I am planning to retire in the next two years and, having lived in Canada all my life, I expect to qualify for the maximum Old Age Security pension. However, I will have other sources of income such as a company pension and dividends. How can I minimize the amount of OAS that is “clawed back” by the government?
Canadians have a love-hate relationship with Old Age Security. They love receiving it, and they hate paying even a penny of it back to Ottawa.
For the vast majority of Canadians, the OAS clawback is a non-issue because their income in retirement isn’t high enough to trigger any OAS repayments. But for those in the “clawback zone," they will lose part – or possibly all – of their OAS.
For the 2020 tax year, the OAS clawback – formally known as the OAS pension recovery tax – kicks in when net income reaches $79,054. For every dollar of income above that threshold (which is indexed to inflation) the OAS benefit is reduced by 15 cents. An individual who is eligible for the current maximum OAS pension at the age of 65 of $613.53 a month, or $7,362.36 annually, would have his or her OAS clawed back entirely when net income reaches about $128,137.
Here are a few tips to minimize the OAS bite from Ottawa.
Split pension income with a spouse
If you have a registered pension plan, you may be able to split up to 50 per cent of the payments for tax purposes with a lower-income spouse. At 65, you can also split income from a registered retirement income fund. Pension splitting not only lowers a couple’s overall income tax bill, but can reduce the OAS clawback for the higher-income spouse. If you collect Canada Pension Plan benefits, you may also be able to share CPP payments with a spouse (CPP sharing has its own set of rules and is not the same as pension income splitting).
Consider deferring OAS
If you’re still working when you turn 65, starting OAS right away may not be the best strategy. That’s because your OAS will likely be taxed at a relatively high marginal rate and, if you’re in the clawback zone, you’ll have to cough up an additional 15 per cent. In such cases, it may be more advantageous to delay OAS until you stop working and have a lower income. For every month you wait after the age of 65, your monthly OAS payment will increase by 0.6 per cent, up to a maximum of 36 per cent if you wait until the age of 70. You should also consider your health before delaying OAS, because waiting is most advantageous for people with a long life expectancy.
Draw from your RRSP or RRIF before you collect OAS
If you expect to be in the clawback zone at 65 – the earliest age at which you can start OAS – consider withdrawing money from your registered retirement savings plan or registered retirement income fund before then. You must convert your RRSP to a RRIF or annuity by the end of the year in which you turn 71 and begin making minimum annual percentage withdrawals the following year. By withdrawing money early from your RRSP or RRIF – ideally during years when your income is low, as may be the case if you retire early – your mandatory minimum withdrawals after the age of 71 will be reduced, which in turn may lower your OAS clawback. This decision has to be balanced against the loss of tax-free growth inside the RRSP.
By the same token, if you are considering the sale of an asset such as a cottage or investment property, you may want to do so before you start collecting OAS. A large capital gain in one year could easily trigger a total clawback of your OAS.
Take advantage of TFSAs
Got unused room in your tax-free savings account? Use it. Money inside a TFSA grows tax-free and, unlike with an RRSP, TFSA withdrawals are not added to your income. So you can take out as much from your TFSA as you want without affecting your OAS payment. Another nice thing about TFSAs: When you make a withdrawal, your contribution room is restored on Jan. 1 of the following year.
Don’t dismiss dividends
You may have heard the argument that dividend stocks should be avoided by seniors who are in or near the OAS clawback zone. Don’t believe it. While it’s true that dividends are “grossed up” by 38 per cent, which inflates an individual’s income and may increase the OAS clawback, even taking that into account dividend stocks are still more tax-efficient than interest income owing to the dividend tax credit. You can see how the math works in a previous Investor Clinic column at tgam.ca/2Qxg3XE. Bottom line: Don’t let the OAS clawback stop you from investing in dividend stocks.
E-mail your questions to jheinzl@globeandmail.com.
John Heinzl