In the Canadian tax system, there is a long list of income-tested credits and benefits that disappear for taxpayers who earn higher incomes. Of all of those, the one that upsets people the most is the "social benefits repayment" of Old Age Security, commonly referred to as the OAS clawback.
OAS is a benefit paid to all Canadian residents age 65 or better, with a maximum benefit of $540 per month paid to anyone who has been resident in Canada for more than 20 years after age 18. The benefit decreases for shorter periods of residency.
If the net income of the recipient (as shown on line 236 of the income tax form) exceeds $69,562, then some of the OAS is clawed back. The clawback is at a rate of 15 cents for every dollar of income, until no OAS is received at all when net income reaches about $110,000.
Emotions aside, this presents a significant tax-planning challenge and opportunity, since it really means any extra income a senior generates between $70,000 and $110,000 is taxed at an effective rate as high as 58 per cent. Ordinary income is taxed at either 39.4 per cent or 43.4 per cent on taxable incomes in this range.
Our mission today is to help you avoid OAS clawback, even if you are much younger than 65 today.
The first concept to understand is which income and deductions appear "above the line" or "below the line." This "line" is, of course, line 236: Net income.
Above the line and included are all income figures, including pension, CPP, OAS, employment and self-employment, support payments from an ex-spouse, and disability income (even though it might not be taxable).
The more variable amounts -- with more planning opportunities -- include all forms of investment income, RRSP withdrawals, RRIF and annuity income. Any money withdrawn from RRSP adds to net income.
Recall that taxpayers are not required to convert RRSPs to RRIFs or annuity until the year in which they turn 71 years of age, and they can defer withdrawals until the following year. Seniors with large RRSPs may be able to avoid OAS clawback until age 72, but then the required 7.4 per annual RRIF withdrawal often pushes them over the threshold.
So, planning point No. 1 -- if you're in this situation -- is to avoid RRSP withdrawals between age 65 and 71. (The exception may be to convert enough RRSP to RRIF at 65 to generate $2,000 of pension income, eligible for the pension credit.)
Another strategy is to withdraw money from RRSPs aggressively prior to age 65, to avoid clawback at 72. However, the downside to this is that you pay tax on the RRSP withdrawal years before necessary. I only recommend this to people who can keep their incomes low prior to age 65.
If a withdrawal before 65 will be taxed at, say, 28 per cent or less, and a withdrawal after age 71 will be "taxed" at more than 50 per cent, then the math makes sense.
A current planning point for younger taxpayers is to maximize the opportunity to grow money tax-free in a TFSA. Future TFSA withdrawals are not taxable and not included in net income.
After 65, also be careful about incurring unnecessary capital gains, though capital gains are always better than interest income. Also note the "grossed-up" amount of dividends is included in net income. The actual tax rate is very low on eligible dividends, but the gross-up calculation means they have a disproportionately negative effect on the OAS clawback.
The available deductions above line 236 include RRSP contributions, interest paid on investment loans, deductible fees paid for investment management services, support payments paid, losses on rental properties or on a business, and the big one -- deduction for elected split-pension amount.
This is the transfer of up to 50 per cent of pension income from the higher-income spouse to lower. For people with very large pensions, this is usually the deduction that can keep them under the clawback threshold.
One sneaky feature about the clawback is that line 236 is not the line on which you pay tax. Several other deductions appear below this line -- like capital losses and capital gains deduction -- so they are tax-free, but still subject to the clawback. Ouch.
However, taking Monty Python's advice and looking on the bright side of life, being subject to the clawback usually means a healthy amount of income in retirement.
The glass can always be half full.
Dollars and Sense is meant as an introduction to this topic and should not in any way be construed as a replacement for personalized professional advice.
David Christianson is a fee-for-service financial planner with Wellington West Total Wealth Management Inc., a portfolio manager (restricted).