How Are Investments Taxed In Retirement?

Note: The winners of last week’s FIRE album giveaway will be announced at the end of this post.

I’ve been asked on numerous occasions how we deal with taxes in retirement. Spoiler alert, if your portfolio is structured properly, you should be able to get away with paying $0 (or pretty damn near close to $0) in taxes after you retire. But how much of that is aspirational, and how does it play out in reality?

So let’s break down how the MR portfolio is optimized to pay as little taxes as possible, and let’s use some real numbers behind it.

First I’ll walk you through how we manage our own personal portfolio as a Canadian, then next time we’ll do one for the Americans. Sound good? Great.

Our Portfolio

However, not all of this income is directly taxable. As part of my tax optimization, I put as much VTI and IEFA, which both pay foreign dividends, into my RRSP as possible, so these dividends are tax sheltered. Some of the Canadian funds are also held inside my TFSA, so those dividends are also not taxed.

So my directly taxable dividends are limited to the ones that were earned inside my taxable accounts, like so.

By the way, one of my favourite features of Passiv is the ability to visualize my dividends as they come in. It’s made planning our retirement income (and tax optimization) so much easier. No more building my own spreadsheets!

Anyhoo, these 7 funds pay dividends in 3 different ways. Canadian funds like ZPR and ZCN pay eligible dividends, foreign equity funds like VTI and IEFA pay foreign dividends, and the money market funds (CMR, SHV, DLR) pay interest. Grouping our taxable income by type looks like this. All figures are in CAD.

Income Type	Funds	Amount (CAD)
Eligible Dividends	ZPR, ZCN	$20,908
Foreign Dividends	VTI, IEFA	$11,754
Interest	CMR, SHV, DLR	$860

Let’s start with the Foreign Dividends and Interest. Both get treated as regular income, so when they get entered into our tax software, they get taxed at your marginal rate. However, in 2024, every Canadian taxpayer gets $15,705 of personal exemption each. And because there’s two of us, this personal exemption gets doubled to $31,410. So any income earned below this amount is essentially tax-free, even if it’s taxed as regular income.

So adding up our foreign dividends and interest, we get a total of $12,614. That fits well within our personal exemption, so our total tax payable so far should be $0.

Next, we add in our eligible dividends.

In Canada, eligible dividends are reported on your taxes by multiplying the amount you received by 1.38. This is known as “grossing up” the dividend. It seems kind of random, but don’t blame me, I don’t make up the rules.

Anyway, this “grossed up” dividend amount is then offset by a federal and provincial dividend tax credit. This tax credit works out to be about equal to the tax rate of the 1^st federal tax bracket. For 2024, the 1st tax bracket is from $0 to $55,867. That means that if you take the dividends you earned for the year, multiply it by 1.38, and add it to your other income, as long as that total is below $55,867 per person, or $111,734 per couple, then the dividends are effectively tax-free since the tax credit completely offsets any taxes owed.

In this example, we are reporting $20,908, which is $20,908 x 1.38 = $28,853.04. Here’s what that looks like.

As you can see, our regular income (Foreign Dividends + Interest) of $12,614 is below the personal exemption line, and our total income of $41,467.04 is below the tax-free dividend line. Therefore, so far, our tax bill should still be $0.

Cash Asset Swaps

That takes care of the income we’ve earned in our taxable accounts. But what about our retirement accounts?

TFSA’s are simple because money can be withdrawn at any time tax-free, so accessing this money is as simple as withdrawing it. No taxes are owed and no tax receipt is issued.

RRSPs are a bit more complicated, since any withdrawal is taxed as normal income. That’s why we came up with the Cash-Asset Swap strategy, which allows us to access the dividends in our tax-sheltered accounts at the far more advantageous capital gains tax rate rather than regular income.

For 2024, we had about $25k in dividends generated inside our RRSPs according to Passiv.

To do a cash-asset swap, you take the cash that’s accumulated in your tax-sheltered account and buy an ETF that you own outside your tax shelter with that money. At the same time, you sell the same ETF that you own in your taxable account. So in this case, I took some VTI that I owned in my taxable trading account and sold $25k worth. Simultaneously, I bought $25k in VTI inside the RRSP account where I had all my cash sitting.

After this is done, the cash that was sitting in my RRSP is now sitting in my taxable, yet my overall portfolio hasn’t changed (since you bought and sold the same number of ETF units).

The cool thing about this strategy is that just because you freed up $25,000 doesn’t mean you have to pay capital gains taxes on $25,000. You have to deduct the Adjusted Cost Basis, or ACB, to calculate how much those units went up in value. For us, those particular units of VTI had an ACB of $13,000. So, our actual capital gain was $25,000 – $13,000 = $12,000.

And because this is a capital gain, only half of that is taxed in Canada, which means we only report $6,000 of taxable income.

Here’s what our income graph now looks like.

Our Interest, Foreign Dividends, and now the taxable portion of our capital gains is still below our personal exemption line, and our total income including grossed-up eligible dividends is still below the tax-free dividend line, so it looks like we’re still good!

Additional Free Income

Now wait a minute, you might say. There’s still space inside our personal exemption that we’re not using! To be precise, of the $31,410 personal exemption, there is still $31,410 – $12,614 (foreign dividends + interest) – $6000 (capital gains) = $12,796 left. We don’t want to let that go to waste, since that’s tax-free income room.

There are two ways that we can use that up. One is to simply withdraw half of that amount ($6,398) from each of our RRSPs. That would use up the rest of our personal exemption, and let us withdraw money from both of our RRSPs for free.

Here’s what our tax return now looks like.

So now we’ve reported all our taxable income, performed a Cash-Asset swap to access the dividends that were earned inside our RRSPs, and done an RRSP withdrawal as well.

I plugged in all these numbers into the tax software we used, and here’s what it calculated.

Net federal tax owed is $0. But why is there still $300 owed to on our provincial taxes?

That’s actually the premiums the Canadian government collects for our government-funded health care plan. Everyone has to pay into the system, and in return we get our sweet-ass socialized health care, so this is effectively the lowest our taxes can get.

So that’s the first way to use your unused personal exemption towards an RRSP withdrawal. The other way to use it up is to harvest some additional capital gains. We actually chose to do that this year, so we deliberately realized more capital gains since we could do it for free.

To create an additional taxable income of $12,796 in capital gains, we would need to realize twice that, or $25,592 (again, since only half of the capital gains are taxed in Canada). Here’s what our tax return now looks like.

Once again, $0 in federal taxes, and the minimum $300 in provincial taxes for our government-funded health care plan, which is the lowest our taxes can effectively go.

Conclusion

This is a simplified example of our own personal tax return. Our actual tax return also includes all the stuff related to us having a kid, medical costs, and the passion project income we earn from our writing activities. Passion project income is treated as regular employment income, so we do pay additional taxes on that. However, those taxes are paid for by the passion project income itself and not by our investments. If our passion project income were to disappear, our tax bill would revert to the ultra-low version that we showed in this article.

So that’s how we manage the taxes on our FIRE portfolio. I was going to do one with the American tax system as well, but because this article is already pretty long, we’re going to split that out into its own article, so stay tuned for that!

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Announcement:

Here are the winners of our FIRE soundtrack giveaway from last week:

What motivates on your FIRE journey?

1) Crystal N: “A huge motivation for me to achieve FIRE is to not end up like my parents who currently live only on social security and food stamps. I make up the rest so they can have internet, electricity, garbage service, toilet paper, and cat food.
While I was still an unemployed college student I watched them nearly starve to death and see how poverty negatively affects health in so many ways.
Learning about FIRE has given me so many tools regarding personal finance. I used to wonder why all the money I made just seemed to vanish. People at work now approach me and ask me questions about our company”

2)  Bill B: “Really great post. I truly enjoy your content. Motivation was never difficult for me, but I can see this challenge in so many others. I will be FI and retiring in 2 weeks at age 53. I have found as I am approaching my final working days I am getting a little separation anxiety, specifically with my work connections and my income. Based on my lifestyle I don’t need the income and value my remaining years more, but I will mostly miss “the journey” as you described so well.”

3) Eileen C: “I love this post Kristy! I feel like I have the feeling of “the boring middle” every year since I discover FIRE in 2018. Every year, I read your “How we got here” series and that helps motivate me to one day feel that moment, I’m done/I quit FREEDOM feeling, where I can put in my resignation letter. Once that happens, I feel like I can finally take back my 40-50 hours a week and have time to focus on things I enjoy doing, like traveling, photography, and content creation. 🙂 Thank you for perking up our Mondays. “

Congrats to all the winners! You’ll be receiving an e-mail shortly with the link to download the entire track.

If you didn’t win, the good news is that the track is out now and you can order it on iTunes or BandCamp. Hopefully it’ll give you that extra bit of energy to push through the “boring middle” (which, incidentally, is also one of my favourite songs on the album).

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