Many Canadian taxpayers spend most of their lives working hard to accumulate sufficient savings to permit them to live a comfortable lifestyle during their retirement years. At age 65, when they can start benefitting from Canada's social programs, they often find themselves with an effective marginal tax rate of 50% on their taxable income. When combined with the Old Age Security (OAS) recovery tax, rates can reach 55%.
Old Age Security benefits
The OAS pension is a monthly payment paid by the Government of Canada. It is available to most Canadian residents 65 and older. (For individuals born after 1957, age of eligibility increases.) For the first quarter of 2015, the basic OAS pension is a monthly amount of $563.74, indexed quarterly. The total annual amount for 2014 was $6,676.59.
OAS clawback
For the 2015 taxation year, if a taxpayer receiving the OAS pension has income in excess of $72,809, they will be subject to the OAS recovery tax at a rate of 15% for every dollar of income in excess of $72,809. (At $117,909, the entire amount is clawed back.)
Consider the scenario of a taxpayer residing in Prince Edward Island with $100,000 of taxable income from pensions and investment income. If the taxpayer earns an additional $1,000 of investment income, the incremental tax and social benefits repayment amounts to $512.95, an effective tax rate of 51.3%.
Minimize the clawback
A number of options are available to help you minimize the OAS recovery tax:
- Voluntary deferral of your OAS pension – This option can be an interesting alternative if you expect your income to decrease in later years during retirement. Not only do you manage the clawback of your OAS pension, but your OAS pension amount increases by 0.6% for every month that you delay receiving it, up to a maximum of 36%.
- Choosing tax-efficient investments – Capital gains, interest and dividend income are taxed differently and have different impacts on the OAS clawback. Choosing investments that generate capital gains or return of capital will reduce the recovery tax. Corporate class mutual funds are an example of investments that can help manage the investment income generated on your personal tax return annually.
- Incorporate your non-registered investments – By transferring your non-registered investments to a corporation, the income generated on the investments will be taxed at the corporate level rather than on your personal tax return, thereby reducing your personal income. If you consider this option, we recommend a review of corporate tax planning strategies, including the recovery of the refundable dividend tax on hand.
- Consider early withdrawal of RRSPs – Once you convert your RRSPs into an RRIF, you will be required to draw out a minimum amount annually, thereby reducing your control over your personal income. Early withdrawal of your RRSPs prior to reaching 65 can reduce your eventual RRIF withdrawals during years in which you will be receiving your OAS pension.
- Income splitting – Consider income splitting with family members, either directly or indirectly through a family trust. A prescribed interest loan at the current rate of 1% can help achieve this result. The investment income earned would be taxed in your family members' hands, thereby reducing the recovery tax.
Careful and early planning can help you retain as much of your Old Age Security as possible during your retirement years. Contact your Collins Barrow advisor for more information.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
