Understanding retirement options: employees postponing retirement can't afford to postpone retirement planning. Their employers should understand the tax and financial issues as well.

Ontario is the latest--and likely not the last--province to outlaw mandatory retirement at age 65. Manitoba, Quebec, Alberta and Prince Edward Island are already on board--as are Nunavut, the Yukon and the Northwest Territories.

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This just makes sense when you realize that there are currently about six workers for every retired person in Canada, and by 2020 there will be only three people working for every retired person. The workforce, and its pool of experienced workers, is shrinking, while the costs of maintaining retired workers rises. Governments obviously benefit when people work past the age of 65, but what about the "senior worker?"

Employees who choose to continue their employment beyond the traditional age of retirement face numerous tax and financial issues, as do the organizations employing them.

Health and pension

Workers older than age 65 are not eligible for many employer group health and dental plans. These senior employees will want to know whether they may continue coverage on a user-pay basis or whether they have to pursue coverage under an individual plan.

If your organization has a pension plan, many over-65 employees will want to determine whether they can participate in the plan. Some pensions allow employees to purchase plan services.

If continued membership is available for a defined benefit plan, employees will need to compare the benefit of deferring income to a year in which they aren't working and perhaps increase the benefit, with the impact on the total amount of pension income that would be received over time.

Registered Retirement Savings Plan (RRSP)

Under the RRSP rules, those who work up to the age of 69 can continue to make RRSP contributions. At the end of the calendar year in which an individual turns 69, he or she must collapse the RRSP. Most people then transfer RRSP funds to either a registered retirement income fund (RRIF) or to an annuity.

Generally, unless someone requires the funds, it's advantageous to defer withdrawals from the plan until the individual stops working. This defers tax and may even save tax if the withdrawal is made in a year when the individual's marginal tax rate is lower.

In most instances, it's also advantageous to defer converting an RRSP into a RRIF or an annuity until age 69; once this happens, a minimum amount must be withdrawn each year. The exception is for individuals who wouldn't otherwise be able to use the pension income credit (i.e. who won't receive benefits from a registered pension plan). In these cases, buying an annuity using RRSP funds (which will pay $1,000 per year) or transferring enough money to an RRIF to fund a $1,000 withdrawal from age 65 to 69 may make sense. Once the individual turns 65, $1,000 annually of RRIF withdrawals or RRSP annuity payments will qualify for the federal/provincial/territorial pension income credit ($1,147 in Alberta and $1,158 in Ontario, where the credit amount is indexed).

Although this income will not be tax-free for those who aren't in the lowest tax bracket, the effective tax rate on the withdrawal will still be low (basically the difference between the individual's marginal tax rate and the marginal rate for the lowest tax bracket for the relevant province). The pension credit can't be carried forward but must be used in a given year.

Canada Pension Plan (CPP)

Under the CPP rules, the amount of an individual's benefit will be based on how much and for how long he or she contributed to the CPP and/or the Quebec Pension Plan--with adjustments for contributed earnings.

CPP benefits usually begin at age 65, although in certain circumstances it is possible to collect CPP before age 65 or to defer benefits to age 70. An individual is required to make CPP contributions on pensionable earnings until the earlier of age 70 or when the person begins to receive a CPP retirement or disability pension (generally at age 65).

Those who intend to continue working past age 65 must decide whether to apply for regular benefits or to defer the pension to receive a higher amount later. For 2005, the maximum CPP benefit is $9,945 annually.

If an individual defers the pension 60 months (the maximum period allowed), the amount he or she would receive at age 70 would be 30% higher, or $12,929 (0.5% more for each month of deferral, ignoring indexing). The individual would receive more per month, but obviously would receive fewer payments over time. In fact, without factoring for indexing and the time value of money, someone would have to live to about age 86 before the amount of deferred benefits would exceed the amount he or she would have received by not deferring.

There are also a few additional factors to consider when it comes to deciding whether to apply for or to defer benefits.

* Deferring may reduce the tax paid on CPP benefits. For example, if an individual's marginal tax rate from age 65 to 70 is 40% and then 25% in retirement after age 70, this would reduce the break-even period by approximately three years. If deferring protects CPP income from OAS clawback (see next section) the break-even period would be reduced by another two years.

* If an individual could invest CPP benefits received at age 65 and earn more than 6% per year, it may make sense to take those benefits at age 65, even if the funds aren't needed, than to defer the payments.

* If receiving CPP benefits at age 65 would mean that more money could be left in deferred income plans, such as an RRSP, more income could accumulate in the plan on a tax-deferred basis.

* If an individual's spouse has little or no income and the couple can split income, this would encourage taking CPP income at age 65.

Old age security (OAS)

OAS is payable at age 65, and unlike CPP, the benefit payable is not based on the number of years worked nor the individual's income. There is also no option to defer OAS payments to receive a larger amount in the future.

When deciding whether or not to work to earn extra income, employees should keep in mind that the OAS clawback can increase an individual's effective tax rate. When net income, including OAS benefits, is over an indexed threshold ($62, 144 for 2006), a clawback of 15% of the excess is payable when the person files an income tax return.

The amount that is clawed back also reduces the OAS benefits subject to tax. Assuming that the total OAS benefit for 2006 will be approximately $5,820, an individual would lose all OAS benefits when net income exceeds approximately $100,140.

When someone earns between $62,806 and approximately $100,140 in 2006, income in excess of the threshold can greatly increase the individual's effective tax rate. For example, in Manitoba, the marginal tax rate on taxable income between $71,190 and $115,739 is 43.40%. Therefore, if an individual's taxable income is $71,190, and he or she earns an extra $1,000, this person will pay $434 more in tax.

For a senior, the marginal tax rate for this tax bracket jumps to 51.9% when factoring in the OAS clawback.

Employment insurance (EI) premiums

Employment insurance rules have no age limitation; therefore workers who are employed beyond age 65 continue to pay EI premiums. Neither are there any age restrictions related to qualification or benefits, therefore, just like his or her under-65 counterparts, a senior employee would also have to be fired to receive benefits.

Age credit

All provinces/territories provide an age credit for those age 65 or older on December 31. Working beyond age 65 could affect this credit. For federal purposes, the credit amount is $4,066 for 2006 (provincial/territorial amounts vary). This credit is phased out when a senior's income exceeds a certain threshold--$30,270 in 2006 for federal purposes. Provincial/territorial thresholds in 2006 range from $25,921 in Newfoundland and Labrador to $30,907 in Alberta. In all cases, the credit amount phase out is 15% of net income in excess of the federal/provincial/territorial threshold. Thus, for federal purposes, the credit is eliminated when net income exceeds $57,376.

According to Statistics Canada, the number of Canadians aged 65 and over is expected to double between 2000 and 2028--from about four million to almost eight million. While we often hear people talk about retiring sooner rather than later, more than 20% of workers aged 45 and up plan to retire after age 65 or not at all.

It seems like the senior employee will be a growing trend in many Canadian organizations. As more employees choose when they want to retire based on their own priorities and circumstances, employers have certain responsibilities to help these senior employees achieve the financial security they deserve--when, or if, they retire.

Stephen R Meek, BBA, FCA, ([e-mail]) is a partner of BDO Dunwoody LLP.