Understanding the difference between a tax deduction and a tax credit will enable you and your advisor to apply strategies and employ financial tools to help you reduce the tax you pay on your retirement income.
Tax deductions are subtracted from total income to arrive at the net and taxable income figures. Any deduction serves to lower the net or taxable income figure. This has a positive effect on your income tax calculation since it will reduce tax at the highest marginal rate.
As such, the value of a tax deduction increases as your income increases.
Tax credits operate differently. Once calculated, the basic federal tax is reduced by federal tax credits, which include the personal credit, age and pension credits, dividend tax credit, spousal credit and medical expense credit. The resulting number is the federal tax payable. A credit is actually more beneficial than a deduction at lower income levels because it is a dollar-for-dollar reduction in tax payable at the lowest marginal rate.
There are two important tax credits that apply directly to your retirement income planning and your blueprint, the pension credit and the age credit. In retirement, when you are drawing your income from assets and benefits, few tax deductions are available unless you also have employment or rental income.
So tax credits become an even more valuable commodity. To lose or waste them needlessly, at any point through the Income Continuum, is extremely inefficient.