice continues to grow in value. This can result in major tax savings for the family overall as each individual who passes certain tax tests stand to save up to about $340,000 in regular income taxes by using their LCGE to shelter taxes related to the sale.
One should start planning at least three years prior to selling their dental practice if they wish to save taxes.
Time the sale of your practice
The year you sell your practice is often your highest tax year ever. In the year of sale, consider maximizing RRSP deductions and charitable donations, while avoiding extra personal income (such as corporate dividends and capital gains), if possible.
In our scenario, in the year of practice sale, Dr. X’s tax bill on the gain can be virtually nil by implementing the LCGE planning above. If she plans to make RRSP contributions and/or large charitable donations, she should do it in the year of sale, which should result in greatest tax savings.
Draw retirement income from multiple sources each year
Individuals staying in the top personal tax level (earning about $260,000 or more per year) after retirement often wonder which investment source (registered, non-registered, Holdco, etc.) to draw from first and which ones last. In general, a good idea is to draw from multiple sources at the same time, in a balanced way. This can help smooth taxable income year-over-year and avoid large income spikes caused by mandatory withdrawals or asset sales. Remember that even at top tax level, it is ideal to avoid triggering a very large tax bill at once, because of cash flow (i.e., paying $100k taxes next year is better than paying $100k taxes today).
For example, Dr. X’s annual income mix can include about $100,000 from RRSP/RRIF, $100,000 dividends from Holdco, and $60,000 from non-registered investments. This will give her a personal income just reaching the top tax level. This takes full advantage of lower tax rates (on income below top level). Taking further income beyond the top level offers no more tax savings but it is optional and can be considered if there is a need for cash.
Do not over-defer RRSPs and pension assets
For dentists who remain in the top tax level in retirement, full deferral is often not the best. In certain situations, earlier and controlled RRSP/RRIF withdrawals may reduce future mandatory withdrawals. This can reduce large taxes later in life or on death. To benefit from the $2,000 annual Pension Income Amount tax credit, consider converting some of your RRSP into a RRIF prior to age 71 when conversion is mandatory.
Given Dr. X’s RRSP value of $1.5M, she can end up in a better tax position if she withdraws $100,000 per year starting at 65. This will reduce future mandatory RRIF withdrawals, lowering taxes later and at death.
Use your holding company (Holdco) strategically
In many cases, Holdco assets are not meant to be fully drawn down early in retirement. Instead, they can be used strategically over time to provide personal income, fund larger expenses, or support estate planning goals.
Dividend planning can improve after-tax results in retirement and for your estate. Remember that passive investment income earned in a Holdco is taxed at a very high rate, until Holdco pays shareholders taxable dividends, which may trigger a dividend refund to Holdco.
In our scenario, suppose Dr. X’s Holdco earns $40,000 dividends a year. Holdco initially needs to pay high taxes on the dividend income, but the taxes are refunded when Holdco pays dividends to Dr. X. Therefore, it is a good idea for Dr. X’s personal income to include at least $40,000 dividends from Holdco. Receiving a higher dividend from Holdco may offer a higher refund, if applicable.
Give priority to capital gains and dividends over fully taxable income
In Ontario, capital gains and dividends are taxed at a lower rate than other investment income (e.g., interest income and all foreign investment income) in non-registered accounts. Consider building both corporate and personal investment portfolios around capital appreciation. This can potentially reduce future taxes. Ensure you obtain appropriate investment advice from an investment professional.
In our example, Dr. X has $800,000 in non-registered investments. If most of the income earned is capital gain/dividends (e.g., public company shares) rather than interest (e.g., bonds and GICs), the tax rate will be lower. Generally speaking, capital gains are taxed at the lowest personal tax rate, followed by dividends. Interest and rental income are taxed at the highest personal tax rate.
Income splitting with a lower-income spouse
Certain types of retirement income, including eligible pension income and RRIF withdrawals after age 65, may be split with a lower-income spouse for tax purposes. This can reduce your family’s total taxes. Where applicable, spousal RRSPs should also be considered.
In our case, Mr. X earns $80,000 a year. After Dr. X reaches age 65, she can split $50,000 of her RRIF withdrawals with him, lowering total taxes for the couple. If spousal RRSP is contributed to by Dr. X, she will receive upfront tax deduction (at top personal rate), while the same contribution is taxed at Mr. X’s lower tax rate when withdrawn in the future.
Use TFSAs strategically
TFSAs provide a source of tax-free cash flow, flexibility in later retirement, and estate planning benefits. Keep in mind TFSA withdrawals do not affect taxable income or government benefits, unlike RRSPs.
If Dr. X needs upfront cash for home renovation of $100,000, given her $400,000 in TFSA, she can withdraw funds from her TFSA. This allows the withdrawal to be tax free and will not impact her income planning. In a subsequent calendar year, Dr. X will have her TFSA room increased by the amount withdrawn, so she could consider using other personal funds to put back into her TFSA.
Manage OAS clawback
For individuals earning high income throughout retirement, full OAS clawback (i.e. you receive no benefits) often cannot be avoided. Taking OAS at age 65 may result in immediate and full clawback, providing little or no benefit at all. As a result, it may often be a good strategy to defer OAS to age 70, which could potentially result in increased future benefits.
However, for these high-income individuals, OAS should not be treated as a central planning goal — i.e., it may not be practical to lower your personal income on purpose, just so that you can receive some extra OAS benefits. Maximum regular OAS benefits are about $9,000 per year. On an after-tax basis, it may only mean pocketing about $4,500 even if there is no clawback.
To obtain OAS benefits, Dr. X would need to reduce her annual net income to a level below about $96,000. OAS benefits are NIL where an individual’s net income is more than about $155,000 per year. Between $96,000 and $155,000 per year, an individual still receives OAS but at a reduced rate. This would require, for example, deferring RRIF withdrawals and/or Holdco dividends. This is unrealistic and will likely result in a worse tax position. The small OAS benefits can hardly justify the tax cost to defer the withdrawals.
Combine estate, charitable, and insurance planning
For dentists with significant assets, retirement tax planning should extend beyond personal cash needs and should include estate planning. Without proper planning, much wealth may be lost to taxes on death. Charitable donations, when set up properly, can significantly reduce taxes while improving the overall impact of your giving.
Life insurance can also help in protecting wealth for family and funding tax payments at death. With proper planning, life insurance may help create cash flow, balance inheritances, and improve the efficiency of wealth transfer.
Suppose when Dr. X passes away, she wishes to give the $1M vacation property to Child 1 and the $800,000 non-registered investment to Child 2. If life insurance is available, the proceeds can help balance inheritances. That is, a further $200,000 can be given to Child 2 so each child’s inheritance is equal, at $1M. The funds from life insurance can also be used for other purposes, such as donations, paying taxes and estate related fees, or increasing inheritance.
About the authors
This article was prepared by David Chong Yen*, CPA, CA, CFP, Louise Wong*, CPA, CA, TEP, Basil Nicastri*, CPA, CA, Eugene Chu, CPA, CA and Jet Cao, MTax, MAcc, CPA of DCY Professional Corporation Chartered Professional Accountants who are tax specialists* and have been advising dentists for decades. Additional information can be obtained by phone (416) 510-8888, fax (416) 510-2699, or e-mail david@dcy.ca / louise@dcy.ca / basil@dcy.ca / eugene@dcy.ca / jet@dcy.ca . Visit our website at www.dcy.ca. This article is intended to present ideas and is not intended to replace professional advice.